 Welcome back. Let me first of all make one sort of final call which is please use the last opportunity to read to rate the posters that are on display. We will close the voting procedure at 12.30 sharp so please use the last occasion to submit your votes for the electronic posters. Now Vitor Constantio, vice president of the ECB will introduce his guests and open the panel discussion which will be followed by a question and answer session. He will also raise a few polling questions to be answered via the iPad. Thank you. Thank you Thierry. So we start now this panel more in principle policy oriented under the shadow of the two good papers we had before and all the subjects that they raised and whereas the members of the panel are totally free to speak their minds about the subjects they have picked up nevertheless I would hope that they will address the general assessment that Dariel Duffy had in his paper about the success or partial success of the regulatory reform that has happened so far it would be nice to have that that that view and by the way I will start even before giving the floor to the members of the panel I will have a question for the audience in the iPad precisely about that general issue which I think will provide a good introduction to the discussion and then we have discussed a little bit how these will go in terms of the aspects that each member of the panel will develop and we very much I am very much hope that Claudia in the end picked up to speak about issues of the decision-making and governance and about the role of microprudential policy in all the changes that we saw in financial regulation that Andrew will speak about the change in structure of the system as a result of the competition that banks are getting from non-banks entities in particular those that are now coming in coming from the digitalized world and that then there will address the structural issues raised by the paper of Stein and also I hope a little bit about the questions of too big to fail and the legislation that has been put in place in different jurisdictions to address that problem but as I said they are free to speak to address the subjects that they feel were more relevant for them but before giving the floor to the panel I then we'll have the first question to be expected perhaps there was a normality range yeah absolutely perhaps there was a slight misinterpretation of the first option which was not to portray the regulatory reforms as totally positive that you know they would have addressed and solve the problems that were at stake that was not the intention of the first option but okay to be expected that by the way coincides with the assessment that they're all made also in his paper and explained at length why you can see that that so we have a very good panel of course I think all the members dispense any lengthy presentations Claudia Borg is now deputy president of the Bundesbank very she's in charge of financial stability so very appropriately Andrew Shang has extensive curriculum he has been a central banker in monetary authority of Hong Kong he has been chairman of the Securities Commission in Hong Kong and is now a distinguished fellow of the Asia Global Institute at the University of Hong Kong and also chief advisor to the Committee of Banking Regulatory Reform in China so among other things and there of course is now chairman of the New Economic Thinking Institute and a member of the House of Lords and before a very active member as chairman of the British FSA in the initial five years of international reform with his active role in the FSB so these are I think the important points to the white light and I give the floor then to Claudia please thank you very much Vitor thank you very much for having me here to give a few thoughts on financial regulatory challenges and actually the the question that was just being asked to the audience here was almost exactly the same question as was being asked to the FSB members in a workshop we had in May this year so how do you assess the effects of reforms and we had a very interesting discussion there on which I will actually highlight a few things the FSB has been mentioned a lot in the in the previous session in the starting point for the discussion we had there was where we initiated a lot of reforms and Dario mentioned the different dimensions of the opposite of the FSB reforms we started these reforms to make the financial system more resilient to contribute to and ensure its contribution to economic growth but reforms were started with a lot of questions open questions and we've heard about Stein talking about the structure of the financial system how do reforms interact in different types of financial systems what are the cross-border effects of financial reforms how do we talk about the overall effects of reforms so typically we have with financial regulations that target some micro level incentive mechanisms but how do we make sure that we have the intended outcome at the at the aggregate level what are if we think about this and in general equilibrium what are the effects on other parts of the of the economy so there there are lots of questions that have to be answered by by policymakers by by academics and the I don't have an answer to all of these questions and I only have my whatever 10 over 10 minutes here so what I would like to propose I would like to propose a structure that we should give to answering these these questions and these this structure then would have to be embedded into policymaking at different national levels institutional structures are going to differ but I think the overall process should be similar across countries and I would be interested in getting some discussion also on this so again why do we need this why do I think we need a more structured discussion of policy effects and reform effects well because we couldn't test many of the reforms that have been implemented ex ante so in an ideal world we would have more time for ex ante impact assessment but you all know that time has been has been short so evaluating what we have done doing doing causal impact assessments at exposes even more is even more important so let me give you a general structure of this of this evaluation process and it has some similarities actually with the way how we conduct monetary policies so you know has mentioned that the similarities between regulatory policies macropodential policies and monetary policymaking they're not perfect they are differences but if you want to think about this this structured process I have in mind try to think about it in the way we also tend to think about monetary policy so one is it seems the natural point but it's not always clear when you when you ask policymakers what exactly are the objective of reforms in particular how should you measure whether these objectives have been have been reached any of such process has to start with a definition what do we want to achieve and for some reforms we have macropodential objectives for some reforms we have micro potential objectives or we might have other policy areas that interact with our regulatory reforms like consumer protection competition policies so I think this should be clear from the beginning what do we actually want to want to achieve now and here comes the difference to monetary policy where over over I would say decades of work going back and forth between policy and academia we know pretty well what are the objectives of the reforms of course this is different for financial stability policies where we don't have these these clear clear