Regulators learn from latest banking sector turmoil

In the wake of the most acute turmoil in the global banking sector since the global financial crisis, a regulatory review found that regulators’ post-crisis reforms helped guard against greater damage, but that bank supervisors must be alert to weaknesses in banks’ business models.

The Basel Committee on Banking Supervision, the global group of bank regulators, published a report examining the banking-sector stress that arose this spring, which resulted in several large U.S. banks failing and Swiss giant UBS AG taking over its struggling rival, Credit Suisse.

Among other things, the report found the reforms to global capital rules adopted in response to the 2008 financial crisis largely worked as hoped.

“The Basel III reforms that have been implemented to date helped shield the global banking system from a more severe banking crisis,” the report concluded. “The regulatory framework is not calibrated to produce ‘zero failures’, but seeks to reduce the likelihood and impact of a banking stress, while facilitating financial intermediation and economic growth.”

The report said the episode highlighted the importance of prudent regulatory standards and the necessity of fully implementing the Basel III reforms, which remains a work in progress.

“Despite the enhanced levels of resilience provided by Basel III, the recent turmoil highlighted that banks can be vulnerable to rapid changes in market sentiment. The combination of high leverage and long-term opaque assets that are funded with short-term runnable deposits makes banks especially vulnerable to a loss of trust in their long-term solvency,” the report noted.

The report also pointed out, “The first and most important source of financial and operational resilience comes from banks’ own risk management practices and governance arrangements.”

The turmoil revealed weaknesses in banks’ basic risk management, failures to understand how individual risks are interrelated, and inadequate and unsustainable business models, the report said, “including an excessive focus on growth and short-term profitability (fuelled by remuneration policies), at the expense of appropriate risk management.”

There are also lessons for regulators: bank supervisors must be willing to quickly take, and enforce, regulatory action when weaknesses are identified; supervisory teams need to be adequately resourced; and, regulators must continuously monitor and adapt to structural changes in the banking system, “especially for banks that are rapidly growing in size or adopting novel business models.”

The report stressed the importance of cross-border supervisory cooperation.

In response to the findings, the Basel Committee said it is prioritizing work to strengthen supervisory effectiveness and to identify areas that may need added regulatory guidance at a global level. The committee also plans to examine how well the Basel III regime worked during the turmoil in certain areas, such as liquidity risk and interest-rate risk, with a view to assessing the need for further reforms in the medium term.

Separately, the committee also approved the results of the annual assessment exercise for global systemically-important banks, which is published in November.

It also agreed to consult on a disclosure framework for banks’ exposures to climate-related financial risks, and to consult on disclosure rules for banks’ crypto exposures. Those proposals are expected to be published in the coming weeks.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.