Risk Management Presentation October 22 2012

7/28/2019 Risk Management Presentation October 22 2012

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International Association of Risk and ComplianceProfessionals (IARCP)

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

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

week's agenda, and what is next Dear Member,

― You would not expect to put an earthquake

tidy in a few minutes, would you?‖

Who said that?

Lord Stamp told that to Keynes. Read the amazing speech given by

Mervyn King, Governor of the Bank of England

According to Mervyn King, the new Keynesian model omits a number of key factors.―The treatment of expectations is simplified, and neglects thepossibility that expectations themselves may be a source of fluctuations,

rather than simply reflecting changes elsewhere in the economy.‖

Grab a cup of coffee first, and readmore at Number 6 below.

Welcome to the Top 11 list (thisweek).

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

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







































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The Federal Reserve Board

Two final rules with stress testing

requirements for certain bank holdingcompanies, state member banks, andsavings and loan holding companies

The Federal Reserve Board on Tuesday publishedtwo final rules withstress testing requirementsfor certain bank holding companies, statemember banks, and savings and loan holding companies.

EIOPA Work Programme 2013

EIOPA Work Programme 2013 describes the goals anddeliverables for EIOPA in its third year of operation.

EIOPA has decided to reshape the structure of its WorkProgramme, following the recommendation from theEuropean Court of Auditors, aligning it with the tasks thatthe Regulation settling EIOPA assigns to the Authority.

EBA publishes follow-upreview of banks‘ transparencyin their 2011 Pillar 3 reports

The European Banking Authority

(EBA) published today a follow-up review aimed at assessing thedisclosures European banks‘ made in response to the Pillar 3requirements set out in the Capital Requirements Directive (CRD).























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Speech by Andrew Bailey, ManagingDirector, Prudential Business Unit at the

Edinburgh Business School

Scotland is home to a very important financialservices industry for the UK and Europe and

although it may at times seem like the changes taking place in regulationappear through London and Whitehall bubbles, they are clearly as

relevant to you as they are to your counterparts in the City of London andCanary Wharf.

Financial Instruments andExchange (Amendment) Actof 2012 [Briefing Materials] October 2012, Financial ServicesAgency, Japan

Twenty years of inflationtargeting

Speech given by Mervyn King, Governor of theBank of England

The Stamp Memorial Lecture, London School of Economics























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Statement by theHonorable, Mr. Koriki

Jojima Minister of Finance of Japan

and Governor of theIMF for Japan

Twenty-Sixth Meeting of the International Monetary and FinancialCommittee, Tokyo, Japan

Communiqué of theTwenty-Sixth Meetingof the IMFC

Chaired by Mr. Tharman Shanmugaratnam, Deputy Prime Minister of Singapore and Minister for Finance

To: Banks Bank Holding Companies

Federally Regulated Trust and Loan

Companies Cooperative Retail Associations

Subject: New Required Interim Public Capital DisclosureRequirements related to Basel I I I Pillar 3

On June 26, 2012, the Basel Committee on Banking Supervision (BCBS)issued its final rules on the information banks must publicly disclosewhen detailing the composition of their capital.























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Hearing before theCommittee on Economic and

Monetary Affairs of the EuropeanParliament Introductory statement by Chair of theESRB, Brussels

Capital and Adventure: The Auditor‘s

Role in the Modern CorporationJames R. Doty, Chairman

International Forum of Independent AuditRegulators (IFIAR) London, England























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The Federal Reserve Board

Two final rules with stress testingrequirements for certain bank holdingcompanies, state member banks, andsavings and loan holding companies

The Federal Reserve Board on Tuesday publishedtwo final rules withstress testing requirementsfor certain bank holding companies, statemember banks, and savings and loan holding companies.

The final rules implement sections 165(i)(1) and (i)(2) of the Dodd-Frank

Wall Street Reform and Consumer Protection Act that require supervisoryand company-run stress tests.

Nonbank financial companiesdesignated by the Financial StabilityOversight Council will also be subject to certain stress testingrequirements contained in the rules.

"Implementation of the Dodd-Frank stress test requirement is animportant step in the Federal Reserve's efforts to promote the health of the financial sector," Governor Daniel K. Tarullo said.

"Stress testing is a key tool to ensure that financial companies haveenough capital to weather a severe economic downturn without posing arisk to their communities, other financial institutions, or to the generaleconomy."

The Federal Reserve will begin conducting supervisory stress tests under the final rules this fall for the 19 bank holding companies that participatedin the 2009 Supervisory Capital Assessment Program and subsequent

Comprehensive Capital Analysis and Reviews.

The final rules also require these companies and their state-member banksubsidiaries to conduct their own Dodd-Frank company-run stress teststhis fall, with the results to be publicly disclosed in March 2013.























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In general, other companies subject to the Board's final rules for Dodd-Frank stress testing will be required to comply with the final rulebeginning in October 2013.

Companies with between $10 billion and $50 billion in total assets thatbegin conducting their first company-run stress test in in the fall of 2013will not have to publicly disclose the results of that first stress test.

The Board's two final rulesrevise portions of the Federal Reserve's noticeof proposed rulemaking to implement the enhanced prudential standardsand early remediation requirements established under the Dodd-FrankAct.

The Board coordinated closely with the Office of the Comptroller of the

Currency and the Federal Deposit Insurance Corporation to ensure thatfinal stress testing rules issued by the agencies are consistent andcomparable.

The Board also coordinated with theFederal Insurance Officeas requiredby the Dodd-Frank Act.

The Federal Reserve will release the scenarios for this year's supervisoryand company-run stress tests no later than November 15, 2012.

As required by the Dodd-Frank Act, the scenarios will describehypothetical baseline, adverse, and severely adverse conditions, withpaths for key macroeconomic and financial variables.

To help firms prepare to estimate their losses and revenues under thescenarios, the Federal Reserve on Tuesday released historical data for variables likely to be used in the scenarios.

A revised version of these historical data, reflecting the latest information,will be published along with the scenarios.























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Important Parts

FEDERAL RESERVE SYSTEM

Annual Company-Run Stress Test Requirements for Banking

Organizations with Total Consolidated Assets over $10 Billion Other thanCovered Companies

AGENCY: Board of Governors of the Federal Reserve System (Board).

ACTION: Final rule.

SUMMARY: The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or Act) requires the Board to issueregulations that require financial companies with total consolidated

assets of more than $10 billion and for which the Board is the primaryfederal financial regulatory agency to conduct stress tests on an annualbasis.

The Board is adopting this final rule to implement the company-run stresstest requirements in section 165(i)(2) of the Dodd-Frank Act regardingcompany-run stress tests for bank holding companieswith totalconsolidated assets greater than $10 billion but less than $50 billion andstate member banks and savings and loan holding companies with totalconsolidated assets greater than $10 billon.

This final rule does not apply to any banking organization with totalconsolidated assets of less than $10 billion.

Furthermore, implementation of the stress testing requirements for bankholding companies, savings and loan holding companies, and statemember banks with total consolidated assets of greater than $10 billionbut less than $50 billion is delayed until September 2013.

DATES: The rule is effective on November 15, 2012.























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Background

The Board has long held the view that a banking organization, such as abank holding company or insured depository institution, should operate

with capital levels well above its minimum regulatory capital ratios andcommensurate with its risk profile.

A banking organization should also have internal processesfor assessingits capital adequacy that reflect a full understanding of its risks andensure that it holds capital commensurate with those risks.

Moreover, a banking organization that is subject to the Board‘s advancedapproaches risk-based capital requirements must satisfy specificrequirements relating to their internal capital adequacy processes in order

to use the advanced approaches to calculate its minimum risk-basedcapital requirements.

Stress testing is one tool that helps both bank supervisors and a bankingorganization measure the sufficiency of capital available to support thebanking organization‘soperations throughout periods of stress.

The Board and the other federal banking agencies previously havehighlighted the use of stress testing as a means to better understand therange of a banking organization‘s potential risk exposures.

In particular, as part of its effort to stabilize the U.S. financial systemduring the recent financial crisis, the Board, along with other federalfinancial regulatory agencies and the Federal Reserve system, conductedstress tests of large, complex bank holding companies through theSupervisory Capital Assessment Program (SCAP).

The SCAP was a forward-looking exercise designed to estimate revenue,losses, and capital needs under an adverse economic and financial market

scenario.

By looking at the broad capital needs of the financial system and thespecific needs of individual companies, these stress tests providedvaluable information to market participants, reduced uncertainty about























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the financial condition of the participating bank holding companiesunder a scenario that was more adverse than that which was anticipatedto occur at the time, and had an overall stabilizing effect.

Building on the SCAP and other supervisory work coming out of thecrisis, the Board initiated the annual Comprehensive Capital Analysis andReview (CCAR) in late 2010 to assess the capital adequacy and theinternal capital planning processes of large, complex bank holdingcompanies and to incorporate stress testing as part of the Board‘s regular supervisory program for assessing capital adequacy and capital planningpractices at large bank holding companies.

The CCAR represents a substantial strengthening of previous approachesto assessing capital adequacy and promotes thorough and robust

processes at large banking organizations for measuring capital needs andfor managing and allocating capital resources.

The CCAR focuses on the risk measurement and management practicessupporting organizations‘capital adequacy assessments, including their ability to deliver credible inputs to their loss estimation techniques, aswell as the governance processes around capital planning practices.

In the wake of the financial crisis, Congress enacted the Dodd-Frank Act,which requires the Board to issue regulations that require bank holding

companies with total consolidated assets of $50 billion or more (largebank holding companies) and nonbank financial companies that theFinancial Stability Oversight Committee has designated to be supervisedby the Board (together, covered companies) to conduct stress tests semi-annually, and requires other financial companies with totalconsolidated assets of more than $10 billion and for which the Board is the

primary federal financial regulatory agency to conduct stress tests on anannual basis (company-run stress tests).

The Act requires that the Board issue regulations that:

(i) Define the term ―stress test‖























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(ii)Establish methodologies for the conduct of the company-run stresstests that provide for at least three different sets of conditions, includingbaseline, adverse, and severely adverse conditions

(iii)Establish the form and content of the report that companies subjectto the regulation must submit to the Board

(iv)Require companies to publish a summary of the results of therequired stress tests.

On January 5, 2012, the Board invited public comment on a notice of proposed rulemaking (proposal or NPR) that would implement theenhanced prudential standards required to be established under section165 of the Dodd-Frank Act and the early remediation requirements

established under Section 166 of the Act, including proposed rulesregarding company-run stress tests.

The proposed rules would have required each bank holding company,state member bank, and savings and loan holding company with morethan $10 billion in total consolidated assetsto conduct an annualcompany-run stress test using data as of September 30 of each year andthe three scenarios provided by the Board.

In addition, each state member bank, bank holding company, and

savings and loan holding company would be required to disclose asummary of the results of its company-run stress tests within 90 days of submitting the results to the Board.

The Dodd-Frank Act mandates that the OCC and the FDIC adopt rulesimplementing stress testing requirements for the depository institutionsthat they supervise, and the OCC and FDIC invited public comment onproposed rules in January of 2012.

The Board is finalizing the stress testing frameworks in two separaterules.

First, the Board is issuing this final rule, which implements thecompany-run stress testing requirements applicable to bank holding























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companies with total consolidated assets greater than $10 billion but lessthan $50 billion and savings and loan holding companies and statemember banks with total consolidated assetsgreater than $10 billion.

Second, the Board is concurrently issuing a final rule implementing thesupervisory and semi-annual company-run stress testing requirementsapplicable to large bank holding companies and nonbank financialcompanies supervised by the Board.

Overview of Comments

The Board received approximately 100 comments on its NPR onenhanced prudential standards and early remediation requirements.Approximately 40 of these comments pertained to the proposed stress

testing requirements.

Commenters ranged from individual banking organizations to trade andindustry groups and public interest groups.

In general, commenters expressed support for stress testing as a valuabletool for identifying and managing both microand macro-prudential risk.

However, several commenters recommended changes to, or clarificationof, certain provisions of the proposed rule, including its timeline for

implementation, reporting requirements, and disclosure requirements.

Commenters also urged greater interagency coordination regarding stresstests.

A. Delayed compliance date

Commenters suggested that companies with total consolidated assets lessthan $50 billion that have not previously been subject to stress-testing

requirements need more time to develop the systems and procedures tobe able to conduct company-run stress tests and to collect the informationthat the Board may require in connection with these tests.