targets so that means we have to define intermediate targets that we want to achieve and one key argument I want to make here is that we also need to give the system sufficient time to adjust to the regulatory reform so we some of the reforms we are talking about have been implemented relatively recently so it the system of course needs time to to adjust then the third step giving this the targets intermediate targets is to calibrate instruments depending on the specific policy goals we want to achieve and let me make one point here this anti-impact assessment then to be followed by an exposed after we have implemented the reforms this really has to take the different structure features of countries and financial systems into into account so this very much aligns with the points Stein has made so we will have different models we'll have different approaches of how do we want to calibrate instruments how do we how do we want to set some macro potential policies in in particular you know that macro potential policy is still a national mandate and then the fourth step will be to to assess the effects of reforms exposed and try to see whether we achieve the intended objectives recalibrate if needed but without compromising obviously on on resilience so this whole process of policy evaluation I would argue can be misleading if we just look at time series indicators trending up or down and if we precisely like we've discussed if we don't take the structure of the financial system into into account and I would just want to give two examples one is and it's also relating to work that we are currently doing on the leveraging and capitalization across countries I will I will show you the details in a second and the second quick point I want to make is about how do we want to interpret trends in bank profitability there's intensive discussions about this now how can we relate this to financial stability that's an open question so let me start just with a few graphs which to some extent probably also look familiar to you one of the issues that we have discussed before is that the capitalization here these are data on European banks you would also see it for global banks capitalization of European banks has increased since the crisis and we all know the difference between capital relative to unweighted assets and weighted assets the increase in the in the capital relative to unweighted assets the inverse of the leverage ratio has been less pronounced than the increase in capital relative to weighted assets so that's one indication that the financial system is more resilient when you look at deleveraging we discussed yesterday we discussed a lot deleveraging trends we again see that there's an the the accumulated change of weighted assets has been stronger than for for unweighted assets so we have to see that of course how to interpret this in terms of stability depends on the on the quality of the risk assessments and then again this is something we referred to yesterday we've seen very different degrees of private sector deleveraging so this is just credit to the private sector and what's interesting about this slide is that the is that the trends have been similar before the crisis but despite similarity in regulation and regulatory change the adjustment after the crisis has been much much different and what we did in one big research project it's a coordinated research project across countries was to look at well what are the drivers of this deleveraging or the the lending of banks to what extent is it related to is it related to regulatory change so that's for those of you're not familiar with it this is the the international banking research network which brings together researchers from from central banks and from international organizations to look at micro data so it's basically the micro data underlying the BIS banking statistics that we're using here and one interesting finding from this is that actually the effects of of potential policies leakages where we mentioned in the previous session are very different across countries are very different across banks business models so there's this is one common finding that it depends on whether or not the regulations are binding not very surprisingly so there's some confirmation of basic principles that we find here but other than that we find a very heterogeneous response to these potential policies also in terms of spillovers this is why we can't have this one-size-fits-all regulatory approach we need to look at the specific underlying features of the data the second quick point i want to make maybe because it's also very much related to the discussion in in germany but also a discussion we have at the european level bank profitability so many observers are concerned about bank profitability which has tended to decline after the crisis i should say though that in particular in germany there's been a structural decline in bank profitability over the past two decades at least and this is of course now becoming a bit more more aggravated what is driving it actually lots of lots of factors and i think this is something what's what's often overlooked in the debate obviously regulatory reforms matter monetary policy matters it's not clear in which direction it pretty much depends on the on the on the interest elasticity of banks activities and also structural change so one of the issues that is often overlooked the low productivity that again we've discussed yesterday of course that has an impact on the profitability of of banks so when you take all of that together it's not so clear that regulation placed the the most important role and it might even be that some decline in bank profitability that we are observing is an intended effect of the reforms if it makes the banks safer so in that sense it's not so clear how to link bank profitability to regulation and then the second step how exactly is bank profitability related to risk taking and financial stability that's also not entirely clear i don't have the time to go into the very details but let me just sum up with them with three main points so i think again coming to the question that we saw on the in the little survey that was done here i think we have to assess the the success of regulatory reforms against our ability to to lower systemic risk and to increase capital we also had a discussion about what does it mean for stock and flow adjustment obviously the the flow adjustment this is also what you see in the cross-border capital flow data the flow adjustment has been much faster but i think we have to refocus the discussion on the stock adjustment we need a structured process for for impact assessments precisely to take into account a timing of reform structural changes of the financial system and the drivers of heterogeneity that we have in the data and i think maybe one point i mean it's very obvious but it's often overlooked when you when you look at the regulatory discussions what's happening in the real economy and how also how are financial structures related to the structure of the of the real economy i think this is also an important point to bear in mind thank you very much well thank you claudia i apologize to you because i forgot to mention that uh ravi menon the chairman of the singapore monetary authority was also part of this panel but he had to drop out at the last minute which means that each member of the panel has a few more minutes of course for their presentations and i forgot to say that before you started so i will try to compensate you in the discussion and i'm sure it will be