risk management presentation march 18 2013

7/28/2019 Risk Management Presentation March 18 2013

1/122

P a g e | 1

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 nextDear Member,Have you seen the average salary and the

demand for Basel I I I skills in I T jobs?

International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/


2/122

P a g e | 2

Source: IT Jobs Watch, that provides a unique perspective on today'sinformation technology job market (no affiliation).Read more at N umber 1 blow.Also, are you good in disaster management?According to Pentti Hakkarainen, Deputy Governor of the Bank ofFinland, one aspect ofdisaster management is keeping particularly riskyor vulnerable business in a separate legal unit thus making it easier todivest/withdraw without exposingthe rest of the operations for contagionby cutting linkages rapidly.Read more at number 3 below.

Welcome to the Top 10 list.

http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/


3/122

P a g e | 3

Amazing: The average salaryand the demand for Basel I I I skills in IT jobs advertised across the UKThe table looks at the demand for Basel I I I skills in I T jobs advertisedacross the UK.Included is a guide to the average salariesoffered in IT jobs that havecited Basel I I I over the 3 months to 6 March 2013 with a comparison tothe same period in the previous 2 years.

Long-term interest ratesSpeech by Mr Ben S Bernanke, Chairman of theBoard of Governors of the Federal Reserve System, atthe Annual Monetary/Macroeconomics ConferenceThe past and future of monetary policy, sponsoredby the Federal Reserve Bank of San Francisco, San Francisco, California

Re-evaluating the universal banking model: Canthe Volcker, Vickers or Liikanen rules makebanks safer?Remarks by Mr Pentti Hakkarainen, Deputy Governorof the Bank of Finland, at the 4th Future of BankingSummit, organised by Economist Conferences, Paris



4/122

P a g e | 4

Reflections on reputation and itsconsequencesSpeech by Ms Sarah Bloom Raskin, Member of theBoard of Governors of the Federal Reserve System, atthe 2013 Banking Outlook Conference, FederalReserve Bank of Atlanta, Atlanta, Georgia

Opinion of the European Insurance andOccupational Pensions Authority onSupervisory Response to aProlonged Low Interest RateEnvironment

Investigations by the FinancialSupervisory Authority into issuesconnected with the banking collapsehave now concludedInvestigations by the Financial Supervisory Authority (FME) into theevents preceding the banking collapse in the autumn of 2008, whichbegan immediately following the failure of the three large commercial

banks, have now concluded.FME investigated a total of205 cases.



5/122

P a g e | 5

A very interesting presentationIcelands pre- and post-crisisexperience

SECURITIES AND EXCHANGE COMM ISSION Notice of Filing of ProposedRule Change to Require that Listed

Companies Have an Internal Audit FunctionPursuant to Section 19(b)(1) of the Securities Exchange Act of 1934(Act) and Rule 19b-4 thereunder, notice is hereby given that onFebruary 20, 2013, The NASDAQ Stock Market LLC (Nasdaq orExchange) filed with the Securities and Exchange Commission(Commission) the proposed rule change as described in I tems I , I I,and II I below, which Items have been prepared by the Exchange.

The European crisis and the development of theEuropean UnionSpeech by Mr Lars Rohde, Governor of the NationalBank of Denmark, at the European AffairsCommitteesconsultation:The European crisis andthe development of the European Union, former Upper Chamber of theDanish Parliament, Copenhagen



6/122

P a g e | 6

Promoting an inclusive financial sector inPakistanSpeech by Mr Yaseen Anwar, Governor of theState Bank of Pakistan, at the Closure Ceremonyof Term Sarmaya Certificate (TFC) issued byTameer Microfinance Bank, Karachi



7/122

P a g e | 7

Amazing: The average salary and the demand for Basel I I I skillsin I T jobs advertised across the UKThe first tablebelow looks at the demand for Basel I I I skills in IT jobsadvertised across the UK.Included is a guide to the average salariesoffered in IT jobs that havecited Basel I I I over the 3 months to 6 March 2013 with a comparison tothe same period in the previous 2 years.The second table is for comparison and provides aggregates for all of theQuality Assurance & Compliance category.