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In response to these comments and to reduce burden on theseinstitutions, the final rule requires most bank holding companies, savingsand loan holding companies, and state member banks to conduct their first stress test in the fall of 2013.

In addition, the final rule requires bank holding companies, savings andloan holding companies, and state member banks with less than $50billion in total consolidated assets to begin publicly disclosing their stresstest results in 2015 with respect to the stress test conducted in the fall of 2014.

Banking organizations that become subject to the rule‘s requirementsafter November 15, 2012 must comply with the requirements beginning inthe fall of the calendar year that follows the year the company meets the

asset threshold, unless that time is extended by the Board in writing.

For example, a company that becomes subject to the rule on March 31,2013 must conduct its first stress test in the fall of 2014 and report theresults in 2015.

B. Tailoring

The proposed rule would have applied consistent annual company-runstress test requirements, including the compliance date and the

disclosure requirements, to all banking organizations with totalconsolidated assets of more than $10 billion.

The Board sought public comment on whether the stress testingrequirements should be tailored, particularly for financial companies thatare not large bank holding companies.

Several commenters expressed concern that the NPR that would haveapplied stress testing requirements previously applicable only to large

bank holding companies, such as those conducted under the CCAR, tosmaller, less complex banking organizations with smaller systemicfootprints.























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The Board recognizes that bank holding companies, savings and loanholdings companies, and state member banks with total consolidatedassets less than $50 billion are generally less complex and pose morelimited risk to U.S. financial stability than larger banking organizations.

As a result, the Board has modified the requirements in the final rule for these institutions, and expects to use a tailored approach inimplementation.

The final rule modifies the requirements for smaller bankingorganizations in a number of ways.

First, as noted above, most banking organizations, other than statemember bank subsidiaries of the large bank holding companies that

participated in the SCAP, are not required to conduct their first stress testuntil 2013.

The final rule also provides a longer period for smaller bankingorganizations to conduct their stress tests.

Under the final rule, smaller banking organizations, other than statemember bank subsidiaries of SCAP bank holding companies, are notrequired to report the results of the stress test until March 31.

The final rule also modifies the public disclosure requirements, generallyrequiring less detailed disclosure for smaller banking organizations thanfor larger banking organizations.

Separately, the Board intends to seek comment on reporting forms thatsmaller banking organizations would use in reporting the results of their stress tests to the Board, which are expected to be significantly morelimited than the reporting forms applicable to large bankingorganizations.

Banking organizations may be required to include additionalcomponents in their adverse and severely adverse scenarios or to useadditional scenarios in their stress tests.























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The Board expects to apply such additional components and additionalscenarios to large, complex banking organizations.

For example, the Board expects to require large banking organizationswith significant trading activities to include global market shockcomponents in their adverse and severely adverse scenarios, and mayrequire large or complex banking organizations to use additionalcomponents in the adverse and severely adverse scenarios or to useadditional scenarios that are designed to capture salient risks to specificlines of business.

Finally, the Board plans to issue supervisory guidance to provide moredetail describing supervisory expectation for company-run stress tests.

This guidance will be tailored to banking organizations with totalconsolidated assets greater than $10 billion but less than $50 billion.

C. Coordination

Many commenters emphasized the need for the federal banking agenciesto coordinate stress testing requirements for parent holding companiesand depository institution subsidiaries and more generally in regard tostress testing frameworks.

Commenters recommended that the Board, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit I nsurance Corporation(FDIC) coordinate in implementing the Dodd-Frank Act stress testingrequirements in order to minimize regulatory burden.

Commenters asked that the agencies eliminate duplicative requirementsand use an interagency forum, like the Federal Financial InstitutionsExamination Council, to develop common forms, policies, procedures,assumptions, methodologies, and application of results.

The Board has coordinated closely with the FDIC and the OCC to help toensure that the company-run stress testing regulations are consistent andcomparable across depository institutions and depository institutionholding companies and to address any burden that may be associated























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with having multiple entities within one organizational structure subjectto stress testing requirements.

The Board anticipates that it will continue to consult with the FDIC andOCC in the implementation of the final rule, and in particular, in thedevelopment of stress scenarios.

The Board plans to develop scenarios each year in close consultation withthe FDIC and the OCC, so that, to the greatest extent possible, a commonset of scenarios can be used for the supervisory stress tests and the annualcompany-run stress tests across various banking entities within the sameorganizational structure.

D. Consolidated publication and group-wide systems and

models

In addition to requesting better coordination, commenters inquired as towhether a company-run stress test conducted by a parent holdingcompany would satisfy the stress testing requirements applicable to thatholding company‘s subsidiary depository institutions.

Commenters recommended that, in order to reduce burden, the Boarddevelop and require the use of a single set of scenarios for a bank holdingcompany and any depository institution subsidiary of the bank holdingcompany, if the Board imposed separate stress testing requirements onboth the bank holding company and bank.

In order to reduce burden on banking organizations, the final ruleprovides that a subsidiary depository institution generally will disclose itsstress testing results as part of the results disclosed by its bank holdingcompany parent.

Disclosure by the bank holding company of its stress test results and

those of any subsidiary state member bank generally will satisfy anydisclosure requirements applicable to the state member bank subsidiary.

Moreover, a state member bank that is controlled by a bank holdingcompany may rely on the systems and models of its parent bank holding























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company if its systems and models fully capture the state member bank‘srisks.

For example, under those circumstances, the bank holding company andstate member bank may use the same data collection processes andmethods and models for projecting and calculating potential losses,

pre-provision net revenues, provision for loan and lease losses, and proforma capital positions over the stress testing planning horizon.

Description of the Final Rule

Scope of Application

The final rule applies to any bank holding company with average total

consolidated assets of greater than $10 billion but less than $50 billion,and any state member bank and savings and loan holding company thathave average total consolidated assets of more than $10 billion (―assetthreshold‖).

Average total consolidated assets is based on the average of the totalconsolidated assets as reported on bank holding company‘sor savingsand loan holding company‘s four most recent Consolidated FinancialStatement for Bank Holding Companies (FR Y-9C) or a state member

bank‘s four most recent Consolidated Report of Condition and Income(Call Report).

If the bank holding company, savings and loan holding company, or statemember bank has not filed the FR Y-9C or Call Report, as applicable, for each of the four most recent quarters, average total consolidated assetswill be based on the average of the company‘s total consolidated assets, asreported on the company‘sFR Y-9C or Call Report, as applicable, for themost recent quarter or consecutive quarters.

In either case, average total consolidated assets are measured on the as-of date of the relevant regulatory report.























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Once a bank holding company, savings and loan holding company, or state member bank meets the asset threshold, the company will remainsubject to the final rule‘s requirements unless and until the totalconsolidated assets of the company are less than $10 billion, as reportedon four consecutively filed FR Y-9C or Call Report, as applicable(measured on the as-of date of the relevant FR Y-9C or Call Report, asapplicable).

A bank holding company, state member bank, or savings and loanholding company that has reduced its total consolidated assets to below

$10 billion will again become subject to the requirements of this rule if itmeets the asset threshold again at a later date.

However, if a bank holding company‘s total consolidated assets equal or

exceed $50 billion or a savings and loan holding company becomesdesignated as a nonbank financial company supervised by the Board,such companieswill be required to conduct stress testsunder subpart Gof the Board‘sRegulation YY (12 CFR Part 252 Subpart G).

Such a company will be required to comply with this final rule until it isrequired to conduct stress tests under subpart G.

The final rule does not apply to foreign banking organizations.

The Board expects to issue a separate rulemaking on the application of enhanced prudential standards to foreign banking organizations.

A U.S.-domiciled bank holding company subsidiary of a foreign bankingorganization that has total consolidated assets of $10 billion or more issubject to the requirements of this rule.

Effective Date

Under the proposal, the company-run stress testing requirementsapplicable to bank holding companies and state member banks wouldhave become effective upon adoption of the final rule.























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A bank holding company, savings and loan holding company, or statemember bank that met the rule‘sasset threshold as of the adoption of therule would have been required to immediately comply with itsrequirements.

A bank holding company, savings and loan holding company, or statemember bank that met the proposal‘s asset threshold more than 90 daysbefore September 30 of a given year would be subject to stress testingrequirements beginning in that calendar year.

The Board received comments with regard to the timing of the first stresstest for institutions that meet the asset threshold upon the rule‘s effectivedate and for institutions that meet the asset threshold at a later date, andhas modified both aspects of the final rule.

1.First Stress Test for Bank Holding Companies and State Member Banks that Meet the Asset Threshold on or before December 31, 2012

Commenters indicated that smaller and mid-sized banking organizationsneed more time to develop the systems and procedures to conductcompany-run stress tests and to collect the information requested by theBoard in connection with these tests.

In response to these comments, the Board is delaying the date that

existing, smaller companies are required to conduct their first stress test,as described below.

a. Bank Holding Companies

Under the final rule, a bank holding company that meets the assetthreshold on or before December 31, 2012, must conduct its first stress testbeginning in the fall of 2013, unless that time is extended by the Board inwriting.

Such a bank holding company isnot required to publicly disclose theresults of its stress test until June 2015.























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b. State Member Banks

Under the final rule, a state member bank that meets the asset thresholdon or before November 15, 2012, and is a subsidiary of a bank holdingcompany that participated in the SCAP, or successor to such bankholding company, must comply with the requirements of this subpartbeginning in the fall of 2012, unless that time is extended by the Board inwriting.

Any other state member bank that meets the asset threshold on or beforeDecember 31, 2012, must comply with the requirements of this subpartbeginning in the fall of 2013, unless that time is extended by the Board inwriting.

If such a state member bank has total consolidated assets of less than $50billion as of December 31, 2012, it is not required to publicly disclose theresults of its stress test until June 2015.

2. First Stress Test for Bank Holding Companies and State Member Banks Subject to Stress Testing Requirements After December 31,2012

Commenters similarly expressed concern that bank holding companies,state member banks, and savings and loan holding companies met the

rule‘s asset threshold after the effective date of the final rule would nothave sufficient time to build the systems, contract with outside vendors,recruit experienced personnel, and develop stress testing models that areunique to their organization under the proposed compliance date.

In addition, the Federal Advisory Council recommended that the Boardphase in disclosure requirements to minimize risk, build precedent, andallow banks and supervisors to gain experience, expertise, and mutualunderstanding of stress testing models.

In response to these comments, the Board extended the compliance dateapplicable to bank holding companies and state member banks thatexceed the final rule‘s asset threshold after December 31, 2012.























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Under the final rule, these companies will be required to conduct their first stress tests beginning in the fall of the calendar year after they meetthe asset threshold, unless that time is extended by the Board in writing.

3. First Stress Test for Savings and Loan Holding Companies

Under the final rule, a savings and loan holding company will not berequired to conduct its first stress test until after it is subject to minimumcapital requirements.

A savings and loan holding company that meets the asset threshold whenit becomes subject to minimum capital requirements will be required toconduct this first stress test in the fall of the calendar year after it firstbecomes subject to capital requirements, unless the Board accelerates or

extends the time in writing.

A savings and loan holding company that meets the asset threshold after it becomes subject to capital requirements will be required to conduct itsfirst stress test beginning in the fall of the calendar year after it meets theasset threshold, unless that time is extended by the Board in writing.

Annual Stress Tests Requirements

Timing of Stress Testing Requirements

The Board proposed the following timeline for company-run tests in theNPR.

The Board would have required an as-of date of September 30 of information to be submitted to the Board.

By no later than mid-November of each calendar year, the Board wouldprovide bank holding companies, state member banks, and savings and

loan holding companies with scenarios for annual stress tests.

By January 5 of the following calendar year, these companies would berequired to submit regulatory reports to the Board on their stress tests.























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By early April of that calendar year, companies would be required to makepublic disclosure of results.

Several commenters provided suggestions on the proposed timeline.

Those commentsfocused on the as-of date for data to be submitted by

bank holding companies, state member banks, and savings and loan

holding companies, the date for submitting results to the Board, and thedates when public disclosures of stress test results are to be made.

For instance, some commenters suggested that the Board should use datacollected at as-of dates other than September 30, such as June 30 or December 31, and make corresponding changes to the timing of publicdisclosure in order to reduce burden on companies during the year-end

period.

