Monday March 11 2013 Top 10 Risk Compliance News Events

7/28/2019 Monday March 11 2013 Top 10 Risk Compliance News Events

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_____________________________________________________________International Association of Risk and Compliance Professionals (IARCP)

www.risk-compliance-association.com

International Association of Risk and ComplianceProfessionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750www.risk-compliance-association.com

Top 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped the

week's agenda, and what is next

Dear Member,

Wholeads the world in its implementation of

Basel III?

According to Wayne Byres, Secretary General, Basel Committee onBanking Supervision, Asia!

I would also like to acknowledge that the Asian region leads the world inits implementation of Basel III.

But he continues:

Goldilocks explored the bears house,testing the porridge, the chairs and thebeds until she found things that shethought were just right

What? Goldilocks explored the bearshouse? Oh, no, Goldilocks is notcovered in our Basel iii course. It couldbe important.

Bears house? He means Russia? No,no, it has nothing to do with the cold war.

Lets learn more Google Search Goldilocks:
http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/


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In 1837 Robert Southey published "The Story of the Three Bears".

In Southey's tale, three anthropomorphic bears"a Little, Small, WeeBear, a Middle-sized Bear, and a Great, Huge Bear"live together in ahouse in the woods.

Southey describes them as very good-natured, trusting, harmless, tidy,and hospitable.

Each bear has his own porridge bowl, chair, and bed.

One day they take a walk in the woods while their porridge cools.

An old woman(who is described at various points in the story as

impudent, bad, foul-mouthed, ugly, dirty and a vagrant deserving of astint in the House of Correction) discovers the bears' dwelling.

She looks through a window, peeps through the keyhole, and lifts thelatch.

Assured that no one is home, she walks in.

The old woman eats the Wee Bear's porridge, then settles into his chairand breaks it.

Prowling about, she finds the bears' beds and falls asleep in Wee Bear'sbed.

The climax of the tale is reached when the bears return.

Wee Bear finds the old woman in his bed and cries, "Somebody has beenlying in my bed,and here she is!"

The old woman starts up, jumps from the window, and runs away never to

be seen again.


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Twelve years after the publication of Southey's tale, Joseph Cundalltransformed the antagonist from an ugly old woman to a pretty little girlin his Treasury of Pleasure Books for Young Children.

The little girl saw a succession of names, including Goldilocks.

Here is where Basel iii comes in, when the old ugly lady (Basel 2)becomes a pretty girl (Basel 3)Disclaimer: This is how I understoodit

But yes, Wayne Byres, Secretary General of the Basel Committee onBanking Supervision said:

Goldilocks explored the bears house, testing the porridge, the chairs

and the beds until she found things that she thought were just right.

It is encoded!!! Pillar 2, confidential. Lets break it.

Goldilocks (Basel 3)explored the bears house (Bear Stearns and otherbanks), testing theporridge(internal models, the butter and porridge onthe bread of consultants), the chairs(fit and proper for the board andsenior management)and the beds(bonuses)until (it will take until 2019to test everything)she found things that she thought (in Basel we haverealisticassumptions, not facts)were just right(final Basel iii

implementation, ready for Basel iv)

You can learn more (about the speech, not Goldilocks, at Number 3 of ourlist below

Welcome to the Top 10 list.


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The UK PrudentialRegulation Authority (PRA)

On 1 April 2013 the Prudential Regulation Authority (PRA) will becomeresponsible for the prudential regulation and supervision of banks,building societies, credit unions, insurers and major investment firms.

In total the PRA will regulate around 1,700 financial firms.

The PRAs role is defined in terms of two statutory objectives topromotethe safety and soundness of these firms and, specifically for insurers, tocontribute to the securing of an appropriate degree of protection for

policyholders.

Semiannual Monetary Policy Report to theCongressSpeech by Mr Ben S Bernanke, Chairman of the Boardof Governors of the Federal Reserve System, beforethe Committee on Banking, Housing, and Urban

Affairs, US Senate, Washington DC

Wayne Byres, Secretary GeneralBasel Committee on BankingSupervision

SIMPLICITY, RISK SENSITIVITY AND COMPARABILITY:THE REGULATORY BALANCING ACT

BCBS-EMEAP-FSI High-Level Meeting, Seoul, Korea


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Protecting Investors through ReliableAudits

Jeanette M. Franzel, Board MemberWayne State University, George R. Husband Distinguished LectureSeries, Detroit, MI

The creation of the PCAOB ended more than 100 years of self-regulationby the public accounting profession in the U.S., and established theBoard's regulatory framework for firms that conduct audits of companies

whose securities trade on the U.S. markets.

Council of the European UnionBasel III in EuropeCRD4

Irish Presidency reaches breakthrough on newrules for stronger EU banks

The Irish Presidency has reached a breakthrough in

talks with the European Parliament on an overhaul of banking rulesincreasing EU financial stability.

Update on Measures to AddressUnrecorded Financial Flows

Bank Negara Malaysia would like to provide an update on measures thathave been undertaken by members of a High Level Multi-Agency Special

Task Force (Task Force) to reduce illicit financial flows.


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PCAOB Issues Report on 2007-2010

Inspections of Domestic Firms that Audit100 or Fewer Public CompaniesWashington, D.C.

The Public Company Accounting Oversight Board today released areport summarizing inspection observations identified in the 2007through 2010 inspections of U.S. firms that audited 100 or fewer publiccompanies.

Remarks by Thomas J. Curry

Comptroller of the CurrencyBefore the National Association of Attorneys General

Washington, DC

NIST Solicits Views, Ideas fromStakeholders for CybersecurityFramework for Critical Infrastructure

The National Institute of Standards and Technology (NIST) issued aRequest for Information (RFI) in the Federal Register as its first step inthe process to develop a Cybersecurity Framework, a set ofvoluntary

standards and best practices to guide industry in reducing cyber risks tothe networks and computers that support critical infrastructure vital to thenation's economy, security and daily life.


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CRD IVFSA refreshed statement regarding CRD IV

implementation

The original proposed deadline for entry into force of the draft EuropeanUnion legislation to update the framework for capital requirements,known as CRD IV,has now passed.

Negotiations between the European Parliament, European Commissionand Council of Ministers to finalise the legislation are still underway.


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The UK Prudential Regulation Authority (PRA)

On 1 April 2013 the Prudential Regulation Authority (PRA) will becomeresponsible for the prudential regulation and supervision of banks,building societies, credit unions, insurers and major investment firms.

In total the PRA will regulate around 1,700 financial firms.

The PRAs role is defined in terms of two statutory objectives topromotethe safety and soundness of these firms and, specifically for insurers, tocontribute to the securing of an appropriate degree of protection for

policyholders.

In promoting safety and soundness, the PRA will focus primarily on theharm that firms can cause to the stability of the UK financial system.

A stable financial system is one in which firms continue to provide criticalfinancial servicesa precondition for a healthy and successful economy.

The PRA will make forward-looking judgements on the risks posed byfirms to its statutory objectives.

Those institutions and issues which pose the greatest risk to the stabilityof the financial system will be the focus of its work.

The PRA was created by the Financial Services Act (2012) and will be partof the Bank of England.


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It will have close working relationships with other parts of the Bank,including the Financial Policy Committee and the Special ResolutionUnit.

The PRA will workalongside the Financial Conduct Authority (FCA)creating a twin peaks regulatory structure in the UK.