8/122

P a g e | 8



9/122

P a g e | 9

Source: IT Jobs Watch, that provides a unique perspective on today'sinformation technology job market (no affiliation).To learn more:http:/ / www.itjobswatch.co.uk/ jobs/ uk/ basel%20iii.do

http://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.dohttp://www.itjobswatch.co.uk/jobs/uk/basel%20iii.do


10/122

P a g e | 10

Long-term interest ratesSpeech by Mr Ben S Bernanke, Chairman of the Board ofGovernors of the Federal Reserve System, at the AnnualMonetary/Macroeconomics Conference The past andfuture of monetary policy, sponsored by the FederalReserve Bank of San Francisco, San Francisco, CaliforniaI will begin my remarks by posing a question: Why are long-term interestrates so low in the United States and in other major industrial countries?At first blush, the answer seems obvious: Central banks in those countries

are pursuing accommodative monetary policies to boost growth andreduce slack in their economies.However, while central banks certainly play a key role in determining thebehavior of long-term interest rates, theirs is only a proximate influence.A more complete explanation of the current low level of rates must takeaccount of the broader economic environment in which central banks arecurrently operating and of the constraints that that environment places ontheir policy choices.Let me start with a brief overview of the recent history of long-terminterest rates in some key economies.Chart 1 shows the 10-year government bond yields for five major industrialcountries: Canada, Germany, Japan, the United Kingdom, and the UnitedStates.Note that the movements in these yields are quite correlated despite somedifferences in the economic circumstances and central bank mandates in

those countries.



11/122

P a g e | 11

Further, with the notable exception of Japan, the levels of the yields havebeen very similar indeed, strikingly so, with long-term yields decliningover time and currently close to 2 percent in each case.The similar behavior of these yieldsattests to the global nature of theeconomic and financial developmentsof recent years, as well as to thebroad similarity in how the monetary policymakers in the advancedeconomies have responded to these developments.Of course, Japanese yields are clearly a case apart, asJapan has enduredan extended period of deflation, while inflation in the other four countrieshas been positive and generally close to the stated objectives of themonetary authorities.But even Japanese yields have shown some tendency to fluctuate alongwith other benchmark yields, and they have also declined over the period

shown.In my comments, I will delve more deeply into the reasons why theselong-term interest rates have fallen so low.



12/122

P a g e | 12

This examination may be useful both for understanding the currentstance of policy and also for thinking about how rates may evolve.In short, we expect that as the economy recovers, long-term rates will riseover time to more normal levels.A return to more normal conditions in financial markets would, of course,be most welcome.Many commentators have noted, however, that both an extended periodof low rates and the transition back toward normal levels may pose risksto financial stability.In the final portion of my remarks, I will discuss some aspects of how the

Federal Reserve is approaching these risks.Why are long-term interest rates so low?So, why are long-term interest rates currently so low?To help answer this question, it is useful to decompose longer-term yieldsinto three components:1.One reflectingexpected inflation over the term of the security;2.Another capturing the expected path of short-term real, orinflation-adjusted, interest rates;3. And a residual component known as the term premium.Of course, none of these three components is observed directly, but thereare standard ways of estimating them.Chart 2 displays one version of this decomposition of the 10-year U.S.



13/122

P a g e | 13

Treasury yield based on a term structure model developed by FederalReserve staff.The broad features I will emphasize are similar to those found by otherauthors using a variety of methods.All three components of the 10-year yield have declined since 2007.The decomposition attributes much of the decline in the yield since 2010to a sharp fall in the term premium, but the expected short-term real ratecomponent also moved down significantly.Letsconsider each component more closely.The expected inflation component has drifted gradually downward formany years and has become quite stable.In large part, the downward trend and stabilization of expected inflationin the United States are products of the increasing credibility of theFederal Reservescommitment to price stability.



14/122

P a g e | 14

In January 2012, the Federal Open Market Committee (FOMC)underscored this commitment by issuing a statement since reaffirmedat its January 2013 meeting on its longer-run goals and policy strategy,which included a longer-run inflation target of 2 percent.The anchoring of long-term inflation expectations near 2 percent hasbeen a key factor influencing long-term interest rates over recent years.It almost certainly helped mitigate the strong disinflationary pressuresimmediately following the crisis.While I have not shown expected inflation for other advanced economies,the pictures would be very similar again, except for Japan.With the expected inflation component of the 10-year rate near 2 percentand the rate itself a bit below 2 percent recently, it is clear that thecombination of the other two components the expected path ofshort-term real interest rates and the term premiummust make a smallnet negative contribution.The expected path of short-term real interest rates is, of course,influenced by monetary policy, both the current stance of policy andmarket participantsexpectations of how policy will evolve.The stance of monetary policy at any given time, in turn, is driven largelyby the economic outlook, the risks surrounding that outlook, and at timesother factors, such as whether the zero lower bound on nominal interestrates is binding.In the current environment, both policymakers and market participantswidely agree that supporting the U.S. economic recovery while keepinginflation close to 2 percent will likely require real short term rates,currently negative, to remain low for some time.As shown in chart 2, the expected average of the short-term real rate overthe next 10 years has gradually declined to near zero over the past fewyears, in part reflecting downward revisions in expectations about the