One commenter suggested having a floating submission date, allowingorganizations to submit their results at the point in the year when it ismost convenient.

Some commenters also requested that the Board release the scenariosearlier to provide banking organizations more time to prepare therequired reports for the stress tests.

The final rule maintains the as-of date for data for the purposes of theannual company-run stress tests so that the same set of scenarios can beused to conduct annual company-run stress tests for large bank holdingcompanies and their subsidiary state-member banks.

The Board believes, and several commenters noted, that such alignmentis beneficial.

Furthermore, using the same scenarios for all firms subject to stresstesting requirements will decrease market confusion, minimize burden

on institutions, and provide for comparability across institutions.

As stated in the concurrent final rule for covered companies, it wasnecessary to maintain the September 30 as-of date for stress test























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requirements for large bank holding companies in order to align thestress testing requirements with the capital planning requirementsapplicable to these institutions under section 225.8 of the Board‘s Regulation Y.

Commenters requested that the Board release the scenarios earlier in theannual stress test cycle to provide banking organizations more time toprepare the reports for company-run stress tests.

Under the final rule, the Board will provide descriptions of the baseline,adverse, and severely adverse scenarios generally applicable to companiesno later than November 15 of each year, and provide any additionalcomponents or scenarios by December 1.

The Board believes that providing scenarios earlier than November couldresult in the scenarios being stale, particularly in a rapidly changingeconomic environment, and that it is important to incorporate economicor financial market data that are as current as possible while providingsufficient time for companies to incorporate the scenarios in their annualcompany-run stress tests.

Commenters suggested that smaller banking organizations be allowedadditional time to conduct their company-run stress tests in light of resource constraints faced by these institutions.

In response to these comments, the Board has delayed the timing of report submission to the Board for most banking organizations.

Consistent with the requirements imposed on large bank holdingcompanies under subpart G, the final rule requires a state member bankthat is controlled by a bank holding company that has average totalconsolidated assets of $50 billion or more and a savings and loan holdingcompany that has average total consolidated assets of $50 billion or moreto conduct its stress test and submit its results to the Board by January 5,unless that time is extended by the Board in writing.























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All other bank holding companies, savings and loan holding companies,and state member banks are required to conduct their stress tests andsubmit the results to the Board by March 31.

Commenters also noted that the proposed public disclosure deadlineswould interfere with so-called―quiet periods‖ that some publicly tradedbanking organizations enforce in the lead up to earnings announcements.

These quiet periods are designed to limit communications that coulddisseminate proprietary company information prior to earningsannouncements.

In light of these comments, the Board adjusted the disclosure date toavoid interfering with f irms‘quiet periods.

Under the final rule, a savings and loan holding company with totalconsolidated assets of $50 billion or more or a state member bank that is asubsidiary of a bank holding company with total consolidated assets of $50 billion or more is required to disclose the results of its stress testsbetween March 15 and March 31 of each year.

All other banking organizations will be required to disclose their resultsbetween June 15 and June 31.

Scenarios

The proposal provided that the Board would publish a minimum of threedifferent sets of economic and financial conditions, including baseline,adverse, and severely adverse scenarios, under which the Board wouldconduct its annual analyses and companies would conduct their annualcompany-run stress tests.

The Board would update, make additions to, or otherwise revise these

scenarios as appropriate, and would publish any such changes to thescenarios in advance of conducting eachyear‘s stress test.























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Commenters suggested that significant changes in scenarios from year toyear could cause a banking organization‘s stress testing results todramatically change.

To ameliorate this volatility, commenters suggest that the federalbanking agencies have a uniform approach for identifying stressscenarios or establish a ―quantitative severity limit‖ in the final rule toensure that scenarios do not drastically change from year to year.

Commenters pointed out that consistency in annual scenariodevelopment will make comparability of stress test results betweeninstitutions and across time periods more accurate, increase marketconfidence in the results of stress tests, and make for more dependablecapital planning by banking organizations.

Commenters also requested the opportunity to provide input on thescenarios.

The Board believes that it is important to have a consistent andtransparent framework to support scenario design.

To further this goal, the final rule clarifies the definition of ―scenarios‖ and includes definitions of baseline, adverse, and severely adversescenarios.

In the final rule, ―scenarios‖are defined as those sets of conditions thataffect the U.S. economy or the financial condition of a bank holdingcompany, savings and loan holding company, or state member bank thatthe Board annually determines are appropriate for use in the

company-run stress tests, including, but not limited to, baseline, adverse,and severely adverse scenarios.

The baseline scenario is defined as a set of conditions that affect the U.S.economy or the financial condition of a bank holding company, savingsand loan holding company, or state member bank, and that reflect theconsensus views of the economic and financial outlook.























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The adverse scenario is defined as a set of conditions that affect the U.S.economy or the financial condition of a bank holding company, savingsand loan holding company, or state member bank that are more adversethan those associated with the baseline scenario and may include tradingor other additional components.

The severely adverse scenario is defined as a set of conditions that affectthe U.S. economy or the financial condition of a bank holding company,savings and loan holding company, or state member bank and that overallare more severe than those associated with the adverse scenario and mayinclude trading or other additional components.

In general, the baseline scenario will reflect the consensus views of themacroeconomic outlook expressed by professional forecasters,

government agencies, and other public-sector organizations as of thebeginning of the annual stress-test cycle.

The Board expects that the severely adverse scenario will, at a minimum,include the paths of economic variables that are generally consistent withthe paths observed during severe post-war U.S. recessions.

Each year, the Board expects to take into account of salient risks thataffect the U.S. economy or the financial condition of a bank holdingcompany, savings and loan holding company, and state member bank

that may not be observed in a typical severe recession.

The Board expects that the adverse scenario will, at a minimum, includethe paths of economic variables that are generally consistent with mild tomoderate recessions.

The Board may vary the approach it uses for the adverse scenario eachyear so that the results of the scenario provide the most value tosupervisors, given the current conditions of the economy and the bankingindustry.

Some of the approaches the Board may consider using include, but arenot limited to, a less severe version of the severely adverse scenario or























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specifically capturing, in the adverse scenario, risks that the Boardbelieves should be understood better or should be monitored.

The scenarios will consist of a set of conditions that affect the U.S.economy or the financial condition of a bank holding company, savingsand loan holding company, or state member bank over the stress testplanning horizon.

These conditions will include projections for a range of macroeconomicand financial indicators, such as real Gross Domestic Product (GDP), theunemployment rate, equity and property prices, and various other keyfinancial variables, and will be updated each year to reflect changes in theoutlook for economic and financial conditions.

The paths of these economic variables could reflect risks to the economicand financial outlook that are especially salient but were not prevalent inrecessions of the past.

Depending on the systemic footprint and scope of operations andactivities of a company, the Board may require that company to includeadditional components in its adverse or severely adverse scenarios or touse additional scenarios or more complex scenarios that are designed tocapture salient risks to specific lines of business.

For example, the Board recognizes that certain trading positions andtrading-related exposures are highly sensitive to adverse market events,potentially leading to large short-term volatility in certain companies‘ earnings.

To address this risk, the Board will require companies with significanttrading activities to include market price and rate ―shocks,‖ as specifiedby the Board, that are consistent with historical or other adverse marketevents.

The final rule also provides that the Board may impose this trading shockon a state member bank that is subject to the Board‘smarket risk rule (12CFR part 208, appendix E) and that is a subsidiary of a bank holdingcompany subject to the trading shock under the final rule or under the























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Board‘scompany-run stress test rule for covered companies (12 CFR252.144(b)(2)(i)).

The Board is making this modification to allow for coordination of thetrading shock between a bank holding company and any state member bank subsidiary that is subject to the market risk rule.

In addition, the scenarios, in some cases, may also include stress factorsthat may not be directly correlated to macroeconomic or financialassumptions but nevertheless can materially affect covered companies‘ risks, such as factors that affect operational risks.

The process by which the Board may require a company to includeadditional components or use additional scenarios is described under

section D.2 of this preamble.

Some commenters suggested that the Board adopt a tailored approach toscenarios to better capture idiosyncratic characteristics of each company.

For example, commenters representing the insurance industry suggestedthat any stress testing regime applicable to insurance companiesincorporate shocks relating to the exogenous factors that actually impacta particular company, such as a shock to the insurance company'sinsurance policy portfolio arising from a natural disaster, and

de-emphasize shocks arising from traditional banking activities.

In the Board‘sview, a generally uniform set of scenarios is necessary toprovide a basis for comparison across companies.

However, the Board expects that each company‘sstress testing practiceswill be tailored to its business model and lines of business, and that thecompany may not use all of the variables provided in the scenario, if thosevariables are not appropriate to the fir m‘s line of business, or may addadditional variables, as appropriate.

In addition, the Board expects banking organizations to consider other scenarios that are more idiosyncratic to their operations and associatedrisks, as part of their ongoing internal analyses of capital adequacy.























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FEDERAL RESERVE SYSTEM

Supervisory and Company-Run Stress Test Requirements for Covered Companies AGENCY: Board of Governors of the Federal Reserve System

(Board). ACTION: Final rule.

SUMMARY: The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or Act) requires the Board to conductannual stress tests of bank holding companies with total consolidatedassets of $50 billion or more and nonbank financial companies theFinancial Stability Oversight Council (Council) designates for supervisionby the Board (nonbank covered companies, and together, with bankholding companies with total consolidated assets of $50 billion or more,covered companies) and also requires the Board to issue regulations thatrequire covered companies to conduct stress tests semi-annually.

The Board is adopting this final rule to implement the stress testrequirements for covered companies established in section 165(i)(1) and

(2) of the Dodd-Frank Act.

This final rule does not apply to any banking organization with totalconsolidated assets of less than $50 billion.

Furthermore, implementation of the stress testing requirements for bankholding companies that did not participate in the Supervisory Capital

Assessment Program is delayed until September 2013.

DATES: The rule is effective on November 15, 2012























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Background

The Board has long held the view that a banking organization, such as abank holding company or insured depository institution, should operate

with capital levels well above its minimum regulatory capital ratios andcommensurate with its risk profile.

A banking organization should also have internal processes for assessingits capital adequacy that reflect a full understanding of its risks andensure that it holds capital commensurate with those risks.

Moreover, a banking organization that is subject to the Board‘s advancedapproaches risk-based capital requirements must satisfy specificrequirements relating to their internal capital adequacy processes in order

to use the advanced approaches to calculate its minimum risk-basedcapital requirements.

Stress testing is one tool that helps both bank supervisors and a bankingorganization measure the sufficiency of capital available to support thebanking organization‘soperations throughout periods of stress.

The Board and the other federal banking agencies previously havehighlighted the use of stress testing as a means to better understand therange of a banking organization‘s potential risk exposures.

In particular, as part of its effort to stabilize the U.S. financial systemduring the recent financial crisis, the Board, along with other federalfinancial regulatory agencies and the Federal Reserve system, conductedstress tests of large, complex bank holding companies through theSupervisory Capital Assessment Program (SCAP).

The SCAP was a forward-looking exercise designed to estimate revenue,losses, and capital needs under an adverse economic and financial market

scenario.

By looking at the broad capital needs of the financial system and thespecific needs of individual companies, these stress tests providedvaluable information to market participants, reduced uncertainty about























P a g e | 31

the financial condition of the participating bank holding companiesunder a scenario that was more adverse than that which was anticipatedto occur at the time, and had an overall stabilizing effect.

Building on the SCAP and other supervisory work coming out of thecrisis, the Board initiated the annual Comprehensive Capital Analysis andReview (CCAR) in late 2010 to assess the capital adequacy and theinternal capital planning processes of large, complex bank holdingcompanies and to incorporate stress testing as part of the Board‘s regular supervisory program for assessing capital adequacy and capital planningpractices at large bank holding companies.

The CCAR represents a substantial strengthening of previous approachesto assessing capital adequacy and promotes thorough and robust

processes at large banking organizations for measuring capital needs andfor managing and allocating capital resources.

The CCAR focuses on the risk measurement and management practicessupporting organizations‘capital adequacy assessments, including their ability to deliver credible inputs to their loss estimation techniques, aswell as the governance processes around capital planning practices.

On November 22, 2011, the Board issued an amendment (capital planrule) to its Regulation Y to require all U.S bank holding companies with

total consolidated assets of $50 billion or more to submit annual capitalplans to the Board to allow the Board to assess whether they have robust,forward-looking capital planning processes and have sufficient capital tocontinue operations throughout times of economic and financial stress.