The FCA will be a separate institution and not part of the Bank ofEngland.

The FCA will be responsible for promoting effective competition,ensuring that relevant markets function well, and for the conductregulation of all financial services firms.

This includes acting toprevent market abuse and ensuring thatconsumers get a fair deal from financial firms.

The FCAwill operate the prudential regulation of those financial servicesfirms not supervised by the PRA, such as asset managers andindependent financial advisers.

Prior to 1 April 2013, the Financial Services Authority (FSA) will continueto be responsible for prudential and conduct regulation in the UK.

The Bank of England will have a responsibility for financial stability,based on an amended statutory objective to protect and enhance thestability of the financial system of the United Kingdom.

And, in support of this objective, the Financial Policy Committee (FPC)will be established within the Bank, charged with identifying, monitoringand taking action to remove or reduce systemic risks.

The FPC, which already exists in interim form, will be able to makerecommendations and give directions to the PRA and the FCA on specific

actions that should be taken in order to achieve the FPCs objectives.


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Sourse: Andrew Bailey, Executive Director of the Bank of England andManaging Director of the Financial ServicesAuthoritys PrudentialBusiness Unit, and Sarah Breeden and Gregory Stevens of the BanksPRA Transition Unit


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The letter

Dear

Latest update as we transition to the Prudential RegulationAuthority (PRA)

This letter gives you more information onwhat you need to do to be readyfor legal cutover (LCO) on 1 April 2013.

The PRAs approach to supervision was outlined in the two approachdocumentsone for insurers and one for deposit-takers and investmentfirms.

We willpublish revised versions of these documents at LCO, andthereafter the documents will act as standing references for firms on thePRAs supervisory approach, key PRA policies, and how we intend tomeet our statutory objectives.

Below is an overview of the key messages from the approach documents:

- The PRA will have two statutory objectives to promote the safety andsoundness of firms and specific to insurers, to contribute to securingan appropriate degree of protection for policyholders.

A stable financial system, that is resilient in providing the criticalfinancial services the economy needs, is a necessary condition for ahealthy and successful economy.

- The PRA will not operate a zero-failure regime.The PRA will, however, seek as far as possible with resolutionarrangements in place, to ensure that any firms that fail do so in a way

that avoids significant disruption to the supply of critical financialservices, including an acceptable degree of continuity of cover forpolicyholders; and


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- The PRAs approach to supervision will be clearly based onjudgement rather than narrowly rules-based, Supervisory judgements

will be forward-looking, taking into account a wide range of possiblerisks to the PRAs objectives.

The approach documents can be accessed via the FSA website:

Bankinghttp://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdf

Insurancehttp://www.fsa.gov.uk/static/pubs/other/pra-approach-insurance.pdf

In December 2012, I gave a short interview entitled A new approach tofinancial supervision: the Prudential Regulation Authority which can be

viewed here:http://www.youtube.com/watch?v=yJDp1XY3DJM

The following is an update on certain aspects of the transition where wecan now provide greater clarity.

1. Changes in policyIndividual Guidance

The PRA will have a different regulatory and supervisory focus than theFSA, including a new set of objectives and a different approach tosupervision, as set out in the approach documents.

This means that guidance previously issued to firms by FSA supervisorsto individual firms will not have been issued with PRA aims andobjectives in mind.

Therefore, apart from the four categories listed below, FSA individualguidance will not automatically be permanently transitioned or confirmedby the PRA.

Guidance to be transitioned
http://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdfhttp://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdfhttp://www.fsa.gov.uk/static/pubs/other/pra-approach-insurance.pdfhttp://www.fsa.gov.uk/static/pubs/other/pra-approach-insurance.pdfhttp://www.youtube.com/watch?v=yJDp1XY3DJMhttp://www.youtube.com/watch?v=yJDp1XY3DJMhttp://www.youtube.com/watch?v=yJDp1XY3DJMhttp://www.fsa.gov.uk/static/pubs/other/pra-approach-insurance.pdfhttp://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdf


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The following four categoriesof individual guidance will beautomatically transitioned at LCO:

1. Individual Capital Requirements Guidance, including capital planningbuffers for banks and capital guidance issued to insurers

2. Individual Liquidity Guidance

3. Individual guidance given by the FSAthat enables a firm to move froma higher proportionality tier to a lower proportionality tier as provided forin the FSAs General Guidance on Proportionality: The RemunerationCode (SYSC 19a) & Pillar 3 disclosures on remuneration (BIPRU 11)

4. Guidance on the completion and submission of Regulatory Returns

Other Guidance

Firms should review all individual guidance and their associatedbehaviour in accordance with such guidance and assess theappropriateness of that behaviour in line with the PRAs statutoryobjectives.

Firms should in many cases be able to do this by exercising judgementand without consulting the PRA.

Firms should document this review.

In certain cases, firms may wish to request that the PRA (FSA until LCO)review items of FSA individual guidance which are:

1. Not included in the categories identified above; and

2. Where the firm wishes the PRA to explicitly consider and confirmwhether behaviour or actions in line with that guidance will remainappropriate in the PRA.

This is not an opportunity to request that all previously issued individualguidance should be retained.


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Between now and 30 September 2013, firms may submit a list of thoseitems of individual guidance which they wish the PRA to review, together

with their own assessment of whether the behaviour or actions set out inthe guidancewould contribute towards the advancement of the PRAsobjectives.

Relationship managed firms should submit requests for review to theirsupervisor, and non-relationship managed firms should submit them tothe Customer Contact Centre at email address [email protected] until 2

April 2013 and the PRA firm enquiries at email [email protected] from 2 April 2013 onwards.

Firms will be able to continue to rely on guidance referred for review untilthe PRA reaches a decision on whether the guidance remains appropriate

or otherwise.

Supervisors will confirm the timetable for the review following thesubmission of the firms list; reviews will be completed no more than 18months after LCO.

Our judgement and any resulting response that we give to a firm willfocus on the advancement of the PRAs objectives.

Any guidance that is not referred to the PRA for review will cease to have

any status as formal PRA individual guidance from 30 September 2013.

This does not mean that firms should automatically change theirbehaviour.

If firms deem that their behaviour is appropriate, they should continue toact in that way.

If firms decide to alter their behaviour, now or in the future, they shoulddiscuss this with their supervisor, in line with Principle 11.

This approach to individual guidance does not change recentassessments of the risks that we see as being posed by a firms business.


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In particular, we still expect Risk Mitigation Plan points (reflecting theFSAs objectives) outlined in previous ARROW letters to be concluded,

where we judge that they will contribute to advancing the PRAsobjective.

Existing waivers will also be automatically transitioned to the PRA.

Threshold Conditions

The existing FSA Threshold Conditions will be replaced in their entiretyby the Threshold Conditions being introduced by HMT via secondarylegislation pursuant to the Financial Services Act 2012.

The Threshold Conditions in the order that has been laid before

parliament are essentially in the form HMT consulted on in October 2012.

The new conditions will take effect at the same time as the rest of theamendments to FSMA are introduced, on 1 April 2013, for both existingauthorised firms and all in-flight cases.

The Financial Services and Markets Act (Threshold Conditions) Order2013, as laid before parliament, can be viewed at:http://www.legislation.gov.uk/ukdsi/2013/9780111533802/pdfs/ukdsi_9780111533802_en.pdf

2. Interaction with the PRA

PRA web presence

A new web page for the PRA is now available on the Bank of Englandwebsite atwww.bankofengland.co.uk/pra

This will be the web address that firms should use from LCO.