15/122

P a g e | 15

pace of the ongoing recovery and, hence, a pushing out of expectationsregarding how long nominal short-term rates will remain low.As the persistence of the effects of the crisis have become clearer, theFederal Reservescommunications have reinforced the expectation thatconditions are likely to warrant highly accommodative policy for sometime:Most recently, the FOMC indicated that it expects to maintain anexceptionally low level of the federal funds rate at least as long as theunemployment rate is above 6.5 percent, projected inflation between oneand two years ahead is no more than a half percentage point above theCommittees2 percent target, and long-term inflation expectationsremain stable.In discussing the role of monetary policy in determining the expectedfuture path of real short-term rates, I have cheated a little:What monetary policy actually controls is nominal short-term rates.

However, because inflation adjusts slowly, control of nominal short-termrates usually translates into control of real short-term rates over the shortand medium term.In the longer term, real interest rates are determined primarily bynonmonetary factors, such as the expected return to capital investments,which in turn is closely related to the underlying strength of the economy.The fact that market yields currently incorporate an expectation of verylow short-term real interest rates over the next 10 years suggests thatmarket participants anticipate persistently slow growth and,consequently, low real returns to investment.In other words, the low level of expected real short rates may reflect not

only investor expectations for a slow cyclical recovery but also somedowngrading of longer-term growth prospects.



16/122

P a g e | 16

Chart 3, which displays yields on inflation-indexed, long-termgovernment bonds for the same five countries represented in chart 1,shows that expected real yields over the longer term are low in otheradvanced industrial economies as well.

Note again the strong similarity in returnsacross these economies,suggesting once again the importance ofcommon global factors.While indexed yields spiked up around the end of 2008, reflecting marketstresses at the height of the crisis that undercut the demand for thesebonds, these effects dissipated in 2009.Since that time, inflation-indexed yields have declined steadily and nowstand below zero in each country.Apparently, low longer-term real rate expectations are playing animportant role in accounting for low 10-year nominal rates in otherindustrial countries, as well as in the United States.



17/122

P a g e | 17

The third and final component of the long-term interest rate is the termpremium, defined as the residual component not captured by expectedreal short-term rates or expected inflation.As I noted, the largest portion of the downward move in long-term ratessince 2010 appears to be due to a fall in the term premium, so it deservessome special discussion.In general, the term premium is the extra return investors expect to obtainfrom holding longterm bonds as opposed to holding and rolling over asequence of short-term securities over the same period.In part, the term premium compensates bondholders for interest rate risk the risk of capital gains and losses that interest rate changes imply for

the value of longer term bonds.Two changes in the nature of this interest rate risk have probablycontributed to a general downward movement of the term premium inrecent years.First, the volatility of Treasury yields has declined, in part becauseshort-term rates are pressed up against the zero lower bound and areexpected to remain there for some time to come.Second, the correlation of bond prices and stock prices has becomeincreasingly negative over time, implying that bonds have become morevaluable as a hedge against risks from holding other assets.Beyond interest rate risk, a number of other factorsalso affect the termpremium in practice.For example, during periods offinancial turmoil, the prices oflonger-term Treasury securities are often driven up by so-calledsafe-haven demandsof investors who place special value on thesafety and liquidity of Treasury securities.Indeed, even during more placid periods, global demands for safe assetsincrease the value of Treasury securities.



18/122

P a g e | 18

Many foreign governments and central banks, particularly those withsustained current account surpluses, hold substantial internationalreserves in the form of Treasuries.Foreign holdings of U.S. Treasury securities currently amount to about$5-1/2 trillion, roughly half of the total amount of marketable Treasurydebt outstanding.The global economic and financial stresses of recent years triggeredfirst by the financial crisis, and then by the problems in the euro area appear to have significantly elevatedthe safe-haven demand forTreasury securities at times, pushing down Treasury yields and implyinga lower, or even a negative, term premium.Federal Reserve actions have also affected term premiums in recent years,most prominently through a series ofLarge-Scale Asset Purchase (LSAP)programs.These programs consist of open market purchases of agency debt, agencymortgage-backed securities, and longer term Treasury securities.To the extent that Treasury securities and agency-guaranteed securitiesare not perfect substitutes for other assets, Federal Reserve purchases ofthese assets should lower their term premiums, putting downward

pressure on longer-term interest rates and easing financial conditionsmore broadly.Although estimated effects vary, a growing body of research supports theview that LSAPs are effective at bringing down term premiums and thusreducing longer-term rates.Of course, the Federal Reserve has used this unconventional approach tolowering longer-term rates because, with short-term rates near zero, it canno longer use its conventional approach of cutting the target for thefederal funds rate.