In the wake of the financial crisis, Congress enacted the Dodd-Frank Act,which requires the Board to implement enhanced prudential supervisorystandards, including requirements for stress tests, for covered companiesto mitigate the threat to financial stability posed by these institutions.

Section 165(i)(1) of the Dodd-Frank Act requires the Board to conduct anannual stress test of each covered company to evaluate whether thecovered company has sufficient capital, on a total consolidated basis, to























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absorb losses as a result of adverse economic conditions (supervisorystress tests).

The Act requires that the supervisory stress test provide for at least threedifferent sets of conditions—baseline, adverse, and severely adverseconditions—under which the Board would conduct its evaluation.

The Act also requires the Board to publish a summary of the supervisorystress test results.

In addition, section 165(i)(2) of the Dodd-Frank Act requires the Board toissue regulations that require covered companies to conduct stress testssemi-annually and require financial companies with total consolidatedassets of more than $10 billion that are not covered companies and for

which the Board is the primary federal financial regulatory agency toconduct stress tests on an annual basis (collectively, company-run stresstests).

The Act requires that the Board issue regulations that:

(i)Define the term ―stress test‖;

(ii)Establish methodologies for the conduct of the company-run stresstests that provide for at least three different sets of conditions, including

baseline, adverse, and severely adverse conditions;

(iii)Establish the form and content of the report that companies subjectto the regulation must submit to the Board; and

(iv)Require companies to publish a summary of the results of therequired stress tests.

On January 5, 2012, the Board invited public comment on a notice of proposed rulemaking (proposal or NPR) that would implement theenhanced prudential standards required to be established under section165 of the Dodd-Frank Act and the early remediation requirementsestablished under Section 166 of the Act, including proposed rulesregarding supervisory and company-run stress tests.























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Under the proposed rules, the Board would conduct an annualsupervisory stress test of covered companies under three sets of scenarios,using data as of September 30 of each year as reported by coveredcompanies, and publish a summary of the results of the supervisory stresstests in early April of the following year.

In addition, the proposed rule required each covered company to conducttwo company-run stress tests each year: an ―annual‖ company-run stresstest using data as-of September 30 of each year and the three scenariosprovided by the Board, and an additional company-run stress test usingdata as of March 31 of each year and three scenarios developed by thecompany.

The proposed rule required each covered company to publish the

summary of the results of its company-run stress tests within 90 days of submitting the results to the Board.

Together, the supervisory stress tests and the company-run stress tests areintended to provide supervisors with forward-looking information to helpidentify downside risks and the potential effect of adverse conditions oncapital adequacy at covered companies.

The stress tests will estimate the covered company‘snet income and other factors affecting capital and how each covered company‘s capital

resources would be affected under the scenarios and will produce proforma projections of capital levels and regulatory capital ratios in eachquarter of the planning horizon, under each scenario.

The publication of summary results from these stress tests will enhancepublic information about covered companies‘ financial condition and theability of those companies to absorb losses as a result of adverseeconomic and financial conditions.

The Board will use the results of the supervisory stress tests andcompany-run stress tests in its supervisory evaluation of a coveredcompany‘s capital adequacy and capital planning practices.























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In addition, the stress tests will also provide a means to assess capitaladequacy across companies more fully and support the Board‘s financialstability efforts.

The Dodd-Frank Act mandates that the OCC and the FDIC adopt rulesimplementing stress testing requirements for the depository institutionsthat they supervise, and the OCC and FDIC invited public comment onproposed rules in January of 2012.

The Board is finalizing the stress testing frameworks in two separaterules.

First, the Board is issuing this final rule, which implements thesupervisory and company-run stress testing requirements for covered

companies (final rule).

Second, the Board is concurrently issuing a final rule implementingannual company-run stress test requirements for bank holdingcompanies, savings and loan holding companies, and state member banks with consolidated assets greater than $10 billion that are nototherwise covered by this rule.

The Board is issuing this final rule implementing the stress testingrequirements in advance of the other enhanced prudential standards and

early remediation requirements in order to address the timing of when thestress testing requirements will apply to various banking organizationsand to require large bank holding companies to publicly disclose theresults of their company-run stress tests conducted in the fall of 2012.

Description of the Final Rule

Scope of Application

This final rule applies to any bank holding company (other than a foreignbanking organization) that has$50 billion or more in average totalconsolidated assetsand to any nonbank financial company that the























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Council has determined under section 113 of the Dodd-Frank Act must besupervised by the Board and for which such determination is in effect.

Average total consolidated assets for bank holding companies is based onthe average of the total consolidated assets as reported on the bankholding company‘s four most recent Consolidated Financial Statement for Bank Holding Companies (FR Y –9C).

If the bank holding company has not filed the FR Y-9C for each of thefour most recent consecutive quarters, average total consolidated assetswill be based the average of the company‘s total consolidated assets, asreported on the company‘sFR Y –9C, for the most recent quarter or consecutive quarters.

In either case, average total consolidated assets are measured on the as-of date of the relevant regulatory report.

Once the average total consolidated assets of a bank holding companyexceed $50 billion, the company will remain subject to the final rule‘s requirements unless and until the total consolidated assets of thecompany are less than $50 billion, as reported on four FR Y-9C reportsconsecutively filed.

Average total consolidated assets are measured on the as-of date of the

FR Y-9C.

The final rule does not apply to foreign banking organizations.

The Board expects to issue for public comment a separate rulemaking onthe application of enhanced prudential standards and early remediationrequirements established under the Dodd-Frank Act, including enhancedcapital and stress testing requirements, to foreign banking organizationsat a later date.

AU.S.-domiciled bank holding company subsidiary of a foreign bankingorganization that has total consolidated assets of $50 billion or more issubject to the requirements of this final rule























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Scenarios

The proposal provided that the Board would publish a minimum of threedifferent sets of economic and financial conditions, including baseline,

adverse, and severely adverse scenarios, under which the Board wouldconduct its annual analyses and companies would conduct their annualcompany-run stress tests.

The Board would update, make additions to, or otherwise revise thesescenarios as appropriate, and would publish any such changes to thescenarios in advance of conducting eachyear‘s stress test.

Commenters suggested that significant changes in scenarios from year toyear could cause a banking organization‘s stress testing results to

dramatically change.

To ameliorate this volatility, commenters suggest that the federalbanking agencies have a uniform approach for identifying stressscenarios or establish a ―quantitative severity limit‖ in the final rule toensure that scenarios do not drastically change from year to year.

Commenters pointed out that consistency in annual scenariodevelopment will make comparability of stress test results betweeninstitutions and across time periods more accurate, increase marketconfidence in the results of stress tests, and make for more dependablecapital planning by banking organizations.

Commenters also requested the opportunity to provide input on thescenarios.

The Board believes that it is important to have a consistent andtransparent framework to support scenario design.

To further this goal, the final rule clarifies the definition of ―scenarios‖ and includes definitions of baseline, adverse, and severely adversescenarios.























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Scenarios are defined as those sets of conditions that affect the U.S.economy or the financial condition of a covered company that the Board,or with respect to the mid-cycle stress test, the covered company, annuallydetermines are appropriate for use in the company-run stress tests,including, but not limited to, baseline, adverse, and severely adversescenarios.

The baseline scenario is defined as a set of conditions that affect the U.S.economy or the financial condition of a covered company and that reflectthe consensus views of the economic and financial outlook.

The adverse scenario is defined as a set of conditions that affect the U.S.economy or the financial condition of a covered company that are moreadverse than those associated with the baseline scenario and may include

trading or other additional components.

The severely adverse scenario is defined as a set of conditions that affectthe U.S. economy or the financial condition of a covered company andthat overall are more severe than those associated with the adversescenario and may include trading or other additional components.

In general, the baseline scenario will reflect the consensus views of themacroeconomic outlook expressed by professional forecasters,government agencies, and other public-sector organizations as of the

beginning of the annual stress-test cycle.

The Board expects that the severely adverse scenario will, at a minimum,include the paths of economic variables that are generally consistent withthe paths observed during severe post-war U.S. recessions.

Each year the Board expects to take into account of salient risks thataffect the U.S. economy or the financial condition of a covered companythat may not be observed in a typical severe recession.

The Board expects that the adverse scenario will, at a minimum, includethe paths of economic variables that are generally consistent with mild tomoderate recessions.























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The Board may vary the approach it uses for the adverse scenario eachyear so that the results of the scenario provide the most value tosupervisors, given the current conditions of the economy and the bankingindustry.

Some of the approaches the Board may consider using include, but arenot limited to, a less severe version of the severely adverse scenario or specifically capturing, in the adverse scenario, risks that the Boardbelieves should be understood better or should be monitored.

The scenarios will consist of a set of conditions that affect the U.S.economy or the financial condition of a covered company over the stresstest planning horizon.

These conditions will include projections for a range of macroeconomicand financial indicators, such as real Gross Domestic Product (GDP), theunemployment rate, equity and property prices, and various other keyfinancial variables, and will be updated each year to reflect changes in theoutlook for economic and financial conditions.

The paths of these economic variables could reflect risks to the economicand financial outlook that are especially salient but were not prevalent inrecessions of the past.

Depending on the systemic footprint and scope of operations andactivities of a company, the Board may use, and require that company touse, additional components in the adverse and severely adverse scenariosor additional or more complex scenarios that are designed to capturesalient risks to specific lines of business.

For example, the Board recognizes that certain trading positions andtrading-related exposures are highly sensitive to adverse market events,potentially leading to large short-term volatility in covered companies‘ earnings.

To address this risk, the Board may require covered companies withsignificant trading activities to include market price and rate ―shocks‖ in























P a g e | 39

their adverse and severely adverse scenarios as specified by the Board,that are consistent with historical or other adverse market events.

In addition, the scenarios, in some cases, may also include stress factorsthat may not be directly correlated to macroeconomic or financialassumptions but nevertheless can materially affect covered companies‘ risks, such as factors that affect operational risks.

The process by which the Board may require a covered company toinclude additional components in its adverse and severely adversescenarios or to use additional scenarios is described under section I I I.E.2of this Supplementary Information.

The Board plans to publish for comment a policy statement that

describes its framework for developing scenarios.

Some commenters suggested that the Board adopt a tailored approach toscenarios to better capture idiosyncratic characteristics of each company.

For example, commenters representing the insurance industry suggestedthat any stress testing regime applicable to insurance companiesincorporate shocks relating to the exogenous factors that actually impacta particular company, such as a shock to the insurance company'sinsurance policy portfolio arising from a natural disaster, and

de-emphasize shocks arising from traditional banking activities.

In the Board‘sview, a generally uniform set of scenarios is necessary toprovide a basis for comparison across companies.

However, the Board expects that each company‘sstress testing practiceswill be tailored to its business model and lines of business, and that thecompany may not use all of the variables provided in the scenario, if thosevariables are not appropriate to the fir m‘s line of business, or may addadditional variables, as appropriate.

In addition, the Board expects banking organizations to consider other scenarios that are more idiosyncratic to their operations and associatedrisks as part of their ongoing internal analyses of capital adequacy and























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include company-specific vulnerabilities in their scenarios whencomplying with the Board‘s requirements for mid-cycle company-runstress test.























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EIOPA Work Programme 2013

EIOPA Work Programme 2013 describes thegoals and deliverables for EIOPA in its third year of operation.

EIOPA has decided to reshape the structure of itsWork Programme, following the recommendationfrom the European Court of Auditors, aligning itwith the tasks that the Regulation settling EIOPAassigns to the Authority.

Such change in structure has not affected thehighly ambitious programme presented for 2013,nor the high quality internal standards that informand guide all E IOPA deliverables.

The content of this Work Programme is driven by EIOPA role towardsSupervisory and Regulatory Convergence, the core importance thatConsumers have in EIOPA strategy and Mission, and the active role inthe field of Financial Stability and Crisis Management.

Relevant projects such as Solvency II will be reshaped, with a clear shiftfrom regulation to supervision.

Other areas of work, in particular in the field of pensions, will demandsignificant efforts from EIOPA in terms of sound and quality deliverablesto the European Commission in the frame of their projected enhancementof pensions regulation.

Supervisory tasks, and their convergence, rank high among EIOPA

priorities.