At this stage firms can find a brief introduction to the PRA on the website.
http://www.legislation.gov.uk/ukdsi/2013/9780111533802/pdfs/ukdsi_9780111533802_en.pdfhttp://www.legislation.gov.uk/ukdsi/2013/9780111533802/pdfs/ukdsi_9780111533802_en.pdfhttp://www.legislation.gov.uk/ukdsi/2013/9780111533802/pdfs/ukdsi_9780111533802_en.pdfhttp://www.bankofengland.co.uk/prahttp://www.bankofengland.co.uk/prahttp://www.bankofengland.co.uk/prahttp://www.bankofengland.co.uk/prahttp://www.legislation.gov.uk/ukdsi/2013/9780111533802/pdfs/ukdsi_9780111533802_en.pdfhttp://www.legislation.gov.uk/ukdsi/2013/9780111533802/pdfs/ukdsi_9780111533802_en.pdf


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Corporate information About the PRA will be added andpages onpolicy and PRA news and events will be published.

The core operational information on authorisations and supervision will

be published at LCO.

Firms are welcome to send feedback including comments and ideasabout the PRA web presence to [email protected].

Firm Enquiries

The October 2012 approach documents explained that firms who do nothave a dedicated supervision team should use the Firm Enquires

Function as their first point of contact with the PRA.

The PRA Firm Enquiries will be operational from 2 April 2013 and itscontact details are:

Telephone number 020 3461 7000 (operating hours 9:0017:00)Email [email protected]

The FSA contact centre must be used for all enquiries up to 2 April 2013.

However, during March some calls to the contact centre will betransferred to the PRAs Firm Enquiries, in preparation for taking firmsenquiries at LCO.
mailto:[email protected]:[email protected]


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3. Publication of the PRA Handbook

As previously stated, at LCO, certain provisions from the FSA Handbookwill be split between the FCA and the PRA.

Two new Handbooks will be created: one for the PRA and one for theFCA.

Most provisions in the FSA Handbook will be incorporated into thePRAs Handbook, the FCAs Handbook, or both, in line with each newregulators set of responsibilities.

The intention is to publish the PRA Handbook in March 2013.

After LCO, the PRA will amend its own suite of policy material as anindependent body in accordance with the processes laid down in theFinancial Services Act 2012, including cooperation with the FCA andexternal consultation.

4. Enforcement Consultation

We published the consultation on the PRA's approach to enforcement,including proposed statutory statements of policy and procedure, on 20December 2012.

The consultation is on the FSA website, we welcome any comments onthe proposals by 28 February 2013.

http://www.fsa.gov.uk/library/policy/cp/2012/12-39.shtmlAttached is a set of updated FAQs and additional information.

Yours sincerely


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FAQs on transition to the PRA

1. General questions

At what stage is the Financial Services Bill?

The Financial Services Bill received Royal Assent on 19 December 2012and became the Financial Services Act 2012 (The Act).

Some sections of The Actcame into force on 23 January 2013, in order toenable the Treasury to make secondary legislation, and to ensure that thenew regulators can prepare for their respective roles post legal cutover.

The rest of the provisions relating to the new regulatory regime will come

into force on 1 April, the date designated for legal cutover to the newstructure.

The Act will be supported by secondary legislation and Treasury hasconsulted on a number of draft orders which will need to be made prior tolegal cutover.

The orders detailing the new Threshold Conditions, allocatingresponsibility for making rules in relation to FSCS between the FCA andthe PRA, amending certain mutuals legislation, determining which types

of holding company the regulators new powers over qualifying parentundertakings apply to and specifying which regulated activities will besubject to the PRAs regulation have already been laid before Parliamentand are expected to be approved by both houses by mid-March.

http://www.legislation.gov.uk/ukdsi/2013/9780111533802/pdfs/ukdsi_9780111533802_en.pdf

How will the PRA determine which investment firms should bedesignated for prudential regulation by the PRA?

We published a draft statement of policy on the designation of investmentfirms by the PRA in October 2012:http://www.fsa.gov.uk/static/pubs/cp/boe-pra-cp.pdf


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The policy statement and the firms to be designated by the PRA will befinalised ahead of legal cutover.

Should I continue to submit my return through GABRIEL?

The PRA will have its own data collection and quality assurance teamthe Regulatory Data Group - which will take over the PRA regulatory datarelated work previously undertaken by the FSAs Data Monitoring Team(the FSAs central data collection team).

For firms who report regulatory data via GABRIEL there will be nochange to this reporting and you will continue to use the GABRIELsystem to report as you do now.

GABRIEL will be operated by FCA. Firms are to continue to use theircurrent URL and login details to access the system.

The existing data items will remain with only minor changes to thewording.

Any technical queries about the system should be raised with the FCAContact Centre on 0845 606 9966 or email address [email protected].

Where should I submit my firms email/paper returns?

For firms who report regulatory data via email or in hard copy (paper)more detail of where to submit your returns will be provided on the PRAsinternet site www.bankofengland.co.uk/pra soon.

Where firms provide data directly to FSA supervisors or policy teams, youwill continue to do so after LCO.

If, after LCO, you are unsure where to report data, please firstly check thePRAs internet site under the section on regulatory data or contact PRAs

Firm Enquiries.

Contact details will be:Telephone number 020 3461 7000


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Email [email protected]

When will the PRA release further contact details/new address?

Moves to 20 Moorgate are taking place in stages, having started in early

January 2013.

Below is a table listing the move dates for each division:

Supervisors will confirm outstanding contact details such as telephonenumbers, email addresses and email addresses around their move dates.

For firms with PGP encrypted keys, communication on new access codes

will also be included.

Will the FCA and PRA have separate registers?

There will be one register maintained by the FCA. It will be available toall firms, reflecting the position of both the PRA and the FCA.

Will I retain the same registration number?

Yes. Your FSA numbers will be carried across to the new Register.

Will there be a Practitioner Panel?

Yes. The PRA will establish a Practitioner Panel.
mailto:[email protected]:[email protected]


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2. Authorisations and transitional arrangements

What will happen to our existing permissions and waivers?

Transitional arrangements for grandfathering existing provisions aredependent on secondary legislation.

We are in discussion with HM Treasury, with a view to the legislationproviding that existing Part IV permissions, controlled functions,passports, limitations and requirements are grandfathered without theneed for a firm to take action.

Exact details of grandfathering arrangements will be finalised oncesecondary legislation has been published.

We also published more detail on transitional arrangements for approvedpersons, and on Handbook transitionals more generally, on 25 January inCP13/3http://www.fsa.gov.uk/library/policy/cp/2013/13-03.shtml

What happens if we are applying for a new or varied permission or waiversover the period including LCO?

The PRA will ensure that applications to the FSA that are made before

legal cutover but not determined until after legal cutover are transitionedto the appropriate regulator and made against the appropriate statutorytests.

Exact details of in-flight authorisation arrangements will be finalisedonce secondary legislation has been published.

When will we know the final changes being made to the ApprovedPersons regime?

There is more detail on our approved person regime in our ApproachDocuments and in the consultation paper (CP12/26) covering changes tothe approved persons Handbook sections.


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This paper can be accessed here:

http://www.fsa.gov.uk/library/policy/cp/2012/12-26.shtml

Consultation for CP 12/26 closed on 7 December 2012, we are currentlyreviewing the proposals in light of responses to the consultation andexpect the final PRA rules on approved persons to be made by the PRABoard at or around LCO, when other substantive changes to theHandbook will also be made, and accompanying Policy Statementsissued.