all right we have time then for a deeper discussion so now i give the floor to andrew please thank you very much vito for your kind invitation to join this very rare prestigious it's wonderful to be amongst old friends and meet many new friends i've been stuck in somewhere out in asia and thinking through what are the problems of the shadow banking in china which is actually you know forced me to to think through some of the issues that china is transiting and so the regulatory challenges that i present do not represent the views of the cbrc csrc or whoever any institutions i represent but i thought the difference between asians and westerners is that we always start with an apology so if there's anything that i criticize or appear to criticize let me apologize and if i am wrong i may have to commit harakiri but never mind so let me first i'm a i grew up in your island of borneo which is really still very wild but i studied in england and in england you learn how to praise everybody first before you cut them down to size and so let me praise what has happened i think such regulation has succeeded very very well uh in raising higher capital ratios define liquidity standards pushing tlac uh there are some corporate governance changes i totally agree with charles uh and there is greater you know attention on conduct but i think the uh it used to be said that asian regulators overregulate and under enforce but this time the enforcement is mostly on aml sanctions the busting etc and so that now that banks who have been trading with some some place called iran and now iran is an ally can we get a discount back but anyway so this is the this these are issues that we need to be very uh clear now where regulatory outcomes have flaws i think uh darrow toffee has done this very well and you know the the previous panel has made a lot of discussions i want to make several key points the first one is that i for one would never want to be on a bank never want to be an independent non-executive director because everything i do i have to check the regulations and if i who had a hand minor hand at least in basel the tool and of course the iosco principles etc if i can't understand it can you imagine some people have problems with this you know uh i read some of the consultation papers and by the time you cross check you know subsection three three reference to practical one reference to certain models reference to parts of of dot frank that has not yet been written how am i going to write my regulations and my complex processes in this issue so the result is what has happened i'm sorry to say this is that when bankers are being micromanaged almost by regulation that's how they feel i'm not saying that they are and there are huge sanctions on them but they move to asset management and fintech and startups they have no such thing where are you getting the talents the danger of excessive sanctions is that you are shooting the survivors of the crisis the guys who caused the crisis are retired somewhere in some very nice place with their all their bonuses none of them went to jail so you know this is an issue that we need to be very carefully careful about the second one of course is about operational risks now any of you who have implemented it systems would know this to get very complex it systems to work together you need to understand very complex rules very complex standards and anything that's understand your system won't work which is why every stress test and examination of any bank you would find they don't have integrated systems they don't have in integrated information systems they have 40 50 different risk models in their system and they they suffer from what we call pilot dial stress what does that mean when the pilot sits there with 40 50 dials he's looking at a dial he's not looking at where the plane is heading and that's when you impose so many risk models into the system the the ceo suite is not concentrating on the business model risk and i think charles and funcion had mentioned this and i'm going to stress this the second one is of course is the risk model we have actually moved to an age and i think mermin king's book raised this if we didn't understand money we didn't understand finance because we completely took risk models as measurable volatilities when the biggest risk is uncertainty right so you know the risk models are too many too flawed they can't cope with radical uncertainty arising from changing geopolitics brexit is geopolitics south china sees geopolitics north korea is is etc etc all these together with technology is changing all this and at the same time as we all know we're worried about secular deflation and what is secular deflation why are we worried about the u.s racing interest rates because if the interest rates are now raised under a situation of near zero interest rates asset bubbles will deflate and if real estate bubbles deflate you're gone and the reason why you're gone when we talk about one two three four percent of capital of risk-based capital and the real estate market is 250 of gdp sorry even 15 percent of capital is not enough so get real there's no such thing as getting rid of too big to fail they are all too big to fail now having you know made these controversial statements let me now go back to stein's paper which i really admire because he was a former colleague from the world bank but i want to step back a little bit on this issue because finance to me is a derivative of the real economy it has a very complex interactive derivative feedback in fact in fact with the real sector and if you don't understand how the real economy is changing you don't understand how finance is changing because finance is supposed to serve the real sector and the the whole crisis showed that it wasn't serving the real sector in fact the real sector had to pay for the mistakes of finance right but in looking at the chinese financial system reforms particularly for rising from the shadow banking i suddenly realized my god china is moving in a in a breakneck speed into a new service driven knowledge economy in which creative destruction is happening and if that is the case if we don't understand how the real sector is economy how can we fix the old finance model and let me explain this in as simple as possible now andy haldane and all the others have always said finance is actually networks okay and if it's a network look very carefully we have moved from a hardware economy to a software economy roads ports airlines c all hardware and then on top of them we built the telcos right recently i went to spain and we looked at a business model of a telco suddenly i realized my god the telco is actually a bank because the telco has a customer and a bank account not a deposit account at the end of it the only thing that stops a telco of becoming a bank is regulation but the telco was complaining that banks sit on us because they move all the the information through us and they're eating our lunch right but hello suddenly you realize that the rise of aribaba and amazon is actually eating the bankers lunch now when i use the word fintech i don't really mean all these little startups i really mean the google's the amazon's the facebook's they have a billion customers the only thing that is stopped you know amazon are all this moving into finance is regulation in china the regulator did not stop aribaba moving into the finance area and all of a sudden once you serve multi markets aribaba is an ecosystem that straddles production distribution logistics and by the way finance it made it completely