Concrete deliverables such as a supervisory handbook, an internal modelssupport expert unit, or an enhancement of the role and scope of thecolleges of supervisors will be provided during 2013.























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External relations, within Europe and outside, will continue playing asignificant role in EIOPA deliverables.

EIOPA places great value on the formal opinions, and other contributions, made by its two stakeholder groups for insurance and for occupational pensions.

In addition to its sectoral work, EIOPA‘sChair will take theChairmanship of the Joint Committee of ESAs.

All these developments will entail a further growth of the organisation, interms of budget and resources.

Staff number, if the Budgetary Authority agrees to the request of E IOPA,

will grow up to 112, to achieve the objectives and deliverables set in thisWork Programme.

Priorities still have to be made with regards to EIOPA mandate, as theAuthority will only reach its anticipated size in 2020.

For 2013, according to EIOPA proposal, the budget will grow from 15.6 to20 million Euro, with a share of 40% from the Commission and 60% fromits Members.

If at the end of the budgetary process EIOPA‘sbudget would not reachthe aforementioned figure, the Work Programme would be reprioritizedand some of the deliverables today incorporated would have to bepostponed.

These deliverables are marked green in Annex I of the Work Programme.

The language versions of the document‘s main part will be made

available at a later stage.

Insurance

The European insurance market is the largest in the world.























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Given its importance there will be substantial benefits from theintroduction under Solvency I I of a Europe-wide harmonised frameworkwhich provides the right incentives for insurers to better understand,measure and manage their risks.

EIOPA has already achieved a great deal in the preparation for SolvencyII.

EIOPA is currently consulting on the technical standards and guidelinesin order to complete the legislative framework for Solvency II .

Its last quantitative impact study (Q IS5) of the impact of Solvency II wasthe most ambitious and comprehensive impact study ever carried out inthe financial sector, involving more than 2,500 insurance companies.

It has provided technical contributions during the political discussions on

key aspects of Solvency II such as long term guarantees and reporting.

It is already carrying out assessments of whether third countries‘insurance frameworks are equivalent to those of theEU‘s.

In 2013 EIOPA will finalise the standards and guidelines which insuranceundertakings require as part of the Solvency I I framework.

These will comprise the 53 standards and guidelinesmandated bylegislation and on its own initiative a guideline on external scrutiny or audit for the purposes of Solvency II publicly disclosed information.

The standards and guidelines will cover the solvency capitalrequirements, own funds, internal models, group supervision, supervisorytransparency and accountability, reporting and disclosure, valuation, thevaluation of assets and liabilities other than technical provisions, andgovernance.

In 2013 EIOPA will also continue to identify, scope and implement theoperational tasks required of it under Solvency II.

This includes the following























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- Publishing a list of authorised firms,

- Collecting and publishing a report about the use of capital add-onsand the extent to which they are consistently applied across member states

- Deriving and publishing the risk free rate.

- Mapping the ratings of External Credit Assessment Institutions.

- Publishing lists of typologies of regional governments and localauthorities, exposures to whom are to be treated as exposures to thecentral government.

- Specifyingadjustmentsto be made for currencies pegged to the euro.

- Choosing the equity index for the equity dampening mechanism

- Determining, at the request of national supervisory authorities or onits own initiative, theexistence of an exceptional fall in financialmarkets for the application of the extension of the SCR recoveryperiod

-Reporting to the European Parliament on the functioning of supervisory collegesand the appointment of the group supervisor.

These specific operational tasks are accompanied by generic tasks whichhave been given to EIOPA as part of the new supervisory structure.

This includes the power for binding mediation, further work onequivalence assessments, and membership of colleges of supervisors.

EIOPA will consider what should be the configuration of working groupsand other mechanisms to deliver this next phase of insurance regulation.

On its own initiative EIOPA will alsodeliver the following during 2013:























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- Start working on best practiceswith respect to aspects of theSupervisory Review Process for supervisors as a practical step tocontributing to a common supervisory culture among supervisors

- Develop a centre of expertise on the use of internal models under Solvency I I

- Collect data in EIOPA for further use for the purposes of financialstability and micro-prudential analysis, as part of implementingEIOPA‘s database strategy EIOPA will continue in 2013 to build linksbetween the Solvency I I framework and other areas.

It will complete the current assessments of equivalence of third countriesand begin to assess the impact on consumer choice of the solvency II

framework.

EIOPA‘s plans are naturally dependent on political and other developments, especially with respect to the quantitative supervisoryframework.

EIOPA will also enter a process of maintenance of its standards andguidelines; this maintenance includes:

- The revision of standardsand guidelines already published.

-Thepotential drafting of additional guidelinesand recommendations,following the further needs which might be identified throughcommunication with stakeholders and National Supervisory Authorities.

Colleges

Colleges of Supervisors (Colleges) are considered efficient and effectivetools used in supervision of financial institutions, and they are essential

instruments to enhance mutual understanding among supervisors andconvergence of supervisory practices, with tangible benefits toundertakings, supervisors and policyholders.























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The overall strategic target of EIOPA‘scollege work is to build theposition of the EEA supervisory community towards the cross border operating insurance groups for the benefit of both group and solosupervision.

The focus is on combining and leveraging the knowledge and forces of the National Supervisory Authorities in the EEA to form a strong andequal supervisory body to effectively deal with centrally organized andmanaged undertakings.

According to EIOPA Regulation, day to day supervision as well as the setup and organisation of the Colleges is the responsibility of the NationalSupervisory Authorities.

EIOPA as a member of Colleges promotes communication, cooperation,consistency, quality and efficiency in Colleges and provides oversight.

EIOPA established in 2011 and reinforced in 2012 a highly qualifiedCollege Team and each staff member has a portfolio comprising severalColleges.

This allows EIOPA to cover all 93 colleges currently active in Europe,targeting physical participation in at least 70 colleges of supervisorsduring 2013.

EIOPA expects that the added value brought by EIOPA into the Collegesand activities of the Colleges will have improved considerably in 2012 andin 2013 the participation of EIOPA Staff in the Colleges can beconsolidated.

When monitoring the functioning of Colleges, the result will form thebasis of EIOPA‘sAction Plan for Colleges 2013 and include measurable,realistic, and at the same time ambitious goals.

As for the 2012 Action Plan, the performance of individual colleges on theagreed deliverables will be made public.

In 2013 EIOPA will:























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- Promote specifically the finalisation of the preparation of the Collegesfor Solvency I I , e.g. coordination agreements are expected to beagreed by year-end 2013 by all Colleges

- EIOPA staff will continue as a Member in the Colleges to adviseGroup Supervisors and Colleges on the possibilities to improve thefunctioning of their College. Practical solutions and examples of supervisory practices will be collected

- Develop best practiceson specific topics with a particular focus ondelegation of tasks amongst supervisors

- To promote a common understanding of the group‘s risk profilewithin Colleges, EIOPA will prepare for a data collection and analysis

system for peer comparisons as a support function to Colleges























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EBA publishes follow-upreview of banks‘ transparency

in their 2011 Pillar 3 reports

The European Banking Authority (EBA) published today a follow-upreview aimed at assessing the disclosures European banks‘ made inresponse to the Pillar 3 requirements set out in the Capital RequirementsDirective (CRD).

Overall, the EBA welcomes efforts made by banks to improve their disclosure practices and to comply with the new requirements introduced

with CRD 3.

Nevertheless, the report notes that there is still room for improvements inBanks‘Pillar 3 disclosures, and the EBA intends to continue to press for such improvements.

Main findings

Weaknesses remain in the areas of banks disclosures of credit risk – onInternal Ratings Based approaches (IRB) and securitisation activities –

and market risk.

The introduction of new disclosure requirements in CRD 3 in particular in the areas of securitisation and market risk may explain some of theweaknesses identified.

But the EBA has also noted that weaknesses already identified in itsprevious assessments remain and calls for further action.

Beyond assessing compliance with CRD disclosures requirements, theEBA has also performed an analysis of banks‘Basel I I I implementation

disclosures, in particular as regards the impact on own funds, and of the2011 EBA Capital Exercise related disclosures.

Information provided by credit institutions in these two areas were foundto be of varying quality.























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In all disclosure areas, the EBA has identified some best practices whichcredit institutions are encouraged to follow, in order to enhance thegeneral quality of Pillar 3 information.

With a view of both facilitating compliance with the requirements as well

as enhancing the quality and comparability of disclosures, the EBA willthis year supplement information on best practices with further explanations on the objective and content of the disclosure requirements,which banks are also encouraged to consider while preparing their Pillar 3disclosures.

Some improvements in the quality of disclosures were noted in the area of remuneration and own funds.

On the latter, credit institutions provided appropriate details of capitalitems and a meaningful breakdown of deductions.

With regards to the timing, formats or verification of disclosures, nosignificant changes have been made in banks‘practices of reporting Pillar 3 information.

However, information was generally published nearer to the reportingdate of banks‘annual accounts and annual report but the EBA will stillpush for publication of these reports at the same time to allow investors tohave the complete set of publicly available information at once.

Next steps

Based on the findings and content of this report, the EBA, throughout2012 and in 2013, plans to implement a strategy for enhanced transparencyand to that end will

i)Keep on identifying best practicesof public disclosures in thepublications as well as the CRD requirements for which compliance hasto be improved and

ii)Will work on these improvements, including in the area of

comparability of disclosures. In this respect, the EBA will consult andengage with the industry and users where it is needed.























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Background

The analysis, carried out in 2012 and covering a sample of nineteenEuropean banks, focussed mainly on those areas where the need for improvement had already been identified in previous assessments as well

as on areas where new disclosure requirements have been introduced withCRD3.

The conclusions of this review will serve as essential input for definingand developing theEBA‘s strategy in enhancing the area of transparency.

The European Banking Authority was established by Regulation (EC)No. 1093/2010 of the European Parliament and of the Council of 24

November 2010.

The EBA has officially come into being as of 1 January 2011 and has takenover all existing and ongoing tasks and responsibilities from theCommittee of European Banking Supervisors (CEBS).

The EBA acts as a hub and spoke network of EU and national bodiessafeguarding public values such as the stability of the financial system,the transparency of markets and financial products and the protection of depositors and investors.

Executive summary

One of the EBA‘s regular tasks is to assess Pillar 3 reports of Europeanbanks / credit institutions1 and monitor their compliance with therequirements of the Capital Requirements Directive (CRD).

This analysis continues from Pillar 3 assessments that have been carriedout annually since 2008.

It focuses particularly on areas where the need for improvement was

already identified in previous assessments.

It also covers areas where new disclosure requirements entered into forcein 2011.























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The current analysis was carried out in 2012 and covers the 2011 Pillar 3reports of nineteen European banks.

No significant changes in banks‘practiceswere noted this year in thepractical aspects of the publication of Pillar 3 information (e.g. timing,

formats or verification of disclosures), although the EBA noted that bankshave generally published their Pillar 3 information nearer to the reportingdate of their annual accounts and publication of their annual reports.

The EBA would prefer the Pillar 3 information to be published at thesame time as these annual reports and accounts, and expects the situationto improve as a result of compliance with the new Capital RequirementsRegulation (CRR).

As far as remuneration disclosures are concerned, if these are not actuallyincluded in the Pillar 3 reports or annual reports, the EBA would alsoprefer them to be published at the same time and provide cross-referencesbetween the reports.

This would then ensure that Pillar 3 report users (investors and other users) have timely access to the complete set of publicly availableinformation that is essential for assessing credit institutions‘ risk profiles.

Disclosures on own funds were generally assessed as comprehensive,with credit institutions providing details of capital items and ameaningful breakdown of deductions.

Cases of non-compliance were mostly related to disclosures on thegrandfathering of instruments, qualitative details about the capitalinstruments or breakdowns of capital items.

The EBA also believes that comparability of disclosures on own-fundswill be significantly improved by the implementation of the CRR and of the relatedEBA‗s implementing technical standards on own fundsdisclosures, which will provide common definitions and templates for disclosures.

However, the analysis of information on credit risk – Internal RatingsBased (IRB) approach and securitisation risk – revealed certainweaknesses as well as the need for improvements and more explanationon the rationale for and the expected content of disclosure requirements.























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In particular, credit institutions are expected to increase the back-testingdisclosures.