Please see section 4 Policy Material below for more detail on finalisingthe PRA Handbook.

We also published more detail on transitional arrangements for approvedpersons on 25th January in CP13/3


Will the new threshold conditions be more specific?

HM Treasury has published indicative threshold conditions. Dualregulated firms will need to meet two sets of conditions, one set from thePRA and one set from the FCA.

For the PRA there will be threshold conditions specific to insurers andthreshold conditions for all other firms regulated by the PRA.

http://www.hm-treasury.gov.uk/d/condoc_fin_regulation_draft_secondary_leg.pdf

Will authorisation and the different approval processes take more or lesstime with the PRA?

The statutory time limit on authorisations in FSMA will remainunchanged after legal cutover.

The PRA will report against statutory time limits.
http://www.fsa.gov.uk/library/policy/cp/2012/12-26.shtmlhttp://www.fsa.gov.uk/library/policy/cp/2012/12-26.shtmlhttp://www.fsa.gov.uk/library/policy/cp/2013/13-03.shtmlhttp://www.fsa.gov.uk/library/policy/cp/2013/13-03.shtmlhttp://www.hm-treasury.gov.uk/d/condoc_fin_regulation_draft_secondary_leg.pdfhttp://www.hm-treasury.gov.uk/d/condoc_fin_regulation_draft_secondary_leg.pdfhttp://www.hm-treasury.gov.uk/d/condoc_fin_regulation_draft_secondary_leg.pdfhttp://www.hm-treasury.gov.uk/d/condoc_fin_regulation_draft_secondary_leg.pdfhttp://www.hm-treasury.gov.uk/d/condoc_fin_regulation_draft_secondary_leg.pdfhttp://www.fsa.gov.uk/library/policy/cp/2013/13-03.shtmlhttp://www.fsa.gov.uk/library/policy/cp/2012/12-26.shtml


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Should I continue to use ONA after legal cutover?

Immediately after LCO, the ONA system will continue to be used for thesubmission of applications and notifications, with some minor changes toreflect that it will be owned by the FCA, but accessible to both regulators.

Will firms still be required to disclose who they are authorised andregulated by?

Yes. We have consulted on revised wording of this status disclosure and aproposed transitional, as part of consultation on Handbook changes. Thepaper can be accessed here:


Will I be required to resubmit any information or notifications that aresubmitted just before LCO?

No. Any submissions or information received prior to LCO will not needto be resubmitted.

CP 13/3 outlines Handbook transitional provisions related to informationsubmissions.

How will I know where to send information or notifications after LCO?

Where information or notifications are required under a rule, theappropriate submission details will be updated in the PRAs rules or onthe PRA website.

CP 13/3 sets out more information in relation to the transition of timelimits and notification requirements in the rulebook.

3. Supervision

What is the PRA's approach to supervision?
http://www.fsa.gov.uk/library/policy/cp/2012/12-24.shtmlhttp://www.fsa.gov.uk/library/policy/cp/2012/12-24.shtmlhttp://www.fsa.gov.uk/library/policy/cp/2012/12-24.shtml


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The PRAs approach to supervision was outlined in the two PRAapproach documents one for deposit-takers and investment firms, onefor insurersinitially published in October 2012 to facilitate scrutiny ofthe PRAs proposed approach as the Financial Services Bill passedthrough Parliament.

The documents also set out some key policy material for firms.

We will publish updated versions at legal cutover, and thereafter thedocuments will act as standing references for firms on the PRAssupervisory approach, key PRA policies, and the PRAs statutoryobjectives.

When will my last FSA risk assessment visit be?

We are currently planning the transition from the FSAs risk assessmentframework to the PRA framework.

Firms will be notified of how their supervision will be transitioned tocontinuous assessment from the Regulatory Period previously indicatedin an ARROW or Supervisory Assessment letter.

The new Supervisory Assessment Framework will be a continuousassessment model, focusing on judgements about key risks to the PRAs

objectives.

For more detail refer to the Approach Documents.

When will I know which category my firm falls into?

A core part of the PRAs work will be to assess the significance of a firm toits objectives.

With this in mind we have divided all firms into five categories of

impact.

Before LCO we will write to firms notifying them of their categorisation.


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Will my firm still be required to comply with FSA Risk MitigationProgramme (RMP) items? What will happen to RMP?

We have streamlined the number of actions in the RMP and split theminto conduct and prudential actions.

Your supervisor will have communicated with your firm to confirm theoutstanding RMP actions, and your firm is accountable to the relevantregulator for their resolution.

Who will be my PRA supervisor?

One of the major changes we made in 2012 was to establish prudentialand conduct supervision teams for dual regulated firms.

You should now be aware of your PRA supervisor.

If you have not been allocated a supervisor you should continue to contactus through the FSA Contact Centre.

At LCO the PRA will have its own Firm Enquires, contact details will be:Telephone number 020 3461 7000Email [email protected]

Will individual capital guidance and individual liquidity guidance stillapply?

Both the individual capital guidance and individual liquidity guidanceissued by the FSA to PRA-regulated firms will continue to apply.

How will European and other policy initiatives such as Solvency II andCRD IV affect the PRAs supervision model?

Information about how the interaction of such initiatives will affect the

PRAs approach will be made available as part of the implementation ofthese policies.


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4. Policy material

How will the PRA issue policy material after LCO?

The PRA Approach Documents set out that the PRA will establish andmaintain published policy material which is consistent with its objectives,clear in intent, straightforward in presentation and as concise as possible.

As set out in our December letter, only a limited amount of FSA nonHandbook guidance will be transferred to the PRA.

In addition, the letter accompanying these FAQs sets out in detail ourapproach to FSA Individual Guidance and the action required by firms.

5. Fees and costs

Will the current fee structure be adopted by the PRA?

Firms current fees will see them through this fee period. For the first feeyear under the PRA (expected to be 2013/14) the PRA fees structure willbe based on adapting the current structure, making only the necessarychanges to accommodate dual-regulation.

These proposed changes are in the fees policy Consultation Paper

(CP12/28)

http://www.fsa.gov.uk/static/pubs/cp/cp12-28.pdf

How will fees be set next year?

For the first year under the PRA (expected to be 2013/14) the PRA feeswill be set to recover the annual funding requirement it needs to meet itsstatutory objectives.

This funding requirement and the fee rates to recover will be included inthe PRA fees rates Consultation Paper (CP) expected to be published in

April 2013.
http://www.fsa.gov.uk/static/pubs/cp/cp12-28.pdfhttp://www.fsa.gov.uk/static/pubs/cp/cp12-28.pdfhttp://www.fsa.gov.uk/static/pubs/cp/cp12-28.pdf


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How is creating the PRA going to be paid for?

The fees that we charge firms fund the FSA and the transition work thatwe are doing for the new regulator.

We have set out the regulatory reform costs in this years business plan.

The Act makes provision for the PRA to recover, from the industry, theregulatory reform transition costs of the FSA and the Bank of England.

6. Co-ordination with the Financial Conduct Authority

On what basis will the Financial Conduct Authority (FCA) and thePrudential Regulation Authority (PRA) work together?

The draft Memorandum of Understanding (MoU) between the FCA andthe PRA sets out a high level framework for how the two regulators will

work together within the new regulatory system provided for by the Act.