convenient for the guy to do this by phone now if you worry about aribaba there's a company called Tencent which did not exist 15 years ago which today has 697 million customers and market cap larger or equal to the size of icbc which as you know is the largest bank in the world market cap larger than icbc with customer base larger than icbc right and 10 times that of the largest bank in germany so you know if these guys are not eating these guys lunch i don't know what is because when amazon.com serves you and eating the retailers lunch etc etc and then suddenly by the way i can offer you services and i'm a lifetime cost lifetime supplier for all your range of service amazon.com can offer you 1.8 million women's dresses of different designs and sizes the largest Walmart mall can't even do this they'd be lucky to have 10 000 so the the technology is changing all this in ways that we don't understand so let me come down to a conclusion i recently talked to some bankers in in singapore and i said this i apologize before i say it i said zero interest rates is taking away your lunch regulation is squeezing your lunch fintech is eating your lunch and some of you are still out at lunch and the only reason you're out of lunch is because you're protected by the by the regulation the current regulations and if the bankers business model is broken what is the regulation doing has the regulation be farcited enough to see where we are moving towards so very simply there are five radical uncertainties changing the normal financial regulation number one's geopolitics brexit is one of them i can only say this number two the zero interest rate is conflating not just the business model of banks but insurance and pension companies and fund managers who wants to pay a fund manager or bank one to one and a half percent management costs when the expected return is zero the only way the fund manager can take earn better than one and a half percent is they're doing leveraged risk so when my private banker tells me he can lend me five times my us dollar deposit in order to get a four percent return on dollars i said the business model seriously broken they've transferred the risk to the customer the third one is of course is deleveraging right the regulations are right but the timing of that regulation is pro cyclical the fourth one is fintech and blockchain is making traditional business models obsolete and creative destruction is happening so if we go back to the earlier model what you're really saying is that at the top end of the software knowledge economy that's where the new value is being created but the creative destruction is happening at the hardware level and so if you imagine a very simple model in which the whole economy moves over to the new economy the value destruction of the old economy is a loss for which we have not yet recognized and we're not able to tax so it's a it's a it's a structural issue that we really need to think about so what are the major questions well as i said risk versus radical uncertainty of course increasing capital is very important essentially our risk model said our present regulatory system is able to cope with a two standard deviation move in markets but hello they are even in the deepest and most liquid of markets moving five to six to seven standard deviations so are you surprised that central banks have moved from lender of last resort to also market maker of almost first resort right the second one is what do you really mean by level playing field we know you know kristina pistor one of the i most admire her because she said the legal theory of finance is that finance is the hierarchy of legal contracts that is highly winner take all situations so the top five banks account for 70 percent of the business the top three news networks you know for which we receive most information accounts for 80 percent everything is hierarchical and the more hierarchical they are the more concentrated they are the more fragile they are they become too big to fail and then thirdly what is fair value when the discounted value the discount rate is zero or negative we are in a mad situation whereby the models cannot measure all these situations so when another mid-sized financial crisis as ellen and you know has said when there's a flea into the safe regional safe assets how do we get actually i'm less worried about the negative real interest rates of high quality bonds as to how much the risk spread of emerging markets and triple c paper is going to shoot up very rapidly so the impact is is is like in hong kong where i learned if you suppress the price of real estate through public housing at below market prices are you surprised that private markets shoot up ludicrously in the same way when zero interest rate for high risk papers those risk free papers is now zero or negative the risk spread of emerging markets shooting up and the higher the real interest rate on emerging markets the more they will deflate and the world is now pushing to a global deflation so we are now through our i'm not blaming anybody because it's a systemic problem this is a mindset issue moving very rapidly and in a systemic problem as Claudia says this is a systemic issue of which not just finance it's actually the real sector the mindset sector are we tinkering at the margin when and and we have a pretense of perfection and pushing the complexity and envelope even more and more rather than stepping back and saying are we headed in the right direction and certainly in terms of business model that is a really problem so to to end up i agree with mario when he says we can't harmonize all this stuff we're not we're not you really have difficulty coordinating but at least we should try to align ourselves on where our common interests are and our common interest is that we're pushing the systems towards greater fragility and the chances of the world sliding to global secular deflation is increasing so to sum up i want to vary minsky's dictum which stability creates instability i i i i evolved this by talking to one of the smartest bankers you know in asia and she told me right that the managing of micro risk actually creates a macro uncertainty and i thought that's a variation of minsky that's very very useful so now we really need to align the incentives between central banks regulators of the industry to really say we can't do all the reforms that we want to do we need to give priority of what we need to do is to fix the business models of the industry that is changing very very rapidly and therefore in a situation where bankers are now feeling demoralized how do we talk to them as equals as partners in order to move ahead and concentrate on how to macro manage rather than micro manage the emerging uncertainty i think is the only solution to go i'm sorry to being too uh seem to be too lecturing too much to all you wise people but then i apologize earlier and i apologize now thank you very much indeed thank you very much andrew for this challenging presentation if i may perhaps too challenging but we will discuss it i'm sure because it was quite provocative in many aspects and now there please thank you vitro and thank you very much for inviting me to what has been an extraordinarily interesting two days in a quite wonderful place to spend time thinking about these important issues i want to focus primarily on some thoughts provoked by stein classens paper and in particular by his focus on what financial systems do vis-a-vis the real economy what functions it performs and i want to suggest that while regulatory reform