19/122

P a g e | 19

Accordingly, this portion of the decline in the term premium mightultimately be attributed to the sluggish economic recovery, whichprompted additional policy action from the Federal Reserve.Lets recap.Long-term interest rates are the sum of expected inflation, expected realshort term interest rates, and a term premium.Expected inflation has been low and stable, reflecting central bankmandates and credibility as well as considerable resource slack in themajor industrial economies.Real interest rates are expected to remain low, reflecting the

weakness of the recovery in advanced economies (and possibly somedowngrading of longer-term growth prospects as well).This weakness, all else being equal, dictates that monetary policy mustremain accommodative if it is to support the recovery and reducedisinflationary risks.Put another way, at the present time the major industrial economiesapparently cannot sustain significantly higher real rates of return; in thatrespect, central banks so long as they are meeting their price stability

mandates have little choice but to take actions that keep nominallong-term rates relatively low, as suggested by the similarity in the levelsof the rates shown in chart 1.Finally, term premiums are low or negative, reflecting a host of factors,includingcentral bank actions in support of economic recovery.Thus, while the current constellation of long-term rates across manyadvanced countries has few precedents, it is not puzzling:It follows naturally from the economic circumstances ofthese countries and the implications of these circumstances for thepolicies of their central banks.



20/122

P a g e | 20

How are long-term rates likely to evolve?So, how are long-term rates likely to evolve over coming years?It is worth pausing to note that, not that long ago, central bankers wouldhave carefully avoided this topic.However, it is now a bedrock principle of central banking thattransparency about the likely path of policy, in general, and interest rates,in particular, can increase the effectiveness of policy.In the present context, I would add that transparency may mitigate risksemanating from unexpected rate movements.Thus, let me turn to prospects for long-term rates, starting with theexpected path of rates and then turning to deviations from the expectedpath that may arise.If, as the FOMC anticipates, the economic recovery continues at amoderate pace, with unemployment slowly declining and inflationexpectations remaining near 2 percent, then long-term interest rateswould be expected to rise gradually toward more normal levels over thenext several years.This rise would occuras the marketsview of the expected date at whichthe Federal Reserve will begin the removal of policy accommodationdraws nearer and then as accommodation is removed.Some normalization of the term premium might also contribute to a risein long-term rates.To illustrate possible paths, Chart 4 displays four different forecasts of theevolution of the 10-year Treasury yield over coming years.



21/122

P a g e | 21

The black line is the forecast reported in the December 2012 Blue ChipFinancial Forecasts survey.The green line gives the Congressional Budget Office forecast publishedin February, and the blue line presents the median from the Survey ofProfessional Forecasters, as reported in the first quarter of this year.Finally, the purple line shows a forecast based on the term structuremodel used for the decomposition of the 10-year yield in chart 2.While these forecasts embody a wide range of underlying models andassumptions, the basic message is clear long-term interest rates areexpected to rise gradually over the next few years, rising (at leastaccording to these forecasts) to around 3 percent at the end of 2014.The forecasts in chart 4 imply a total increase of between 200 and 300basis points in long-term yields between now and 2017.



22/122

P a g e | 22

Of course, the forecasts in chart 4 are just forecasts, and reality might wellturn out to be different.Chart 5 provides three complementary approaches to summarizing theuncertaintysurrounding forecasts of long-term rates.

The dark gray barsin the chart are based on the range of forecastsreported in the Blue Chip Financial Forecasts, the blue bars are based onthe historical uncertainty regarding long-term interest rates as reflected inthe Board staffs FRB/US model of the U.S. economy, and the orangebars give a market-based measure of uncertainty derived from swaptions.These three different measures give a broadly similar picture about theupside and downside risks to the forecasts of long-term rates.Rates 100 basis points higher than the expected paths in chart 4 by 2014are certainly plausible outcomes as judged by each of the three measures,and this uncertainty grows to as much as 175 basis points by 2017.



23/122

P a g e | 23

Note, though, that while the risk of an unexpected rise in interest rateshas drawn much attention, the level of long-term interest rates also couldprove to be lower than forecast.Indeed, by the measures shown in chart 5, the upside and downside risksto the level of rates are roughly symmetric as of 2017.We also have some historical experience with increases in rates duringtightening cycles to consider.For example, in 1994, 10-year Treasury yields rose about 220 basis pointsover the course of a year, reflecting an unexpected quickening in the paceof economic growth and signs of building inflation pressures.This increase in long-term rates appears to have reflected a mix of apronounced rise in the expected path of the policy interest rate and someincrease in the term premium.A rise of more than 200 basis points in a year is at the upper end of what isimplied by the mean paths and uncertainty measures shown in charts 4and 5, but these measures still admit a substantial probability of higherand lower paths.Overall, then, we anticipate that long-term rates will rise as the recovery

progresses and expected short-term real rates and term premiums returnto more normal levels.The precise timing and pace of the increase will depend importantly onhow economic conditions develop, however, and is subject toconsiderable two-sided uncertainty.Managing risks associated with the future course of long-terminterest ratesAs I noted when I began my remarks, one reason to focus on the timingand pace of a possible increase in long-term rates is that these outcomesmay have implications for financial stability.