It will be vital that the two authorities pursue their own mandates,respecting the UKs Twin Peaks supervisory system.

But it will also be essential that they coordinate activities in some areas,and cooperate in others.

The MoU sets out these arrangements to help ensure they are effectiveand efficient.

There will also be a separate MoU covering the specific issues raised bythe joint regulation of with-profits insurance contracts.

Both the FCA and PRA are visiting us next year, how do you intend toseparate the two areas?

The FCA and PRA are two different regulators looking at differentaspects of the business, although there is a requirement to shareinformation. Detail of the FCA and the PRAs assessments andexpectations of firms are set out in the respective Approach Documents


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7. Current & forthcoming publications

There are a variety of publications that firms should be aware of,including:

- Banking - The Bank of England, Prudential Regulation Authorityapproach document to banking supervision

http://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdf

- Insurance - The Bank of England, Prudential Regulation Authorityapproach document to insurance supervision

http://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdf

- Designation of investment firms by the PRA - this document sets outhow the PRA will exercise the powers that will be conferred underFSMA 2000, Order 201 (the draft Order).

http://www.fsa.gov.uk/static/pubs/other/designation.pdf

Draft Memoranda of Understanding (MoU)

- Draft MoU between the FCA and the PRAhttp://www.fsa.gov.uk/static/pubs/mou/fca_pra.pdf

- Draft With-Profits MoU between the FCA and the PRAhttp://www.fsa.gov.uk/static/pubs/mou/draft-with-profits.pdf

- Draft MoU between the PRA and the FSCShttp://www.fsa.gov.uk/static/pubs/mou/fca_pra.pdf

- Draft MoU between the HMT, Bank, PRA and FCA on internationalorganisations
http://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdfhttp://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdfhttp://www.fsa.gov.uk/static/pubs/other/designation.pdfhttp://www.fsa.gov.uk/static/pubs/other/designation.pdfhttp://www.fsa.gov.uk/static/pubs/mou/fca_pra.pdfhttp://www.fsa.gov.uk/static/pubs/mou/fca_pra.pdfhttp://www.fsa.gov.uk/static/pubs/mou/draft-with-profits.pdfhttp://www.fsa.gov.uk/static/pubs/mou/draft-with-profits.pdfhttp://www.fsa.gov.uk/static/pubs/mou/fca_pra.pdfhttp://www.fsa.gov.uk/static/pubs/mou/fca_pra.pdfhttp://www.fsa.gov.uk/static/pubs/mou/fca_pra.pdfhttp://www.fsa.gov.uk/static/pubs/mou/draft-with-profits.pdfhttp://www.fsa.gov.uk/static/pubs/mou/fca_pra.pdfhttp://www.fsa.gov.uk/static/pubs/other/designation.pdfhttp://www.fsa.gov.uk/static/pubs/other/pra-approach-banking.pdf


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http://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_international_organisations_jan2012.pdf

- MoU between HMT, Bank (including the PRA) on financial crisismanagement

http://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_financial_crisis_management_jan2012.pdf
http://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_international_organisations_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_international_organisations_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_international_organisations_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_financial_crisis_management_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_financial_crisis_management_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_financial_crisis_management_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_financial_crisis_management_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_financial_crisis_management_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_international_organisations_jan2012.pdfhttp://www.hm-treasury.gov.uk/d/fin_fs_bill_mou_international_organisations_jan2012.pdf


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Semiannual Monetary Policy Report to theCongress

Speech by Mr Ben S Bernanke, Chairman of the Boardof Governors of the Federal Reserve System, beforethe Committee on Banking, Housing, and Urban

Affairs, US Senate, Washington DC

* * *

Chairman Johnson, Ranking Member Crapo, and other members of theCommittee, I ampleased to present the Federal Reserves semiannualMonetary Policy Report.

I will begin with a short summary of current economic conditions andthen discuss aspects of monetary and fiscal policy.

Current economic conditions

Since I last reported to this Committee in mid-2012, economic activity inthe United States has continued to expand at a moderate if somewhatuneven pace.

In particular, real gross domestic product (GDP) is estimated to haverisen at an annual rate of about 3 percent in the third quarter but to havebeen essentially flat in the fourth quarter.

The pause in real GDP growth last quarter does not appear to reflect astalling-out of the recovery.

Rather, economic activity was temporarily restrained byweather-relateddisruptions and by transitory declines in a few volatile categories of

spending, even as demand by U.S. households and businesses continuedto expand.


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Available information suggests that economic growth has picked upagain this year.

Consistent with the moderate pace of economic growth, conditions in thelabor market have been improving gradually.

Since July, nonfarm payroll employment has increased by 175,000 jobspermonth on average, and the unemployment rate declined 0.3 percentage

point to 7.9 percent over the same period.

Cumulatively, private-sector payrolls have now grown by about 6.1 millionjobs since their low point in early 2010, and the unemployment rate hasfallen a bit more than 2 percentage points since its cyclical peak in late2009.

Despite these gains, however, the job market remains generally weak,with the unemployment rate well above its longer-run normal level.

About 4.7 million of the unemployed have been without a job for sixmonths or more, and millions more would like full-time employment butare able to find only part-time work.

High unemployment has substantial costs, including not only thehardship faced by the unemployed and their families, but also the harm

done to the vitality and productive potential of our economy as a whole.

Lengthy periods of unemployment and underemployment can erodeworkers' skills and attachment to the labor force orprevent young peoplefrom gaining skills and experience in the first placedevelopments thatcould significantly reduce their productivity and earnings in the longerterm.

The loss of output and earnings associated with high unemployment alsoreduces government revenues and increases spending, thereby leading to

larger deficits and higher levels of debt.

The recent increase in gasoline prices, which reflects both higher crudeoil prices and wider refining margins, is hitting family budgets.


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However, overall inflation remains low.

Over the second half of 2012, the price index for personal consumptionexpenditures rose at an annual rate of 1-1/2 percent, similar to the rate ofincrease in the first half of the year.

Measures of longer-term inflation expectations have remained in thenarrow ranges seen over the past several years.

Against this backdrop, the Federal Open Market Committee(FOMC) anticipates that inflation over the medium term likely will run ator below its 2 percent objective.

Monetary policy

With unemployment well above normal levels and inflation subdued,progress toward the Federal Reserves mandated objectives of maximumemployment and price stability has required a highly accommodativemonetary policy.

Under normal circumstances, policy accommodation would be providedthrough reductions in the FOMCs target for the federal funds ratetheinterest rate on overnight loans between banks.

However, as this rate has been close to zero since December 2008, theFederal Reserve has had to use alternative policy tools.

These alternative tools have fallen into two categories.

The first is forward guidanceregarding the FOMCs anticipated pathfor the federal funds rate.

Since longer-term interest rates reflect market expectations for

shorter-term rates over time, our guidance influences longer-term ratesand thus supports a stronger recovery.

The formulation of this guidance has evolved over time.


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Between August 2011 and December 2012, the Committee used calendardates to indicate how long it expected economic conditions to warrantexceptionally low levels for the federal funds rate.

At its December 2012 meeting, the FOMC agreed to shift to providingmore explicit guidance on how it expects the policy rate to respond toeconomic developments.

Specifically, the December postmeeting statement indicated that thecurrent exceptionally low range for the federal funds rate will beappropriate at least as long as the unemployment rate remains above6-1/2 percent, inflation between one and two years ahead is projected tobe no more than a half percentage point above the Committees 2 percentlonger-run goal, and longer-term inflation expectations continue to be

well anchored.