since the crisis has made really quite a lot of progress in making the financial system itself more resilient we have not yet addressed the fundamental issue of how much real economy debt the financial system helps generate and what types of debt now what i'm going to say overlaps to a significant extent with what charles goodheart said earlier but with a a slight difference because charles started with the words from the confession from the english book of common prayer we have done those things that we ought not to have done and we have left undone those things that we ought to have done now i happen to agree with the second part of that statement but not the first i think broadly speaking the things that we have done were the right things but there are other things we should do as well so whether that leaves us in the position of the absolutely opening words of that confession oh lord we have erred and strayed like lost sheep i will i'm not sure i think we've done somewhat better than that but there are other things we need to do i'm actually fairly confident that the financial system is significantly more resilient than it was before 2008 that reflects the significant progress on bank capital and liquidity which daryl duffy talked about in his paper it reflects the significant process that daryl also talked about in the arenas of derivatives counterparty clearing etc and while i agree with daryl that that creates a potential single point of failure i think the fact that we have concentrated derivatives clearing in those single points gives us the capacity to set the appropriate capital and the appropriate margin requirements which will deal with that single point of failure risk as for shadow banking while we always have to be alert to the dangers created by what is a continually mutating and innovating financial system and while there are some developments in asset manager roles and practices which we must monitor very carefully as the bis has pointed out i think we should also recognize that in several ways in the advanced economies though definitely i have to say not in china the specific forms of shadow banking activities which created major risks before 2008 have significantly declined in importance as we have more tightly regulated the banks there has been some shift of credit provision to non-bank channels but that has actually primarily if you look at the figures reflected the growth of a form of non-bank credit intermediation which is the issue of single name corporate bonds by large corporates which existed long before the financial innovations of shadow banking and which in principle could be a stable form of credit intermediation and conversely we have seen a dramatic decline in the role of complex structured credit securities the alphabet soup of CDOs and CDO squares etc distributed via complex and opaque distribution chains passing through SIVs and the ABCP market and money market mutual funds and repo in non-standard securities so a lot of the institution's contracts and combinations of activities most implicated in the origins of the 2008 crisis have largely disappeared from the system so while we must never be complacent because new forms of risk will continually emerge for now i think the financial system is more resilient ahead of the brexit vote i was asked by several people in the international press if there is brexit is there going to be a lemons moment and i argued i replied that if by a lemons moment you mean that process whereby one event produces another in a self-reinforcing domino effect of crisis within the guts of the financial system itself i was very confident that the answer was no because i think we have a more resilient financial system in itself but the global economy is not in good shape it is suffering from inadequate demand and inadequately high inflation and the fundamental reason for that is that before the crisis the private financial system created excessive private leverage with private credit to GDP growing from 50 percent in 1950 to 170 percent by 2007 and that left us in a situation where post the crisis the leverage doesn't go away it simply moves around the global economy from the private sector to the public sector or from the advanced economies to the chinese economy but with total global debt to GDP as has been pointed out in several reports produced by several authors in this room total global debt to GDP now higher than ever now the before the crisis as schnein sets out the predominant academic attitude to that growth of private credit as a percent of GDP is that it was one element within beneficial financial deepening with multiple empirical studies which seemed to show positive correlations between private credit to GDP and either growth or welfare or some measure of utility and with any concerns tending to be focused on those emerging economies where there was a reasonable argument it seemed that private credit to GDP was too low and as schnein points out this positive assessment was built on an assumption and i quote from his paper that financial intermediation is about deposits and other funds passing being passed from households and then channeled to the corporate sector and that is indeed if you look at our economic textbooks and at most until recent academic papers the standard model of what we say the financial system does it takes deposits from the household sector and it allocates them as credit to businesses or entrepreneurs thus allocating credit between alternative capital investment projects but i have to say that it is as a description of what banks do in advanced economies this belongs on the same shelves of the bookshelf bookshop as harry potter it is a largely fictional account for as georda schullerich and taylor have put it that standard textbook function of bank credit intermediation constitutes only a minor share of the business of banking today and the vast majority of bank lending or in the usa of capital market lending is devoted to real estate and with a large proportion of that real estate lending in turn not actually financing actual new capital investment in new houses or commercial real estate but a competition between people or firms for the ownership of real estate assets that already exist and it is that reality which i believe lies behind the emerging empirical findings to which stein's paper refers the findings from chichetti and kerubi and from the oecd last june that there is not a linear and limitless positive relationship between private credit to gdp and growth but some sort of inverse u function a range over which there is a positive relationship and then a turning point and a negative negative element and the findings from several studies that the impact of increasing debt depends crucially on its specific nature that while an expansion of that iconic textbook private credit to fund capital investment might be beneficial high levels of housing finance seem in some cases to be harmful a finding which i suspect actually tells us that it's about real estate i think many of the studies focus on housing finance because it's the easy thing empirically to get hold of but that the implication also applies in relation to commercial real estate and with the harmful effects of excessive real estate lending arising both from the strong tendency of debt financed real estate booms to produce serious misallocation of capital a point which claudio borio and others have pointed out in papers at the bis and from the pure debt overhang effects which at if me and an amir suti have described overhang effects which