Half of the banks in the sample failed to comply with the relevant CRDrequirement, and many of the banks provided confusing information

about the assumptions underlying internally developed models.

In this context, the EBA also notes that to allow meaningful and reliableconclusions to be drawn on the functioning of the model, disclosures of acomparison between expected losses against actual losses should beprovided for a period of at least three years - a best practice that is notfollowed by the majority of the banks.

As far as securitisation risk is concerned, the small number of disclosuresassessed as adequate was mainly due to the introduction of newqualitative and quantitative disclosures requirements with theimplementation of CRD I I I .

Significant improvement is therefore needed for new disclosures on riskmanagement and exposures in the trading book or related to specialpurpose entities (SPEs).

However, there were also failures to comply with disclosure requirementswhich were related to pre-CRD I I I requirements.

Market risk was another area where many new disclosure requirements

were introduced and here the analysis also identified certain areas wheresignificant improvements were needed.

These included disclosures on back-testing of internal models, stresstesting, valuation models, adequate breakdown of market risk capitalrequirements, stressed VaR measure, the new incremental risk charge aswell as the comprehensive risk measure.

On the other hand, significant improvements were noted in the area of remuneration disclosures with a total of 57% of the banks in the sampleassessed as providing adequate disclosures or disclosures that captured

the spirit of the CRD requirements.

In all these disclosure areas, the EBA identified some best practiceswhich credit institutions are encouraged to follow to enhance the qualityof Pillar 3 information.























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In addition to the assessment results and detailed findings as set forth inthis report, there are two other sections.

The EBA decided to add further analysis that was not limited to acompliance exercise, but touched upon disclosure related issues, outside

the Pillar 3 framework.

The EBA thereforecarried out a thematic study reviewing and comparingBasel I I I implementation disclosures, focusing on information providedby banks about the resulting impact on own funds, and on disclosures for the EBA 2011 capital exercise.

It was found that all credit institutions provided some disclosures, but thecontent and presentation of these greatly varied.

Some institutions only disclosed qualitative elements while others

supplemented these qualitative disclosures with some quantitative data.

Data were however not comparable, due to differences in terms of granularity and of hypotheses used to estimate the impacts of regulatorychanges on own-funds.

As last year, the EBA noticed that one of the main challenges of Pillar 3information, regardless the requirements considered, was comparabilityof disclosures between credit institutions.

The EBA still believes greater comparability or some standardisation

would enhance the benefits of Pillar 3 information for users, including theESAs and the ESRB.

The conclusions of the report are the result of productive discussionsbetween the National Supervisory Authorities and the EBA, informed byinputs from preparers and users of Pillar 3 disclosures.

These conclusions have highlighted topics where further discussionsshould be encouraged between those preparing and those using of Pillar 3information and the NSAs/EBA to enhance of quality of disclosures in

these areas.

The EBA will use these conclusions as a basis for initiating discussionsand also as essential input for defining and developing its strategy inenhancing the area of transparency.























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Indeed, as a result to the findings from this report, the EBA will in 2012and 2013 :

- Keep on identifying best practicesof public disclosures in thepublications

- Keep on identifying the CRD requirements for which compliance hasto be improved and those that should be improved, and work on theseimprovements, including in the area of comparability

- Consult and work with industry and users to improve transparency inareas where it is needed























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Speech by Andrew Bailey, ManagingDirector, Prudential Business Unit at the

Edinburgh Business School

It is a great pleasure to be in Edinburgh againand to have the opportunity to set out progresson the reform of financial regulation as we

approach the formal introduction of the new arrangements.

Scotland is home to a very important financial services industry for theUK and Europe and although it may at times seem like the changestaking place in regulation appear through London and Whitehall bubbles,

they are clearly as relevant to you as they are to your counterparts in theCity of London and Canary Wharf.

All of us witnessed the costs associated with the failures of banks.

We have learnt the lessons of that experience and that is why the reformswe are making to the way we regulate will affect us all and will create asystem that is safer and stronger for every part of the UK.

One thing I should emphasise is that this is a reform of the whole of financial regulation.

I say that because it is easy to conclude from observation of the issues weface as regulators, and the public debate, that we are just dealing withreforming the regulation of banks.

That is not the case, and what we are doing is not about dragging the restof the financial services industry into reform to solve a problem that is inessence only about the banks.

We have to design a system that works effectively for all sectors of theindustry.

On that theme, I would like to start by reflecting for a few moments on thelessons of history.























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My main theme is that I think integrated regulation –by which I meanregulation which combines Prudential and Conduct of Business in oneregulatory body with single teams of supervisors covering both – has notworked as effectively as it would need to do, for reasons that are

deep-seated in the structure.

I think there are a number of closely related reasons for this.

First, on a rather practical point, I think it is hard for a single organisationto balance, particularly during a period of crisis, a wide range of verydemanding issues which are individually rightly of great concern to thepublic and can come from anywhere in a landscape of around 25,000authorised firms.

Second, I think the evidence suggests that, over the last 15 years, therehave been periods when either conduct or prudential supervision hasbeen more in the ascendancy to the detriment of the other.

In the years leading up to the start of the crisis there was a dearth of prudential supervision, but I am quite prepared to acknowledge that therehave been periods where the opposite has been true.

My point here is that I don‘t think the system of integrated regulationdemonstrated the ability to deliver a stable equilibrium of conduct and

prudential supervision.

Third, there is something of an inbuilt tendency within integratedregulation to play down the active debate of issues where conduct andprudential regulators find themselves with potentially conflictingobjectives.

Of course, it can be said that the ‗twinpeaks‘approach that we areintroducing could lead to endless debate and no outcomes.

My own view is that that is not correct, and that the benefits of clarity indefining the objectives of the PRA and the new Conduct Authority, theFCA, will dominate any other consequences.























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There are several important reasons why reform of financial regulationwill, in my view, be an important step forward, starting with establishingvery clear public policy objectives for financial regulation to which we, asthe regulators, are fully committed.

For both banks and insurance companies, the PRA will have the objectiveof promoting the safety and soundness of firms.

Consistent with this objective, it will focus on the potential harm thatfirms can cause to the stability of the financial system in the UK.

We define a stable financial system as one that is resilient in providing thecritical financial services that the economy needs.

And this supply of services is a necessary condition for a healthy andsuccessful economy, as demonstrated by the costs imposed by thefinancial crisis on the public and society at large.

For insurance companies, the PRA will have the second objective of contributing to securing an appropriate degree of protection for thosepolicyholders.

Why do we need a second objective for insurance?

For me, it rightly emphasises that in taking out some forms of insurancepolicies, the public can become locked into very long-term contracts,much longer often than is the case in banking with deposit contracts.

Bearing this in mind, the public interest I think justifies a secondobjective for insurance, which is more directly targeted at the situation of individual policyholders. In contrast as bank deposits are redeemable on demand at par value, andas banks lend the deposits at longer maturities, so they are inherentlyfragile and vulnerable to contagion, so protecting the system protectsdepositors.

There are a number of important points in this description of the PRA‘sobjectives.























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First, the emphasis on economic well-beingas an ultimate goal aligns thesupervision of banks and insurers more closely to the field of macroeconomic policy.

This is in line with the definition of ‗financial stability‘ as the continuity of supply of critical financial services which are important to the functioningof the economy.

Three services stand out here: the provision of payment servicesincluding access to funds; credit extension; and, risk transfer.

This definition is critical to clarifying the public interest-objective in astable financial system, and that this public interest can diverge from theprivate interest of a firm in profit maximisation without reference to the

public interest.

One of the biggest lessons I take from the financial crisis is the need toensure that the boards and management of firms appreciate and actconsistent with the public interest.

To achieve this end, we need a much better definition of the ‗publicinterest‘,which will come from the legislation.

The second important point regarding the meaning of the PRA‘s

objectives is that it will not be the PRA‘s role to ensure that no firm fails.

Rather, the PRA will seek to ensure that any firm it regulates that does failshould do so in a way that avoids significant disruption to the supply of critical financial services.

Nevertheless, failure is not without cost and there is inherent uncertaintyabout whether a firm can fail without damaging the financial system andthe supply of critical services.

Consequently, the PRA will expect a given level of resilience to failurefrom all firms.























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Now, I recognise that we have a lot to do still on resolution planning to becomfortable about our objective of avoiding a ‗no f ailure‘regime.

For large banks, we are making progress on resolution planning, and thisworld is different to five years ago, but we are not there yet by any means.

I have a background in resolving banks, and I regard having the capacityto resolve failed large banks – including the largest – as the Holy Grail of resolution.

Unlike the legendary Holy Grail, I think there is a good reason to believethat the objective of being able to resolve large banks that fail can bewithin our grasp.

But the challenge of resolving PRA-regulated firms goes beyond banks.Insurers raise exactly the same issue of continuity of provision of criticalfinancial services.

Moreover, in a line of business such as with-profits life, the businessmodel involves pooling many vintages of long-term contracts in a singlefund for the benefit of policyholders.

A typical resolution involves run-off over a long period, which remains asensible approach.

But the public policy interest is reasonably directed towards ensuring aprocess of resolution, which is fair to those various vintages and morebroadly which allows more rapid payout to policyholders, since thecurrent arrangements can involve long delays and pressure for policyholders to accept lower payouts in return for greater speed.

This is a different, but nonetheless important, public policy interest inorderly resolution.

I am very clear that when firms mess up, they should be allowed to fail,and by doing so they are putting at risk the money of their shareholdersand if necessary after that, those who provide debt funding according tolevels of seniority.























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But I am also very clear that really achieving the objective of avoiding a nofailure regime requires a fundamental change of mindset both inside thePRA and in society more broadly.

Fear of failure is an important conditioner of behaviour in a financialregulator, and achieving a change on this front depends on establishing awide acceptance of our approach that orderly failure that does notcompromise our public policy objectives is an acceptable outcome.

To be clear, we should be criticised where failure compromises thoseobjectives and we could have taken steps to avoid it, and we will berequired to report on such failures.

But if failure is orderly, and does not compromise our public policy

objectives, the responsibility should rest with the board and managementfor failing to serve the private interest of their shareholders and creditors.

Last on the theme of failure, having firms that are either too big or tooimportant to fail is bad for competition in the industries that we regulate.

An industry where exit is too difficult is one where entry is likewiseinhibited.

Put simply, if we don‘t know how to deal with a failed firm, we will

inevitably set a higher barrier to entry.

This is what we see in the banking industry.

Embedding resolution into the public policy objectives of financialregulation matters for two reasons relevant to competition: first, because,to repeat, exit enables entry; and, second, because if, as we will, werequire new entrants to satisfy us on their resolvability in order to beauthorised, we can lower the barriers and costs of opening for business.

We have already started to put this new approach into operation.

Resolution of failed firms consistent with the public policy objectives isone key plank of the new approach to financial regulation.























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Another key plank concerns the macro-prudential approach to regulation.

The legislation will establish the Financial Policy Committee (FPC),charged with the primary objective of identifying, monitoring and takingaction to remove or reduce systemic risks with a view to protecting andenhancing the resilience of the UK financial system.

In June, the Chancellor announced that the government would amend theBill to give the FPC a secondary objective so that subject to being contenton the first objective, it should support the economic policy of thegovernment, including its objectives for growth and employment.

Currently, the FPC is acting in an interim capacity to undertake, as far aspossible, the future statutory FPC‘s macro-prudential role.

Macro-prudential regulation is focused on protecting the financial systemas a whole.

In a very ‗big picture‘sense, there is nothing new about this activity.

The problems of the last five years have emphasised the close linksbetween the health and behaviour of banks and the condition of theeconomy.

This is a lesson of history, and one that should not have been forgotten.

But, forgotten it was.

At present the FPC is pursuing two important objectives: seeking toincrease the resilience of the UK banking system, including to the threatsemanating from the euro areas; and, subject to being content with thepath towards greater resilience, supporting the creation of credit in theUK economy.

I am in no doubt that if banks take reasonable steps to enhance their resilience, they will be better placed to sustain the availability of credit tothe economy by lowering their cost of funding and reducing their vulnerability to unanticipated events.























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Macro-prudentialregulation takes a system-wide view of the risks we faceand the buffers of capital and liquidity that banks should hold againstpossible stress events.

This is very clearly the resilience objective for the system, to which theFPC attaches great weight.

Banks in the UK have made substantial progress over the last four years inbuilding that resilience, from of course a very low base.