An advantage of the new formulation, relative to the previous date-basedguidance, is that it allows market participants and the public to updatetheir monetary policy expectations more accurately in response to newinformation about the economic outlook.

The new guidance also serves to underscore the Committees intention tomaintain accommodation as long as needed topromote a strongereconomic recovery with stable prices.

The second type of nontraditional policy tool employed by the FOMC islarge-scale purchases of longer-term securities, which, like our forwardguidance, are intended to support economic growth by putting downward

pressure on longer-term interest rates.

The Federal Reserve has engaged in several rounds of such purchasessince late 2008.

Last September the FOMC announced that it would purchase agency

mortgage-backed securities at a pace of$40 billion per month, and inDecember the Committee stated that, in addition, beginning in January it

would purchase longer-term Treasury securities at an initial pace of$45billion per month.


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These additional purchases of longer-term Treasury securities replacethe purchases we were conducting under our now-completed maturityextension program, which lengthened the maturity of our securities

portfolio without increasing its size.

The FOMC has indicated that it will continue purchases until it observesa substantial improvement in the outlook for the labor market in a contextof price stability.

The Committee also stated that in determining the size, pace, andcomposition of its asset purchases, it will take appropriate account oftheir likely efficacy and costs.

In other words, as with all of its policy decisions, the Committee

continues to assess its program of asset purchases within a cost-benefitframework.

In the current economic environment, the benefits of asset purchases,and of policy accommodation more generally, are clear:

Monetary policy is providing important support to the recovery whilekeeping inflation close to the FOMCs 2 percent objective.

Notably, keeping longer-term interest rates low has helped spark

recovery in the housing market and led to increased sales and productionof automobiles and other durable goods.

By raising employment and household wealthfor example, throughhigher home pricesthese developments have in turn supportedconsumer sentiment and spending.

Highly accommodative monetary policy also has several potential costsand risks, which the Committee is monitoring closely.

For example, if further expansion of the Federal Reserves balance sheetwere to undermine public confidence in our ability to exit smoothly fromour accommodative policies at the appropriate time, inflation


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expectations could rise, putting the FOMCs price-stability objective atrisk.

However, the Committee remains confident that it has the tools necessaryto tighten monetary policy when the time comes to do so.

As I noted, inflation is currently subdued, and inflation expectationsappear well anchored; neither the FOMC nor private forecasters are

projecting the development of significant inflation pressures.

Another potential cost that the Committee takes very seriously is thepossibility that very low interest rates, if maintained for a considerabletime, could impair financial stability.

For example,portfolio managers dissatisfied with low returns may reachfor yield by taking on more credit risk, duration risk, or leverage.

On the other hand, some risk-takingsuch as when an entrepreneurtakes out a loan to start a new business or an existing firm expandscapacityis a necessary element of a healthy economic recovery.

Moreover, although accommodative monetary policies may increasecertain types of risk-taking, in the present circumstances they also servein some ways to reduce risk in the system, most importantly by

strengthening the overall economy, but also by encouraging firms to relymore on longer term funding, and by reducing debt service costs forhouseholds and businesses.

In any case, the Federal Reserve is responding actively to financialstability concerns through substantially expanded monitoring ofemerging risks in the financial system, an approach to the supervision offinancial firms that takes a more systemic perspective, and the ongoingimplementation of reforms to make the financial system more transparentand resilient.

Although a long period of low rates could encourage excessiverisk-taking, and continued close attention to such developments iscertainly warranted, to this point we do not see the potential costs of the


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increased risk-taking in some financial markets as outweighing thebenefits of promoting a stronger economic recovery and more-rapid jobcreation.

Another aspect of the Federal Reserves policies that has been discussedis their implications for the federal budget.

The Federal Reserve earns substantial interest on the assets it holds in itsportfolio, and, other than the amount needed to fund our cost ofoperations, all net income is remitted to the Treasury.

With the expansion of the Federal Reserves balance sheet, yearlyremittances have roughly tripled in recent years, with payments to the

Treasury totaling approximately $290 billion between 2009 and 2012.

However, if the economy continues to strengthen, as we anticipate, andpolicy accommodation is accordingly reduced, these remittances wouldlikely decline in coming years.

Federal Reserve analysis shows that remittances to the Treasury could bequite low for a time in some scenarios, particularly if interest rates were torise quickly.

However, even in such scenarios, it is highly likely that average annual

remittances over the period affected by the Federal Reserves purchaseswill remain higher than the pre-crisis norm, perhaps substantially so.

Moreover, to the extent that monetary policy promotes growth and jobcreation, the resulting reduction in the federal deficit would dwarf any

variation in the Federal Reserves remittances to the Treasury.

Thoughts on fiscal policy

Although monetary policy is working to promote a more robust recovery,it cannot carry the entire burden of ensuring a speedier return toeconomic health.


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The economys performance both over the near term and in the longerrun will depend importantly on the course of fiscal policy.

The challenge for the Congress and the Administration is toput thefederal budget on a sustainable long-run path that promotes economicgrowth and stability without unnecessarily impeding the current recovery.

Significant progress has been made recently toward reducing the federalbudget deficit over the next few years.

The projections released earlier this month by the Congressional BudgetOffice (CBO) indicate that, under current law, the federal deficit willnarrow from 7 percent of GDP last year to 2-1/2 percent in fiscal year 2015.

As a result, the federal debt held by the public (including that held by theFederal Reserve) is projected to remain roughly 75 per cent of GDPthrough much of the current decade.

However, a substantial portion of the recent progress in lowering thedeficit has been concentrated in near-term budget changes, which, takentogether, could create a significant headwind for the economic recovery.

The CBO estimates that deficit-reduction policies in current law will slowthe pace of real GDP growth by about 1-1/2 percentage points this year,

relative to what it would have been otherwise.

A significant portion of this effect is related to the automatic spendingsequestration that is scheduled to begin on March 1, which, according tothe CBOs estimates, will contribute about 0.6 percentage point to thefiscal drag on economic growth this year.

Given the still-moderate underlying pace of economic growth, thisadditional near-term burden on the recovery is significant.

Moreover, besides having adverse effects on jobs and incomes, a slowerrecovery would lead to less actual deficit reduction in the short run for anygiven set of fiscal actions.


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At the same time, and despite progress in reducing near-term budgetdeficits, the difficult process of addressing longer-term fiscal imbalanceshas only begun.

Indeed, the CBO projects that the federal deficit and debt as a percentageof GDP will begin rising again in the latter part of this decade, reflectingin large part the aging of the population and fast-rising health-care costs.

To promote economic growth in the longer term, and to preserveeconomic and financial stability, fiscal policymakers will have to put thefederal budget on a sustainable long-run path that first stabilizes the ratioof federal debt to GDP and, given the current elevated level of debt,eventually places that ratio on a downward trajectory.

Between 1960 and the onset of the financial crisis, federal debt averagedless than 40 percent of GDP.

This relatively low level of debt provided the nation much-neededflexibility to meet the economic challenges of the past few years.

Replenishing this fiscal capacity will give future Congresses andAdministrations greater scope to deal with unforeseen events.

To address both the near- and longer-term issues, the Congress and the

Administration should consider replacing the sharp, frontloadedspending cuts required by the sequestration with policies that reduce thefederal deficit more gradually in the near term but more substantially inthe longer run.