24/122

P a g e | 24

Commentators have raised two broad concerns surrounding the outlookfor long-term rates.To oversimplify, the first risk is that rates will remain low, and the secondis that they will not.In particular, in an environment of persistently low returns, incentivesmay grow for some investors to engage in an unsafe reach for yieldeither through excessive use of leverage or through other forms of risk-taking.My Board colleague Jeremy Stein recently discussed how this behaviormay arise in some financial markets, including credit markets.Alternatively, we face a risk that longer-term rates will rise sharply atsome point, imposing capital losses on holders of fixed-incomeinstruments, including financial institutions.Of course, the two risks may very well be mutually reinforcing:Taking on duration risk is one way investors may reach for yield, and thelosses resulting from a sharp rise in longer-term rates will be greater ifinvestors have done so.One might argue that the right response to these risks is to tightenmonetary policy, raising long-term interest rates with the aim offorestalling any undesirable buildup of risk.I hope my discussion this evening has convinced you that, at least ineconomic circumstances of the sort that prevail today, such an approachcould be quite costly and might well be counterproductive from thestandpoint of promoting financial stability.Long-term interest rates in the major industrial countries are low for goodreason: Inflation is low and stable and, given expectations of weakgrowth, expected real short rates are low.



25/122

P a g e | 25

Premature rate increases would carry a high risk of short-circuiting therecovery, possibly leading ironically enough to an even longer periodof low long-term rates.Only a strong economy can deliver persistently high real returns to saversand investors, and the economies of the major industrial countries are stillin the recovery phase.So how can financial stability concernswhich the Federal Reserve takesvery seriouslybe addressed?Our strategy, undertaken in cooperation with other regulators and centralbanks, has a number of elements.First, we have greatly increased our macroprudential oversight, with aparticular focus on potential systemic vulnerabilities, including buildupsof leverage and unstable funding patterns as well as interest rate risk.Under the umbrella of our interdisciplinary Large Institutions SupervisionCoordinating Committee, we pay special attention to developments at thelargest, most complex financial firms, making use of information gatheredin our supervision of the institutions and drawn from financial marketindicators of their health and systemic vulnerability.We also monitor the shadow banking sector, especially its interaction withregulated institutions; in this work, we look for factors that may leave thesystem vulnerable to an adverse firesaledynamic, in which decliningasset values could force leveraged investors to sell assets, depressingprices further.We exchange information regularly with other regulatory agencies, bothdirectly and under the auspices of the Financial Stability OversightCouncil.Throughout the Federal Reserve System, work in these areas is conductedby experts in banking, financial markets, monetary policy, and otherdisciplines, and at the Federal Reserve Board we have established



26/122

P a g e | 26

our Office for Financial Stability Policy and Research to help coordinatethis work.Findings are presented regularly to the Board and to the FOMC for use inits monetary policy deliberations.Second, recognizing that our monitoring of the financial sectorwill alwaysbe imperfect, we are using regulatory and supervisory tools to help ensurethat financial institutions are sufficiently resilient to weather losses andperiods of market turmoil arising from any source.Indeed, reflectingexpectations embodied in the new Basel I I I andDodd-Frank standards, the largest and most complex financial firms havesubstantially increased both their capital and their liquidity in recentyears.Our current round of stress testing of the largest bank holdingcompanies, to be completed early this month, examines whether thelargest banking firms have sufficient capital to come through a seriouslyadverse economic downturn and still have the capacity to perform theirroles as providers of credit.In a related exercise, we are also asking banks to stress-test the adequacyof their capital in the face of a hypothetical sharp upward shift in the term

structure of interest rates.Third, our approach to communicating and implementing monetarypolicy provides the Federal Reserve with new tools that could potentiallybe used to mitigate the risk of sharp increases in interest rates.In 1994 the period discussed earlier in which sharp increases ininterest rates strained financial markets the FOMCs communicationtools were very limited; indeed, it had just begun issuing publicstatements following policy moves.By contrast, in recent years, the Federal Reserve has provided a great dealof additional information about its expectations for the path of theeconomy and the stance of monetary policy.