could result from debt financed housing booms and busts even if there were actually no new construction at all but simply a boom in the price of already existing assets so i believe that our best understanding of the economic impact of financial deepening in particular in general and in particular of rising private leverage is now quite different than before the crisis there can be too much private leverage and different forms of debt perform different economic functions with different implications for growth and macro stability but our financial regulation agenda has not caught up with those emerging findings focusing until now on the narrower issue of how to make the financial system itself more resilient thus for instance if you look at the guideline for the application of the basal 3 counter cyclical capital buffer it says that we should apply that buffer if credit growth is progressing faster than its past historic trend but the implication of that is that if credit growth was protruding at 10 per cent per annum and had always been proceeding at 10 per annum that continual growth at 10 per cent per annum would be perfectly okay even if nominal GDP was growing at 5 per cent per annum which however would produce a relentless rise in leverage which would eventually produce some crisis which would place us in the situation where we are now with a severe debt overhang problem now of course our biggest macro economic problem today is how to escape the debt overhang position in which we are already and as some of you know I have some fairly radical points of view on what we should do about that problem but if our focus for now is what we should do to ensure that we do not in future and we do not in the first place create too much debt I believe that we should have put in place an approach to macro prudential regulation combined if possible with the sort of tax changes which Barry Eichengreen referred to yesterday which quite explicitly seeks to limit the total amount of leverage within the economy and that I believe would imply considerably higher bank capital in requirements than we have introduced so far Charles earlier mentioned the fact that Mark Carney had said that he was very confident that so far the introduction of higher bank capital requirements had not yet produced and he considered it a good thing a lower level of credit supply to the real economy let me be absolutely blunt I think we should have an overt aim of producing a less leveraged real economy but I think we should also I suggest see quite explicitly to influence the broad allocation of credit between economic functions in order to produce a different allocation than that which free market banking systems focusing on private profit maximization will quite rationally choose and here I want to suggest that the entire fundamental structure of the Basel II and Basel III internal ratings approach to setting risk capital weights is based on a profound intellectual mistake that approach assumes that risks is best managed by requiring banks themselves to assess the risk of loss the probability of default and the loss given default which they privately face but there is I believe here a massive externality problem a profound disconnect between what seems to be and what is indeed rational for the private banks left to themselves and what is optimal at the level of the whole society and economy as Steiner's references and as I have already said there is an emerging body of evidence that too much housing finance is harmful and as I have said already I believe that the more general point is that too much real estate financing can be harmful and there are many studies for instance by Claudio Borio which have pointed out that the real estate credit and asset price cycles is not just part of the story of financial and macro stability in the modern economy it is again and again pretty much 90 percent of the story but seen from the private perspective real estate lending a secured claim against an asset which has multiple alternative users not just seems to be the lowest risk thing to do but actually is often post facto the lowest risk thing to have done even if that lending has produced macroeconomic instability in the UK through this latest cycle losses on UK bank loans for residential mortgages have been incredibly low and almost no one has lost money from investing in a UK retail mortgage back security but the fact is that the boom and then bust in real estate credit and property prices still played a role in the UK and driving our recession our central problem is indeed that real estate lending and in particular residential but also commercial can be low risk for the banks and even for the banking system in aggregate even while through the debt overhang and balance sheet recession effects which Richard Koo described for corporate Japan and which Mian and Sufi described for residential America have harmful effects in Mian and Sufi's model and in Richard Koo's the macroeconomic harm of a debt overhang actually derives as much from the borrowers who do pay back their debts but who in order to pay back their debts cut investment and consumption as from those borrowers who actually default and thus impose losses on the banking system and it is indeed I fact in fact I suggest theoretically possible to describe a model in which excessive debt extended against existing real estate could produce severe economic harm without producing a single loss on any bank loan or a single loss on any traded credit security the solvency of individual banks and even the resilience of the total financial system is therefore in itself an insufficient definition of the objectives of macro prudential policy and socially optimal risk capital weights will not be chosen by banks focused even if they are rationally focused on the risks that they privately face finally then what does this specifically imply well specifically I would suggest that we should not leave the setting of risk weights for real estate lending to private assessments of risk but that for instance I think we should set a minimum capital weight for residential mortgages of say 50% with modeling used to determine whether higher weight rates are required for specifically more risky loans and for instance a minimum capital weight for commercial real estate lending of 100% or higher thus increasing the risk weights for real estate lending significantly compared with those which apply for lending in line with our classic textbook definition of banks which is lending for capital investment in the real economy now these suggestions these figures are of course only illustrative and apart from risk weights there are also other important regulations and levers which Charles Goodhart described the treatment of mortgages under the net stable funding ratio and that there are the issue as a borrower constraints through for instance loan to value limits which are high on talked about earlier but my specific examples are intended to illustrate an important philosophical shift we need to focus not just on how to make individual banks or even the whole financial system more resilient we need to focus also on how much debt the financial system produces and what type of debt thank you thank you there and the interventions both of Andrew and are there provide a good background to the next two questions that we will put to the audience so second question now conduce okay yes well if you compare Germany and the US after the second world war see may have a justification for the majority view now the next question will be about