Such an approach could lessen the near-term fiscal headwinds facing therecovery while more effectively addressing the longer-term imbalances inthe federal budget.

The sizes of deficits and debt matter, of course, but not all tax and

spending programs are created equal with respect to their effects on theeconomy.


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To the greatest extent possible, in their efforts to achieve sound publicfinances, fiscal policymakers should not lose sight of the need for federaltax and spending policies that increase incentives to work and save,encourage investments in workforce skills, advance private capitalformation, promote research and development, and provide necessaryand productive public infrastructure.

Although economic growth alone cannot eliminate federal budgetimbalances, in either the short or longer term, a more rapidly expandingeconomic pie will ease the difficult choices we face.


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Wayne Byres, Secretary GeneralBasel Committee on BankingSupervision

SIMPLICITY, RISK SENSITIVITY AND COMPARABILITY:THE REGULATORY BALANCING ACT

BCBS-EMEAP-FSI High-Level Meeting, Seoul, Korea

Before I begin my remarks today, I would like to thank the FSI andEMEAP for once again organising yet another excellent event in theseries of High-Level Meetings in Asia.

Prior to taking up my current role in Basel, I attended these events as anAustralian bank supervisor, and always found them to be valuableopportunities for the exchange of ideas and views between the regionssenior regulators and industry representatives.

Although I am now based in another part of the world, I am very happy tobe able to continue to participate and contribute to these discussions.

I would also like to acknowledge that the Asian region leads the world in

its implementation of Basel III.

The region has benefited from the development of strong bankingsystems supported by strong regulatory regimes.

Furthermore, many of you have recognised Basel III as a minimum, andhave adopted local practices that impose additional requirements to deal

with local risks.

The result is healthy banking systems that are well equipped to supporteconomic growth, not least by stepping into the gap created by theconstraints faced by many banks in other parts of the world.


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Finding the right balance

I am sure that many of you know the story of Goldilocks and the threebears.

In it, Goldilocks explored the bears house, testing the porridge, thechairs and the beds until she found things that she thought were justright.

When I took up my role in Basel, a friend suggested I had a Goldilocksjob.

By this he meant that my task was to take a range of competingobjectives, and find some middle ground that was just right.

In an international policymaking context, that impliespolicies that are:

comprehensive, yet simple;

strong, but not burdensome;

risk-based, yet easy to understand and compare;

flexible and adaptable, yet consistently applied;

suitable for normal times, but founded on the lessons from crises;

built on consensus, but also on the broadest possible engagement; and

utilising appropriately the relative strengths of both regulation (rules)and supervision (oversight).

With such a multidimensional set of trade-offs, finding the optimal point

for any given set of regulatory proposals is inevitably very difficult.

In the case ofBasel III, the Committee sought a suitable minimumamount of capital that was just rightnot so little that the financialsystem remained susceptible to the weaknesses revealed in 200708, but


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not so much that banks could not perform their important economicfunctions.

The Committee also needed to improve the way that the adequacy ofcapital was measured so that it appropriately recognises the materiallydifferent magnitudes of risk within individual bank balance sheets, but atthe same time provides an overall measure of soundness that investorscan compare across banks.

And, recognising that the Basel framework is the global standard for bankcapital, the Committee needed something that was suitable forinternationally active banksour core constituencybut could also beapplied more broadly.

Capital requirementsadequate and comparable

Regulatory capital requirements do many things, but at their heart theymust achieve two fundamental objectives:

ensure banks have an adequate level of capital (ie relative to their riskprofile); and

provide a measure of capital that is comparable over time and betweenbanks.

The first of these objectivesadequacyis an obvious goal, but failure toachieve the secondcomparabilityundermines confidence that the firstis being achieved.

Since we are dealing with institutions that have a business model foundedon confidence, the importance of comparability should not beunderestimated.

During the recent crisis, questions began to be asked about the reliabilityof risk-based capital ratios as an indicator of bank health.

In my view, there were three factors which served to undermineconfidence in the risk-based measure of capital:


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the regulatory capital base included capital instruments that were nottruly loss-absorbingfinancial markets increasingly discounted these;

the regulatory capital base in some countries filtered out (ie ignored)some unrealised losses that banks had incurredfinancial markets

wanted to account for these; and

risk-weighted asset calculations had become complex and opaque,making them difficult for external investors to understandfinancialmarkets became confused by these.

In other words, questions were legitimately being asked about whethercapital was both adequate and comparable.

The questions related to both the numerator and the denominator of theregulatory measure.

The reforms contained in Basel III largely deal with these first two items.

Basel III raises the minimum quantity of truly loss-absorbing capital bymany multiples.

It also improves the quality of that capital by eliminating quasi-capitalinstruments, and certain other assets, thatproved of limited value in times

of stress (indeed, investors in some of these instruments, rather thanproviding a source of support, had to be bailed out themselves!).

In addition, by removing prudential filters and forcing banks to recogniseunrealised losses on fair value assets, capital ratios will be more credibleby better reflecting the true capacity of a bank to absorb further losses atany given point in time.

Having substantially simplified and improved the numerator of thecapital ratio, the Committees attention is now turning to concerns about

the risk-weighting framework:

it is said by some to be too complex and difficult to understand, and thatsomething simpler (indeed, some say simple) would be better; and


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it is said by some to provide too much flexibility on how risk should bemeasured, making it difficult to compare reported capital ratios.

These concerns are closely relatedalthough that does not mean lesscomplexity and less flexibility always lead to more comparability.

Complexity and flexibility

International banks are complex organisations.

Today, not even traditional lines of business, such as retail andcommercial banking, are simple businesses to run, if they ever were.

Capturing the risk profile of these businesses in a single measure of

financial soundness is extremely difficult.

The complexity in the capital framework largely comes from the decisionto allow banks to use their own internal models to measure risk, the majorinnovation contained in Basel II.

Although internal models had already been part of the regulatoryframework for a decade, this was only for a relatively small area of activity.

Basel II provided the capacity to do this for the biggest risk most banks

facethe credit riskwithin their loan books.

While, of course, banks were required to jump a large number of hurdlesin relation to model specification and validation before they could usetheir own models the new framework did move banks away from the onemodel fits all approach that was at the core of Basel I.

The primary objective behind this important step was to better aligncapital with underlying risks.

Regulatory requirements create incentives; Basel II attempted to alignthose incentives much more closely with economic reality than was thecase in Basel I.


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In this respect, Basel IIs goal can be thought of aspromoting bothcapital adequacy and capital efficiency.

Properly applied, banks capital requirements could be much moreresponsive to the underlying risks they were taking; low-risk banks wouldbenefit by not being burdened with unnecessary capital requirements,and those with higher risk profiles would need to hold additional capitalcommensurate with the risks they are exposed to.

To put it another way, Basel II sought to better distinguish between high-and low-risk banks, and it required higher-risk banks to operate withlower levels of leverage than their low-risk peers.

But as anyone knows who has built, supervised or just tried to understand

internal risk models within a bank, they are not simple.

They are, of course, a simplification of the real world, but that is not muchof a consolation since the real world is extremely complex.

The difficulty is that, if models are oversimplified, they do not producerisk measures that reflect reality.

But if made too complex, hardly anyone can say whether they producerealistic risk measures or not!

And by allowing a degree of flexibility for banks to model risks as they seethem, we make it more difficult to achieve comparability. Getting it justright therefore requires careful judgement.