27/122

P a g e | 27

Most recently, as I mentioned, the FOMC announcedunemployment andinflation thresholds characterizing conditions that will guide the timing ofthe first increase in the target for the federal funds rate.Further, the FOMC stated that a highly accommodative stance ofmonetary policy is likely to remain appropriate for a considerable timeafter our current asset purchase program ends.By providing greater clarity concerning the likely course of thefederal funds rate, FOMC communication should both make policy moreeffective and reduce the risk that market misperceptions of theCommittees intentions would lead to unnecessary interest rate volatility.In addition, the Federal Reserve could, if necessary, use its balance sheettools to mitigate the risk of a sharp rise in rates.For example, the Committee has indicated its intention to sell its agencysecurities gradually once conditions warrant.The Committee also noted, however, that the pace of sales could beadjusted up or down in response to material changes in either theeconomic outlook or financial conditions.In particular, adjustments to the pace or timing of asset sales could beused, under some circumstances, to dampen excessively sharpadjustments in longer-term interest rates.ConclusionLet me finish with some thoughts on balancing the risks we face in thecurrent challenging economic environment, at a time when our mainpolicy tool, the federal funds rate, is near its effective lower bound.On the one hand, the Fedsdual mandate has led us to provide strongsupport for the recovery, both to promote maximum employment and tokeep inflation from falling below our price stability objective.



28/122

P a g e | 28

One purpose of this support is to prompt a return to the productiverisk-taking that is essential to robust growth and to getting theunemployed back to work.On the other hand, we must be mindful of the possibility that sustainedperiods of low interest rates and highly accommodative policy could leadto excessive risk-taking in some financial markets. The balance here isnot an easy one to strike.While the recent crisis is vivid testament to the costs ofill-judgedrisk-taking, we must also be aware of constraints posed by the presentstate of the economy.In light of the moderate pace of the recovery and the continued high level

of economic slack, dialing back accommodation with the goal ofdeterring excessive risk-taking in some areas poses its own risks togrowth, price stability, and, ultimately, financial stability.Indeed, as I noted, a premature removal of accommodation could, byslowing the economy, perversely serve to extend the period of lowlong-term rates.For these reasons,we are responding to financial stability concerns withthe multipronged approach I summarized a moment ago, which relies

primarily on monitoring, supervision and regulation, andcommunication.We will, however, be evaluating these issues carefully and on an ongoingbasis; we will be alert for any developments that pose risks to theachievement of the Federal Reservesmandated objectives of pricestability and maximum employment; and we will, of course, remainprepared to use all of our tools as needed to address any suchdevelopments.



29/122

P a g e | 29

Re-evaluating the universal banking model:Can the Volcker, Vickers or Liikanen rules

make banks safer?Remarks by Mr Pentti Hakkarainen, DeputyGovernor of the Bank of Finland, at the 4th Futureof Banking Summit, organised by EconomistConferences, ParisThoughts on the reasons why the universal bank model exists, i.e. why itis valuableThere are benefits from combining different business lines under oneroofThere are a number of reasons why banks combine several business linesunder one roof:strive for optimal use of capitaldiversification of risk asdistribution of profits and losses of differentbusiness lines are less than fully correlated synergies from combination of different expertisesservicing the multiple needs of clients, especially in the case ofcorporate clients (one-stop-shopping)There is now one way of structuring a universal bank.E.g. some universal banks have numerous business lines under one legal

unit, whereas other universal banks operate as a holding group ofseparate companies.The business lines or legal units can be defined based on e.g. businessareas or functions and/or geographical reach.



30/122

P a g e | 30

The way banks aim to be structured is crystallised in the strategy, but e.g.M&A history and ability to achieve organic growth has had a great impacton how universal banks are structured today.However, some banks already see the value of applying a universal bankmodel where various business activities are clearly structured andbusiness lines are legally separatedEven without regulation requiring so, many banks already managedifferent business linesseparately, which closely resembles a structurewith different legal units.Banks find management, risk management and HR /recruiting easier ifthe business is separated along logical units, i.e. functions/activities

which fall naturally together.From a risk management perspective, portfolios are already managedseparately.In some cases an important driver for legal separation of businesses isDisaster management, i.e. keeping particularly risky or vulnerablebusiness in a separate legal unit thus making it easier to divest/ withdrawwithout exposing the rest of the operations for contagion by cuttinglinkages rapidly.There are also benefits of being organised along separated business lines.The pricing of internal funding of business units can be arranged atarms length with risk-adjusted transfer pricing.Allocation of economic capital can be done by business line and even atthe level of individual customers, which support decision making andcarrying out the business in an optimal way.Making the structure of universal banks clearer would simplify thegovernance of banks and improve risk management.