the non-bank sector and are there talked about monitoring the overall leverage of the system and for that this question is then pertinent quoting the Stein's paper very good very good so now we generalize the discussion we will start with the panel itself making some remarks or comments on the others interventions I will also have two remarks in particular to the intervention of Andrew because he also as others mentioned the fact that the banks are under pressure and in his presentation huge pressure from many sides and one side being of course the low interest rate environment I have two two remarks there the first is that of course the low interest rate environment was not created only by monetary policy but it comes also from the developments on the real side that have determined a big reduction of what we can say a real equilibrium interest rate which has according to several estimates become negative both in the US and in the euro area in my more recent speech I reproduce internal estimates from our experts about real equilibrium interest rates in the euro area and they come out as negative also and significantly so so that's one point but that's not the main point I wanted to make because the effect of the expansionary monetary policies that exist in particular in the euro area is broader on the profitability of banks it's not just the effect on margins and about margins I have a later point to make but it's not only that there are temporary effects that offset that effect first capital gains because part of our policies have increased asset prices and decreased yields and we register in the accounts of the banks last year for the whole year we registered capital gains that were significant also by helping the recovery we see that there has been a reduction in impairment costs throughout last year and there has been also an increase in volumes of credit and credit was decreasing in the euro area until mid 2014 and it was as a result of our several policies credit easing the liquidity provision longer term and so on that indeed credit started to increase again and is increasing the low environmental interest rates also reduces the cost of funding for banks that use market-based funding and there are many particular in weaker economies and by our policies we have reduced and bring to negative territory the all-money market curve up to 12 months and so the cost of funding for banks has decreased well the so taking all these into consideration we have well the past and we have model-based projections that give that at least until the end of last year the overall effect on average on profitability of banks is positive. Part of these effects are temporary like the capital gains of course we know that so which means that certain type of policies have limits and we are aware of those limits and cannot go forever or go much further and we know that but that's the reality and what we are doing we are doing for other reasons than what happens to the banks and that justifies the policy but even about interest rate margins let me say that there is something that is partially free in terms of the decisions of the banks which is their lending rates they are constrained by the alternative of bond financing but only for big firms for SMEs or also that alternative is not there so in principle they were free and could offset which we would not like but they could do it what are they not doing in most countries well it has to do with the structure of banking and the element of over banking compare with what is happening in sweden in sweden negative rates and interest rates are even lower than in the euro area the banks in sweden are having a very nice net interest margin and they have protected you know their business because there are very few banks in sweden in the Nordic countries by the way because there were mergers across border whereas in other countries well banks do in view of competition cannot use that so that's a final comment about the new giants that are coming and I don't deny they are coming not the very small peer-to-peer institutions and so on that will not go anywhere in my view it will not become a big thing but the things you mentioned yes you are right but then let me say if such institutions will go into providing credit and receiving funds from the public then the whole type of externalities that have the justify regulating banks then will justify to regulate those activities necessarily because symmetry of information, adverse selection everything then will be there and society we have to be protected the same way that led to the development over history of banking activity so we have to have that also into perspective and with this I give the floor to the members of the panel first and then your question so Claudia please thanks so from Pollack discussion we had here I would have two additional questions one could ask to the audience and I think the answers would be pretty clear one is about complexity of regulation I think most of us would agree that the regulation is extremely complex and that's creating all incentives for regulatory arbitrage and also the the notion that the risk weights we have in the regulation are not reflecting are not systemic risk weights I think that's also something which is pretty pretty clear now the question is how do we get from here to there so we have this framework now and we could all wish a different world but this is where this is where my argument comes in that we really have to have a good process of how to look at what are the negative side effects of the regulation we have in place now and that requires very detailed work using microdata really detecting the where incentives go often where we have perhaps misaligned incentives and regulatory arbitrage I think at the same time we also need a better public debate on what financial stability policies macro potential policies are about because if you follow I don't know I can't follow obviously the discussions in other countries but if you follow the discussion in Germany you have a very hard time explaining what we are doing with with macro potential policy with financial stability policies over and above the the standard regulation of banks because the response you very often get to the points when it comes for instance to to really state finance people would say well look at the german housing market look at the situation everything is fine I mean we are you know the lending terms are very solid which I mean this is our general assessment right now is that we don't see a deterioration in lending conditions but we may have to we our assessment of the situation may change we may see see that the price increases also leading to to to credit growth which could which could be unsustainable so that that may happen but the general perception is that we are immune against this and I'm sure there are similar discussions in other countries we saw the the slides on on Spain and I mean with hindsight it looks it should have been clear obviously it wasn't such a clear case to to the observers at the time so we need both we need this detailed process we need good micro data we need to look at what are the effects of the reforms and we need good narratives let me call it narratives on why financial stability policies are important I think otherwise we're not gonna gonna get there that by the way is also concerned about this the the regulatory risk weights when it comes to real estate I mean this is I think also the lesson from the UK it's not enough to target the supply side but also to have instruments in