Comparability

Basel II was undoubtedly a major improvement in the conceptualsoundness of the capital measurement process.

It also created important incentives for banks to refine and improve theirrisk models, and to avoid high correlations between risk managementmethodswhich could have detrimental implications for financial stability.


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These benefits should not be lightly dismissed, but there are nowconcerns that the way in which models are currently used hinderscomparability, since users of information cannot understand the impactthat modelling choices have on the resulting capital requirements.

The Committee therefore needs to ensure that this additional risksensitivity is not, as a result of its complexity, undermining the overallregime by making comparison too difficult for all but supervisory experts(and maybe even for the experts too!).

But before we revert to a simpler measurement methodology, we need tobe sure that it would really be more comparable.

Comparability has two basic dimensions:

between banks at a given point in time; and

for a given bank, over a period of time.

Any standardised approach will necessarily be blunt.

It will be simpler to understand than an internal model, but that isbecause it will necessarily make many assumptions.

These assumptions will mean risk can be incorrectly measured.

They will also mean that changes in a banks risk profile can goundetected.

Take the example of the leverage ratio.

It will not distinguish between two similarly sized banks even if one holdsa large portfolio of high-quality sovereign exposures, and the other a large

portfolio of highly leveraged loans for property development.

Nor will it show any response if a bank switches its balance sheet fromone of those portfolios to the other over time.


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A leverage ratio measures exactly what it saysthe degree of leverage ona banks balance sheet.

For this purpose, it is perfectly suited.

That does not necessarily make the most useful measure for judging theadequacy of a banks capital base.

Risk-based regimes seek to respond to this problem by introducinggreater risk sensitivity.

But even with the standardised approaches in the Basel framework, thereare limits to what can be achieved.

The risk-based framework would respond, via changes in the reportedcapital ratio, to the situations I have mentioned above.

It would not, however, necessarily respond at a more detailed level forexample, it does not meaningfully distinguish between portfolios oflowloan-to-value ratio (LVR),full documentation, amortising mortgageloans, and high LVR, interest-only, self-certified mortgage loans.

Only with additional complexity can we take greater account of themultifaceted risks within a banks loan book.

However, as the framework becomes more and more risk-sensitive injudging capital adequacy, it may no longer be the best means ofmonitoring, comparing and controlling overall leverage.

For these reasons, Basel III utilises both a risk-based capital ratio and anon-risk-based leverage ratio to provide complementary measures ofcapital adequacy and leverage.

Both ratios serve their individual purposes: one a measure of capital

relative to risk; the other a measure of overall leverage.


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The two measures can also be compared with each other, providingadditional information that would not be readily available from eithermeasure on its own.

Improving comparability

The inclusion of the leverage ratio in Basel III does not remove the needto further review the comparability of the risk-based regime.

To borrow from Winston Churchill, however beautiful the strategy, youshould occasionally look at the results.

The Committee has been conscious of this issue for some time, and overthe past year it has been exploring the issue from both a bottom-up and

top-down perspective.

With regard to the concerns about the comparability of model-basedrisk-weighted asset calculations, the Committee has established two

workstreams; one to look at the consistency of calculations in relation tothe trading book and another parallel stream for the banking book.

This work has examined publicly available data for a selection of largebanks across multiple jurisdictions, as well as asking a number of banksto provide risk measures for a series of hypothetical portfolios.

The outcome of this work has been supplemented with a series ofmeetings with individual banks by an international team of supervisoryexperts, with the aim of providing greater understanding of the reasonsbehind different results.

The trading book reviewwas published at the end of January, and I willfocus my comments on it today.

The results of the banking book work will be released in the comingmonths.


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The trading book review found that it is reasonable for investors tocomplain that they find current risk disclosures opaquetheCommittees analysis found the same thing!

Current disclosures were not adequate for external parties to be able tojudge whether movements in modelled risk-weighted assets over time, orbetween banks, were due to underlying differences in risk, or for otherreasons.

That there is variability in results between banks should not surprise.

It is inevitable, and indeed desirable, in any model-based framework thatthere be some.

What was possibly surprising, however, was that regulatory andsupervisory decisions were producing a non-trivial proportion of thevariability: contrary to the initial hypothesis of many, it did not arise solelyfrom giving banks too much freedom to model risk.

Around a quarter of the variability was due to one single factor: the use ofsupervisory multipliers, which are applied as an incentive for banks toimprove their models and risk management systems.

There are two other points worth noting from the trading book analysis:

The variability driven by supervisors (due to the use of multipliers, or byrestricting modelling choices) will almost invariably increase capitalrequirements relative to what they might otherwise be.

In other words, some of the variability is due to some banks being held toa higher standard than the Basel minimum requires.

This improves the adequacy of capital resulting from internal models but,due to the fact that some supervisory discretion is not disclosed, reduces

comparability.

The outcomes produced by banks were benchmarked to a risk modelproduced by the team of supervisory experts conducting the analysis.


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The output of this model was broadly consistent with the average of theresults being produced by banks.

Although the analysis is necessarily limited to the sample of banks and bythe simple portfolios used, there was no evidence to suggest that thebanks modelling efforts systematically under-estimated risk (and hencethe adequacy of capital requirements) across the group as a whole.

Nonetheless, even after allowing for supervisory decisions, bankmodelling practices were the primary driver of variability, and that

variability makes comparability more difficult to achieve.

Thankfully, the analysis showed that the bulk of this could be attributedto a relatively small set of modelling choices, giving the Committee some

obvious areas to look at if it decides that variability should be reduced. Iwill say more about this shortly.

In parallel with this detailed analysis, the Committee has appointed a taskforce to look into the question of the simplicity and comparability of theregulatory framework from a top-down perspective.

This task force has not been looking at specific issues of detail, butinstead is approaching the issue from a more conceptual perspective:

what is the optimal trade-off between simplicity, risk-sensitivity and

comparability?

The task force found that there are many drivers of complexity in theregulatory framework, and that the greater focus on the risk sensitivity ofcapital measures is just one of them.

Others include the need to reflect developments in financial markets,integrate modern risk management practices, and respond to innovation.

Nevertheless, the task force has highlighted a number of areas the

Committee could consider if it wanted to rebalance the currentframework to promote greater simplicity.


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Getting the balance just right

The Committee is still consideringwhat, if any, changes could to bemade to the regulatory frameworkto enhance the comparability of

risk-based capital ratios, bringing together the top-down strategicthinking of the task force with the bottom-up analysis of the teamsexamining the results of internal models.

However, the potential means of enhancing comparability are likely to fallunder three broad themes:

Enhancing disclosure: If current disclosure is inadequate to enableinvestors to understand changes in risk profile, then it makes sense toexamine how disclosures can be improved.

The Committee recently established a new Working Group onDisclosure, with a view to reconsidering existing Pillar 3 disclosurerequirements, as well ideas proposed by groups such as the EnhancedDisclosure Task Force, to see whether they can be improved.

That does not necessarily mean we will advocate ever-increasing levels ofdisclosure; it may be that less is more and that we can streamlinedisclosures and make them more useful at the same time.

Making modelling more robust and consistent: To fully standardiseinternal models (ie to make them external models) would defeat someof their purpose: we would just be imposing a standard supervisory modelon banks, and thereby imposing a single regulatory judgment on the best

way to model risks.

Thus,we would end up with a complex system, but without necessarilyreaping any of the benefits that come from using internal models.