31/122

P a g e | 31

I have some insights from practice on what the consequences of legalseparation of business lines could be.In my view legal separation would benefit in particular the governanceand risk management of banks.As the HLEG report states, I have also experienced that the cultures oftraditional retail banking and investment banking/ trading activities arevery different and blended cultures can cause problems.The nature of the business and the attitude towards risk-taking aredifferent.In investment banking and trading activities profits are generated byactively seeking risk-taking opportunitiesby opening risky positions.Whether these risk exposures had good risk-adjusted return prospects,has often been of secondary importance.Models and warning signs flagged by risk management were oftendisregarded; high risks were taken even if the probability of success waslow and the potential downside was significant.In traditional retail banking, profits are mainly earned from interest rate

margin income from long term customer relationships in a more stablemanner.Credit quality assessment and pricing policy lie at the core of thebusiness. Also the time horizon differs markedly.In the trading activity the results settled and assessed every single day.

In retail banking profits are generated over several years time period.The responsibility and independence of the management is enhanced ifbusiness lines are separated to legal entities.



32/122

P a g e | 32

Separation also facilitates management, risk management andH R /recruiting, as the objective and needs are clearer in a separatelydefined business unit.Aligning incentives to the strategy of the business line by means of targetsincluded in remuneration schemes will also be easier.If the operations to be separated are logical units then it is mostprobable that required reporting systems to support governance arealready in place.Separation will also facilitate monitoring by external stakeholders thusimproving market discipline, which can be seen as an extension to the

internal corporate governance mechanisms.

Specifically, separation may improve transparency and reduceuncertainty about the quality of banks as an investment opportunity thusfacilitating pricing of the separated parts.This, on the other hand, would improve the access to market fundingamong above average quality banksMoreover making the structure of universal banks clearer through

separation of businesses also facilitates the task of supervisors andauthorities responsible for resolution.Separation will certainly facilitate the application of recovery andresolution measures hence reducing the likelihood of public bail-outs,which would in turn have dramatic implications for e.g. funding costs.Differences between the proposals of Independent Commission onBanking and High level Expert GroupThe difference in the location of the ring-fence is important, ...



33/122

P a g e | 33

John Vickers has made very insightful comments on the compatibility ofthe proposal of his group, the Independent Commission of Banking withthe proposal of the High-level Expert Group.I have a few comments on this theme:ICB and HLEG proposals started from different directions; theapproach taken by ICB started from the narrow banking philosophy,whereas HLEG focused on the most volatile parts of banking business.However, the groups ended up with qualitatively similar proposals.As John Vickers has stated already, the main question as regards theposition of the ring-fence isWhere should securities underwriting be; in

the investment bank (such as in ICB) or in the deposit bank (as inHLEG)?Another difference is that ICBsproposal includes geographicalrestrictions as non-EEA customers cannot be served by the deposit bank.This highlights the focus on the viability of the UK banking sector in theICB.HLEG is based on the view that underwriting is closely connected with

corporate banking and thus naturally belongs to the deposit bank.From the corporate clientsperspective, issuing a bond is an alternativeway of financing to taking a bank loan.From the banks perspective, there are similar elements in both, becauseboth involve a customer credit quality assessment, although inunderwriting the banks own position taking is normally quite limited.It is true that a promise of market making can be an importantcomplement to a successful underwriting of a bond.



34/122

P a g e | 34

However, separate entities within the bank group can well provide theunderwriting and market making services without any additional cost tothe customer.HLEG did emphasise the importance that authorities require additionalseparation if that is needed to make the recovery and resolution planscredible, a measure that would bring the HLEG separation proposalcloser to the ICB ring-fencing proposal.The proposals are also somewhat different with respect to the height ofthe ring-fence.The ICB included restrictions on cross-ownership, for example.As suggested by the Parliamentary Commission of Banking, tasked withthe pre-legislative review of the bill, the ring-fence will now beelectrifiedby giving authorities reserve powers to require fullseparation.... but the difference in capital requirements imposed on retail bankingmay have greater implications for banks.However, in my view the fundamental difference between the twoproposals is the difference in capital requirements.ICB imposes an extra capital requirement on the ring-fenced retail bank(~deposit bank).The HLEG was more concerned ofstrengthening the capitalisation ofthe trading entity and therefore suggested a review of capitalrequirements on trading book requirements.It also suggested a review on capital requirements on real estate relatedlending.HLEG did, however, not make any explicit requirement on imposinghigher capital requirements.