place for the demand side and but I think you would agree on it thank you Claudia and you do you want to say something about the others no I think I want to emphasize that I have gone beyond blaming anybody it's not a cause or effect issue yeah yeah right low interest rates are actually both a cause and an effect it's actually the interaction of you know maybe excess savings you know in the world today maybe insufficient demand aggregate demand and this leads up to a low interest environment especially in the advanced markets but you notice what is happening that low interest rate creates huge asset bubbles last year we've already moved slightly beyond that last year peaks in stock markets peaks in asset real estate markets you know peaks in bond market prices right not yet finished but that's essentially the game but then what has happened effectively emerging markets are devaluing around this so you know your real interest rate uh the it's not the risk-free real interest rate it's the actual lending rate factoring into emerging market risks are actually causing the emerging markets to deflate even faster and so advanced markets if it's not careful and because there's no money I mean you know Nick Stern on his environmental report says if we don't spend six trillion dollars a year on climate change we're going to burn up it's a huge market failure that we have the huge liquidity washing around the world at almost zero interest rates we cannot finance climate change which will all burn up now and why is that and the answer is the risk of any bank to lend into that area if it factors in all the risk weights nobody wouldn't the right mind would lend right so we actually have situations now whereby I've discovered everybody's working very hard everybody's working 24 hours a day micro managing a risk trying to identify this perfection but the outcome is completely unsatisfactory nobody's happy and why is that Brexit is an expression of that unhappiness right you are increasing writing more and more rules as if the law will change behavior we all know that's the old saying you cannot legislate good behavior so why are we still pretending this why do we pretend that we can measure this risk when the biggest problem is uncertainty and if it is uncertainty how have society in history dealt with uncertainty the answer is common good you know Elena Ostrom you know the public good comes from establishing alignment of common objectives versus common threats right and so the result is that unless we you know even individuals as leaders as community leaders try to pass this message the biggest problem now today is climate change because you know what is Syria Syria start out of as a drought and then the geopolitics got got got complicated right and so if we don't appreciate that if we don't deal with these problems that are highly complicated at the real economy level finances pretends we're just playing with the house of cards that won't solve the fundamental problems in the real economy now but if you don't have finance you can't solve some of the real economy issues and that that that is that is the question that we face you may have some good points there but I think you run the risk the real risk of having too much confidence in human nature and there please you could have that at alignment of common good and so yeah very good and there please I'd like to pick up Claudio's point about a careful process for assessing the consequences including the side effects and maybe the unintended consequences of the regulation but I think when we've done that we I need to identify both what the detailed consequences are but then we need very detailed reflections which need us to push forward some of our theories about whether those consequences are actually good or bad let me take the particular issue which Darrell raised which is the impact of the leverage ratio and the the trading book capital regime on the level of liquidity in certain traded markets I think the facts are clear that the banks have downscaled their trading activities not only in some non-standard and risky securities but also in risk-free assets such as government bonds and I think this is clearly a consequence both of the leverage ratio and of the reforms that we made to the capital required against trading books activity what I'm less convinced is that it's an adverse side effect because I think we need a far deeper reflection than we have in the past about the value of liquidity in liquid traded markets I think we probably have in liquidity in liquid traded markets yet another inverse U along with private credit as a percent of GDP where there is clearly a value in a certain amount of liquidity in trading but beyond it the self-induced instability may offset the benefits and I'm not entirely convinced that a reduced liquidity in the repo market in government bonds has significant or really important effects for the transmission of monetary policy I think in the transmission of monetary policy as we think about whether it works today there are always two steps in the transmission of monetary policy one is whether when the central bank changes the policy interest rate is there a somewhat pervasive and somewhat parry pursue movement in all the other interest rates in all the other different contracts in the economy the second key point in the transmission of monetary policy is if there is such a pervasive or if Jeremy Stein calls it getting into all the cracks and somewhat parry pursue movement in all those interest rates what is the response of the real economy is consumption and investment in the real economy actually elastic to further movements downwards in interest rates I think if we face a problem with the effectiveness of monetary policy close to the zero lower bound our problems are 90% or 95% or 99% to do with the latter the interest rate elasticity of response of the real economy and only to a very minor re-expand the degree to which changes in the policy rate are getting through to contracts relevant for the real economy as we have reduced the interest rates the big reductions of course as sometime in the past the fact is there was a feed through to real economy contracts both on the deposit side on bond side on a lending side as well when the ECB introduced its latest round of quantitative easing in March German bond yields came down from 20 basis points to 10 basis points it strikes me that the transmission to the yield structure is quite effective both of standard monetary policy and unconventional but our problem rather is that I don't know a single major German corporate which faced with a reduction of 10 basis points in an already low rate of interest is going to rush out and start investing so I accept that there might theoretically be certain problems arising from a lack of liquidity in the transmission mechanisms of monetary policy but I think they are minor compared with the fundamental issue of the transmission of mechanism of monetary policy which is the interest rate elasticity of investment and consumption in the real economy yeah there is nothing else though um so net now me oh sorry I will compensate you by giving you the floor again for the two-end intervention yeah so it's a very quick one which is related exactly to what we just discussed what I hear from our markets people is also that as banks are withdrawing from market making there are there are other firms going in and there maybe we don't have them in our data so I think to get a get a full picture I think it would be interesting to look also at those developments