We believe that there is further to go on capital, and the FPC has set thisposition out, but in doing so we should not forget the distance that hasbeen travelled.

We should also remember that more capital cannot be conjured from thinair, particularly as there are at present quite severe constraints around therate of return earned by banks due to low interest margins and redress for past misdeeds on conduct issues.

Credit growth in the UK economy continues to be weak.

The latest Bank of England credit conditions survey indicates early signsof an increase in the amount of mortgage lending available to households,though much less evidence of a change in credit conditions for

businesses.

But it is very early days for the recently announced policy measures – inparticular the Funding for Lending Scheme –which are intended to havea positive impact on domestic credit conditions.

So, we can see a picture of gradually improving resilience in the bankingsystem but with further to go, but also credit growth which remains weak.

In that context, and recognising the balance of objectives withinmacro-prudential policy, the FSA has taken a number of steps.

We have allowed banks to reduce the capital buffers they hold over theminimum requirements in line with new lending to the UK economy.























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Our view here is that a reduction in the risk arising from this new lendingcaused by an improvement in credit conditions should offset the risk fromlowering capital buffers.

If such extra lending boosts economic growth, it will enhance resiliencein the financial system.

Likewise, we have altered our guidance to banks on the liquid assetbuffers that they need to maintain.

This reflects the Bank of England‘sstance on the potential access of banks to liquidity from the Bank, and a wider desire to reduce theincentives for banks to hold excessive liquid asset buffers for precautionary reasons.

This, too, we hope will support credit availability.

It is too soon to assess the impact of all these changes on the resilience of the financial system and on credit creation.

We will monitor the results of these actions very carefully, and we will beprepared to amend our judgements in the light of experience.

The key point here is that we are applying judgement to our decisions on

regulation and within a framework that quite explicitly defines and seeksto balance our objectives of resilience, the primary objective, and, subjectto that primary objective, supporting credit conditions and economicactivity.

To be clear, in this world of judgement-based regulation, we will not getall the calls correct, not least because the future is uncertain.

But, I am a lot more comfortable that we have a framework in which wecan apply judgement more consistently and be held to account for those

judgements in a more open way.























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There is one further element to the package of reforms, namely themeasures proposed by the Commission chaired by Sir John Vickers,which the government intends to place into legislation in the near future.

I fully support the Vickers proposals.

The key plank of this is to ring-fence commercial from investmentbanking and, in doing so, define the scope of commercial banking thatcan be inside the ring-fence.

This will be a major structural change for the banking system, and willhave important implications for us as regulators.

There are two key points for me in the Vickers reforms.

First, in the last ten years or more, the nature of investment banking haschanged to include a much larger element of proprietary position taking.

The incentives and risks of this activity are quite different fromcommercial banking, and I do not believe that the two should be mixed inthe same legal entity.

Regulators around the world have struggled to regulate this mixture, andwill continue to do so even though we have raised the cost of doing

investment banking business through changes to the regulatory regime.

Second, in a world where we will not accept banks being too big or complicated to fail, it is sensible to be able to resolve commercial andinvestment banks separately, and to achieve this we need the ring-fenceapproach.

This will support the continuity of provision of financial services.

In conclusion, we have a very big programme of reforms under way, withthe central objective that we must not let a financial crisis of this scalehappen again.

The reform programme is founded on very clear public policy objectives.























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We are absolutely committed to the reform programme and knittingtogether the various parts.

We expect financial institutions to abide by the spirit of it too.

There are big changes in what we are doing, and it is an exciting time tobe putting these changes into effect.

We will get a much clearer focus from splitting prudential and conductregulation for banks and insurers, from introducing macro-prudentialregulation to help to protect the financial system as a whole, and fromfocusing our regulation on applying judgement in a transparent way.

Firms that mess up should, and will, be allowed to fail, but it must not be

at the cost of damaging the financial system and economy.

Ringfencing commercial and investment banking will help to achievethat objective.

And, out of these reforms I hope we can encourage a banking system thatis more open to competition and serves the public more effectively and,more broadly, a financial system that delivers the public policy objectiveof financial stability.

Thank you.























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Financial I nstruments and Exchange (Amendment) Act of 2012[Briefing Materials]

October 2012, Financial Services Agency, Japan























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Twenty years of inflationtargeting

Speech given by Mervyn King,Governor of the Bank of England

The Stamp Memorial Lecture, London School of Economics

Introduction

I am delighted to be back at the School to deliver the Stamp Memorial Lecture.

Lord Stamp was eminent in the worlds of bothacademic and public life.

Among other achievements, he was an alumnus and a governor of theSchool, and a Director of the Bank of England.

Following his untimely death, in an air raid in 1941, he was succeeded atthe Bank by John Maynard Keynes.

Keynes and Stamp often broadcast live discussions on the BBC whichwere published a week later in The Listener.

Their conversations during the 1930s, at the height of the GreatDepression, are eerily reminiscent of the enormous challenges we facetoday, as you can see from the following exchange in 1930:

KEYNES: Is not the mere existence of general unemployment for anylength of time an absurdity, a confession of failure, and a hopeless and

inexcusable breakdown of the economic machine?

STAMP: Your language is rather violent. You would not expect to put anearthquake tidy in a few minutes, would you?I object to the view that it is























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a confession of failure if you cannot put a complicated machine right all atonce.

KEYNES: In my opinion the return to the gold standard in the way wedid it set our currency system an almost impossible task ... I f pricesoutside this country had been going up since 1925 that would have donesomething to balance the effect on this country of the return to the goldstandard.

STAMP: Hush, Maynard; I cannot bear it. Remember, I am a Director of the Bank of England.

In some respects our experience today is no different: putting right our economic machine is proving a slow and difficult task.

But in the 1920s the Government made the task substantially harder byreinstating the gold standard at a rate that left sterling overvalued.

Today, monetary policy is part of the solution, not part of the problem.

That is thanks, in large part, to the monetary framework we have had in

place since 1992.

Twenty years ago today, on 9 October 1992, the newspapers reported that

for the first time monetary policy in Britain would be based on an explicittarget for inflation.

Three weeks earlier, sterling had been forced out of the EuropeanExchange Rate Mechanism (ERM).

A new framework for monetary policy was needed.

After keen debates within the Treasury and the Bank of England, theanswer emerged – the inflation target.

The essence of this new approach was the combination of a numericaltarget for inflation in the medium term and the flexibility to respond toshocks to the economy in the short run – and so the framework became























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known as flexible inflation targeting.

It is time to reflect on twenty year s‘experience of inflation targeting;fifteen years of stability and five years of turbulence – the Great Stabilityand the Great Recession, shown in Table 1 and Charts 1-3.























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Over that period, monetary policy around the world has changedradically.

Inflation targeting has spread to more than 30 countries.

And the results in terms of low and stable inflation have been impressive.

There have been pronounced reductions in the mean, variance and

persistence of inflation in Britain and elsewhere.

During the past twenty years, annual consumer price inflation in thiscountry has averaged 2.1%, remarkably close to the 2% target and well

below the averages of over 12% a year in the 1970s and nearly 6% a year inthe 1980s.

But did we pay too high a price for this achievement in lowering inflation?























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After fifteen years of apparent success, the past five years of financialcrisis and turmoil in the world economy have raised serious questionsabout the adequacy of inflation targeting.

We don‘thave to look far to see that the costs of financial instability arehuge.

In Britain, total output is today some 15% below an extrapolation of itspre-crisis trend, and that gap is likely to persist for some time yet.

In the light of such costs, should monetary policy go beyond targetingprice stability and also target financial stability? And should the presentfinancial crisis lead us to question the intellectual basis of monetarypolicy as practised in most of the industrialised world today?

Those questions are the subject of tonight‘s lecture.

The story of inflation targeting

But let us start at the beginning.

Shortly after the adoption of inflation targeting, my predecessor but one,Lord Kingsdown (Robin Leigh-Pemberton as he then was), gave animportant speech at the London School of Economics – indeed in this

room – entitled ―The Case for Price Stability‖.

I remember it vividly – for I had been involved in drafting it.

It was an exciting time; we were reconstructing British monetary policyafter the trauma of forced exit from the ERM.

In those days, of course, the Chancellor set monetary policy and theBank of England played only a behind the scenes role.

But the role of the Bank was about to change – first with the InflationReport in February 1993, which gave the Bank its own public voice, andthen with independence for the Bank and the creation of the MonetaryPolicy Committee (MPC) in 1997.























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The inflation target was born out of the experience that high and variableinflation was very costly to reduce and that only a policy based ondomestic considerations would be credible.

The objective of monetary policy in the medium term wouldunambiguously be price stability.

As the then Chancellor of the Exchequer, Norman Lamont, put it ―we wish to reduce inflation to the point where expected changes in theaverage price level are small enough and gradual enough that they do notmaterially affect business and household financial plans‖.

The idea that there is a long-run trade-off between price stability andemployment had long since been abandoned.

That intellectual revolution, associated with the names of Friedman,Phelps and Lucas, had stood the test of time and formed the foundationsof inflation targeting.

The initial reception of the inflation target among economists andcommentators alike was distinctly mixed.

As the Financial Times put it in a leader published twenty years agotoday, ―the Chancellor's speech was as economically thin as it was

politically disappointing‖.

The critics argued that the new framework was inadequate to controlinflation.

They were to be proved wrong.

Over the previous twenty years inflation had been the single biggestproblem facing the UK economy, peaking at 27% a year in 1975.

Over the subsequent twenty years, inflation, as I mentioned earlier, wouldaverage only 2.1%.























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From the outset, inflation targeting was conceived as a means by whichcentral banks could improve the credibility and predictability of monetarypolicy.

The overriding concern was not to eliminate fluctuations in consumer price inflation from year to year, but to reduce the degree of uncertaintyover the price level in the long run because it is from that unpredictabilitythat the real costs of inflation stem.

The improvement in credibility of policy is shown by the fact that whereasin 1992 expected inflation, as measured by the difference between yieldson conventional and index-linked gilts, was close to 6%, today the samemeasure is around 2½ %.

Predictability of the price level is greater because over a long periodinflation has on average been close to the target.

Even if inflation deviates from target – as will often be the case – it isexpected to return to target, and so inflation expectations are anchored.

That is why since 2007 the UK has been able to absorb the largestdepreciation of sterling since the Second World War, as well as very largerises in oil and commodity prices, with an increase in inflation to anaverage of only 3.2% over the past five years and without dislodging

long-term inflation expectations.

So the framework has been tested and has proved its worth.

But the current crisis has demonstrated vividly that price stability is notsufficient for economic stability more generally.

Low and stable inflation did not prevent a banking crisis.

Did the single-minded pursuit of consumer price stability allow a disaster to unfold?























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Would it have been better to accept sustained periods of below or abovetarget inflation in order to prevent the build up of imbalances in thefinancial system?

Is there, in other words, sometimes a trade-off between price stability andfinancial stability?

The intellectual foundations of monetary policy

The experience of the past five years suggests that we reassess theintellectual framework underpinning monetary policy.

The emergence of inflation targeting, and the successful results in theform of the Great Stability, coincided with the development of the

so-called New Keynesian consensus on macroeconomic theory.

This framework offered a theoretical foundation for flexible inflationtargeting.

Central to the New Keynesian view is the assumption that some prices are―sticky‖ and adjust slowly.

That assumption hastwo implications.

First, high inflation produces inefficient changes in relative prices.

As a result, there is a cost to inflation.

Second, when central banks change nominal interest rates they also affectreal interest rates, and so encourage households and businesses to switchexpenditure from today to tomorrow or, as in present circumstances, theother way round.

In this way, central banks can, in the model at least, offset shocks toaggregate demand.

But there are shocks to supply as well as demand.























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External cost shocks sometimes drive inflation away from the target, aswe saw in recent years with rises in world energy and food prices.

Because other prices are ―sticky‖,attempts to keep inflation at target allthe time would result in inefficient fluctuations in output.

There is, therefore, a trade-off between stabilising inflation andstabilising output.

Following a cost shock, it is sensible to bring inflation back to targetgradually.

In this, by now conventional, framework, the proper objective of monetary policy is to minimise the variability of inflation around the

target rate and the variability of output (or employment) around asustainable path consistent with stable inflation.

Such an objective means that the central bank is effectively choosing atrade-off between the volatility of inflation and the volatility of output.