35/122

P a g e | 35

I do recognise that the requirement to issue designated bail-ininstruments can be interpreted as higher capital requirements.These would, however, apply across business lines not only to the depositbank.Some banks might be able to implement separation without significantcosts as many banks already have the needed governance system in place,whereas suggested changes to the funding structure (tougher capitalrequirements) could entail additional costs.I tend to agree with the critiques that it can be challenging for thering-fenced banks to remain viable as the relatively narrowly definedoperations might not be sufficient to generate the profits needed to buildup the required level of capital.On the other hand, the HLEG proposal would not separate moreactivities than mandated, and this might be the voluntary outcome insome banks.It would also be very important to ensure that capital requirements arealigned globally to ensure the level playing field of banks.Now ICB proposal will set the UK banks and foreign subsidiaries in a

disadvantaged position in comparison to foreign banksnon-subsidiaryoperations in the UK and with non-UK banks which can provide UKcustomers with financing elsewhere.Finally, I would like to highlight the importance of sufficient lossabsorption capacity across business areas.As highlighted in recent work by Anat Admati and Martin H ellwig,imposing higher capital requirements has a positive impact on bankincentives and behaviour.Among other things, well-capitalised banks maintain their lending alsoduring downturns.



36/122

P a g e | 36

Proprietary trading and market making is the question whether they areseparable or whether they should be separated?The first argument for the approach taken by HLEG is based on thedesired scope of the safety net. It is important to note that in the proposed separation, the question isnot whether certain type of market making supports the real economy ornot; as a starting point, all banking activities support the real economy.Instead, the question is whether there is a market failure of some degreein certain banking activities so that those activities need to be publiclysupported by giving them access to insured deposits as a funding base.I.e., is it so that market making cannot be carried out in a profitablemanner without cheap funding from deposit taking?If that is the case, then it means that market making is cross-subsidized.To draw on a recent comment by Darrell Duffie the more limited thetypes of risks that are legally permitted by those within the safety net, theless opportunity for moral hazardI would like to highlight theimportance of ensuring that as small a fraction of banking activity aspossible, preferably only the activities essential to the functioning of the

society, i.e. the deposit taking, payment system, and perhaps lending tohouseholds and SMEs, ought to benefit from a government safety net.When deciding what activities are allowed to be funded with insureddeposits, there may of course be a question of level playing field betweendifferent jurisdictions.But that should be addressed via sufficient harmonisation of the structuralmeasures taken, not by being too lax about extending the use of deposits.In short, there appears to be no clear case that market making,excluding few exceptions, ought to benefit from explicit or implicitgovernment guarantees.



37/122

P a g e | 37

So, market making should not have access to insured deposits.The second argument underlying the HLEG proposal relates to whetherit is possible to make the distinction between proprietary trading andmarket making. From a regulatory and supervisory perspective it is very challenging todraw a clear line between proprietary trading and market making.E.g. in the US the implementation of the Volcker rule has been delayed asa result and when implemented the supervisors will have to rely ontedious transaction-by-transaction supervision.In its pure form, market making is not about taking open positions and

the price spreads given re very narrow.Only when things do not go as planned inventory is building up and thisis when we get closer to the territory of proprietary trading.At the level of the trading floor, it is relatively easy to distinguish theproprietary trading and market making.However, things can also be hidden if so desired, hence making thesupervision potentially very difficult.



38/122

P a g e | 38

Reflections on reputation and itsconsequencesSpeech by Ms Sarah Bloom Raskin, Member of theBoard of Governors of the Federal Reserve System,at the 2013 Banking Outlook Conference, FederalReserve Bank of Atlanta, Atlanta, GeorgiaGood afternoon. I want to thank the Federal Reserve Bank of Atlanta forinviting me to join you for todays2013 banking outlook discussion.There are a number of interesting and very relevant topics on youragenda, most of which are rightly focused on the financial and regulatory

environment.I would like to share some thoughts this afternoon on a broader topic,however, that may be due for a refreshed look: the relevance of a banksreputation.Letsstart in an elementary way in constructing a concept of reputation:

We know that reputation is not entirely a moral trait.We understand that there is a distinction between character andreputation.When we say that someone shows good character, we are usually referringto something at the core of their being or personality.On the other hand, when we refer to a persons reputation, we recognizethat reputation is our perception of the person, that it is externally derivedand not necessarily intrinsic to that individual.In other words, we understand that a person may not have completecontrol over the perception that has been created.Reputation, through no fault of onesown, can be tarnished.



39/122

P a g e | 39

In the same way, onesreputation can be golden, even though nothingwas done to earn it.But like the notion of character, reputation can be earned and it can be atype of stored value for when challenges to ones own reputation comelater.Now lets bring this distinction into the context of banks:Many bankers have a sterling character, and they operate financialinstitutions with sterling reputations that reflect that basic character.At the same time, there are bankers who, regardless of their personalcharacter, manage financial institutions with reputations that have been

tarnished.

Their banksreputations could hav

risk management presentation march 18 2013

Documents