This is sometimes described as choosing a point on the Taylor frontier showing, as in Chart 4, the combinations of lowest volatility of inflationfor a given volatility of output.























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That optimal choice leads to a policy reaction function describing howthe central bank responds to shocks hitting the economy.

The success of the New Keynesian framework was that it showed how thelong run objective of price stability could be implemented by anappropriate central bank policy reaction function.

It stressed the importance of expectations and credibility, to which toolittle attention had been paid during the inflationary episodes of the1970s and 1980s.

But inevitably, as with all models, the basic New Keynesian model omitsa number of key factors.

The treatment of expectations is simplified, and neglects the possibilitythat expectations themselves may be a source of fluctuations, rather thansimply reflecting changes elsewhere in the economy.

Sentiment can vary, misperceptions occur, and people can change theheuristics they use to cope with a complex world.























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And it lacks an account of financial intermediation, so money, credit andbanking play no meaningful role.

Those omissions obviously limit the ability of the model to help usunderstand the trade-offs between monetary policy and financial stability.

Although there is a, by now extensive, literature on financial frictions,including attempts to incorporate them in New Keynesian models, itturns out that such extensions make little difference to the propagation of shocks, to optimal policy, or to the quantitative conclusion thatoverwhelmingly the most important objective remains inflationstabilisation.

There is no doubt that financial frictions such as asymmetric information,

credit constraints, and costly monitoring of borrowers, to name but a few,are an important part of the story of how crises happen and why theyimpact on output.

But those models do not provide a convincing account of the gradualbuild-up of debt, leverage and fragility that characterises the run-up tofinancial crises.

Existing models, then, do not tell us why stability today may come at theexpense of instability tomorrow.

Perhaps we should heed the advice of Ricardo Caballero, who has writtenthat ―macr oeconomic research has been in ‗fine-tuning‘mode within thelocal maximum of the dynamic stochastic general equilibrium world,when we should be in ‗broad-exploration‘mode‖.

So let me now move into broad exploration mode and give three examplesin which a trade-off between monetary and financial stability might arise,and which could in theory justify a policy of aiming off the inflation targetin order to reduce the risk of future financial instability, before I turn towhether such a policy would have been appropriate before the crisis.























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The first is where misperceptions about future incomes persist and areembodied in key prices, such as the exchange rate and long-term interestrates.

Households, businesses, and banks can all make big mistakes whenforming judgements about the future, and make spending decisionstoday which they will come to regret when their true lifetime budgetconstraints are revealed.

There is no mechanism for ensuring that misperceptions about thesustainable level of spending are corrected quickly.

It may take many years before those beliefs are invalidated by experience.

So an equilibrium pattern of spending and saving can emerge that is

stable temporarily but not sustainable indefinitely.

And misaligned prices may reinforce mistaken beliefs if people are usingmarket prices to extract signals about future incomes and consumptionopportunities.

Evidence of the persistence of misperceptions can be seen in theimbalances in the world, and especially the European, economies.

I do not mean to imply that when economic agents make these mistakesthey are behaving irrationally.

Rather that in a world of intrinsic uncertainty it is far from obvious how tomake decisions.

The assumption of rational expectations is very helpful for economistswhen trying to understand the implications of their own models – it is adiscipline to prevent the drawing of arbitrary conclusions.

In practice, however, households are on their own in a highly uncertainand complex world where they are learning from experience.























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When it comes to decisions about how much to spend and how much tosave, expectations of future incomes are crucial.

In the absence of a complete set of markets for future consumption goods – and labour – there is no mechanism to ensure that decisions today, andso the implied plans for tomorrow, will be consistent with the possibilities

available in the future.

If revisions to expectations of future incomes are uncorrelated acrosshouseholds, then aggregate spending will be relatively stable.

The problem comes when many households have similarlyover-optimistic views about the future.

Aggregate spending and borrowing can then be unsustainably high andlead to an inevitable correction at an unpredictable date when realitydawns.

Financial markets both reflect and propagate that common degree of optimism.

Sentiment and animal spirits can change very quickly.

Examples include the extrapolation of past growth rates of incomes or

asset prices into the future when in fact they reflect an adjustment of thelevel of income or asset price to a new equilibrium.

At the time, the MPC argued that the rise in the ratio of house prices toincomes in the years leading up to 2007 reflected a fall in long-term realinterest rates – in other words, an adjustment to a new equilibrium houseprice to income ratio.

But if households extrapolated past increases in house prices into thefuture, then they may have mistakenly inferred that future incomes toowould be higher, and so spending and borrowing more than could besustained.























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Similar arguments could be made about the reaction of businesses andhouseholds to the rise in the sterling effective exchange rate in the late1990s, and I shall return to this later.

Since long-term interest rates in financial markets are, if anything, evenlower today the question of sustainability has not yet been resolved.

Misperceptions mean that unsustainable levels of spending, andassociated levels of debt, can build up over many years.

When those misperceptions are eventually corrected, they lead to suddenlarge changes in asset values, a synchronised de-leveraging of balancesheets, a large downward correction to spending and output, and defaults.

Keynesian policies to smooth the path of adjustment by supportingaggregate demand can help in the short run, but their effectiveness islimited by the fact that a significant adjustment to spending – fromconsumption to investment – is required.

If policymakers can, first, identify misperceptions, and, second, correctthem by changes in monetary policy –both highly uncertain empirically – then there is indeed a trade-off between hitting the inflation target andreducing the chance of a financial crisis down the road.

But are central banks less prone to misperceptions than others?

My second example concerns what Masaaki Shirakawa, Governor of theBank of Japan calls the ‗cycle of confidence‘.

He argues that success breeds confidence, and eventuallyover-confidence and complacency, leading to collapse.

Such ideas are closely associated with the work of Hyman Minsky andothers.























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Minsky set out a ‗financial instability hypothesis‘ in which a period of stability encourages exuberance in credit markets and subsequentinstability.

Perhaps the experience of unprecedented stability in the UK and worldeconomies before the crisis dulled the senses and bred complacencyabout future risks.

I talked about this when I christened the period leading up to 2003 thenice (non-inflationary consistently expansionary) decade.

The point of that speech was that the following decade was unlikely to beas nice. And, of course, it wasn‘t.

But the point didn‘t get home, and the financial system became more andmore fragile as the leverage of our banking system rose to unprecedentedlevels.

The experience of continuing stability may have sowed the seeds of itsown destruction.

That idea has been explored recently in an interesting new book byNassim Taleb.

He argues that the opposite of fragility is not resilience or robustness, but―antifragility‖, that is a state in which people or institutions thrive onvolatility, shocks to the system and risk.

We go to the gym to stress our muscles in order to strengthen them;occasional seismic activity may prevent a more damaging earthquake.

Frequent exposure to shocks and surprises may improve the way peoplelearn about and manage risks.

In a complex world, we are ―better at doing than we are at thinking‖, inTaleb‘swords.























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Unless we train and practice at coping with bad outcomes we may fail torespond in the right way to adverse shocks when they come.

―Antifragility‖ does not imply that it might be desirable to engineer smallrecessions in order to head off a deep depression.

We know far too little about the economy to attempt any such strategy,and in a world of intrinsic uncertainty we rely on heuristics – simplifiedrules of thumb – to guide our behaviour.

But it offers a warning of the dangers of believing that the role of monetary policy is to offset all shocks.

Rather than pretend that we can forecast the future, a more intelligent

response is to reinforce the resilience of those parts of the financial systemthat we cannot permit to fail and encourage entry and exit in a free marketin other parts.

It is clear that we need to understand more about how stability affectsrisk-taking, leverage, and the ‗cycle of confidence‘.

My third example relates to the so-called ‗risk taking‘channel of monetary policy.

Short-term policy rates, especially when they are, as now, exceptionallylow, may encourage investors to take on more risk than they wouldotherwise wish as they ‗sear ch for yield‘.

Financial institutions with long-term commitments (pension funds andinsurance companies, for example) need to match the yield they promisedon their liabilities, with the yield on their assets.

When interest rates are high, they can invest in safe assets to generate thenecessary revenue.

When interest rates are low, however, they are forced to invest in riskier assets to continue to meet their target nominal rate of return.























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That tends to push down risk premia and lower the price of borrowing.

Other investors too find it difficult to accept that in a world of lownominal and real interest rates equilibrium rates of return will not meettheir previous expectations.

If these mechanisms are important, the financial cycle may be heavilyinfluenced by monetary policy, especially when interest rates are low.

That also creates the possibility of a trade-off between monetary andfinancial stability.

All three examples suggest that the conventional analysis of the trade-off between the volatility of inflation and the volatility of output is likely to be

far too optimistic.

Does this add up to a case for ‗leaning against the wind‘of rising assetprices rather than waiting to ‗mop‘up after the bust?

Certainly we have seen that monetary policy cannot fully offset the effectsof financial crises for two reasons.

First, crises may impact output before the response of monetary policy isfelt.

Second, crises typically reduce potential supply growth, for example by

disrupting the supply of credit to productive firms.

A failure to take financial instability into account creates an undulyoptimistic view of where the Taylor frontier lies, especially when it isbased on data drawn from a period of stability.

Relative to a Taylor frontier that reflects only aggregate demand and costshocks, the addition of financial instability shocks generates what I callthe Minsky-Taylor frontier, shown in Chart 5.























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This reflects the influence of misperceptions, financial cycles and thesearch for yield.

On the Minsky-Taylor curve, for a given degree of inflation variability,output is more volatile in the long run than on the simple Taylor curve.

Ignoring financial instability might mean choosing a policy reactionfunction that is believed to imply a trade-off at point O in Chart 5.

In fact, the true trade-off is given by point P.

Once that is understood then the optimal policy reaction function mightwell change and correspond to a trade-off at point Q.

The examples I have given suggest the possibility that there is a trade-off between meeting the inflation target in the short run and reducing the riskof a financial crisis in the long run.

To shed light on whether that possibility warrants a change to the way weimplement inflation targeting, I want now to conduct a counter-factualthought experiment and ask whether monetary policy before 2007 mighthave moderated the crisis if it had not simply pursued a target for inflation.























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A Counter-Factual Monetary Policy 1997-2007

I want to ask whether, with the benefit of hindsight, monetary policyshould have been set differently during the period of the so-called Great

Stability.

Should interest rates have been higher during that period in order tomitigate some of the growth of credit, rise in asset prices, and increase inthe leverage of the banking system?

Many commentators today seem to think that the answer is clearly yes – though I seem to remember that fewer said so at the time – and most of the pressure on the MPC, both from without and within, was for lower rather than higher levels of Bank Rate.

Before trying to answer the question, let me remind you of two key factsabout the Great Stability.

First, the growth rate of GDP over the period prior to the onset of thecrisis in 2007 was 2.9%, very close to its previous long-run average of 2.8%(see Table 2).























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Second, the policy rate set by the MPC was higher than that in any other G7 country for almost the whole of the ten years prior to the crisis (seeChart 6).

But if the rate of growth was sustainable, its pattern was not.

In the late 1990s, there had been a substantial, and not entirely explicable,rise in sterling of around 25% against most other currencies, leading tothe emergence of imbalances in the UK economy.

These took the form of a shift in the composition of output away from

manufacturing and towards services, and a shift in demand away fromexports towards domestic demand.

National saving fell to unsustainably low levels.

In the early years of the MPC there was an intense debate about theseimbalances, and how they should affect monetary policy.

In a speech in April 2000, I argued that ―it is important not to let domesticdemand grow too rapidly for too long.

The longer the correction is left, the sharper the required adjustment willbe‖.























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The question was how much to stimulate domestic demand, at the cost of exacerbating the imbalances, in order to compensate for weak externaldemand, and the minutes of the MPC in 2001 and 2002 explicitlydiscussed the case for accepting inflation below target over the two-year horizon.

The Committee rejected the case, and during that period most of thedissenting votes on the MPC were for lower rates (see Table 3).

The dilemma, and the MPC‘s resolution of it, was summed up by mypredecessor Eddie George in 2002 when he said ―So in effect we havetaken the view that unbalanced growth in our present situation is better than no growth –or as some commentators have put it, a two-speedeconomy is better than a no-speed economy.‖

Was that the right choice?

As in some other industrialised countries, asset prices, including houseprices, had been pushed up by falls in long-term real interest rates (seeChart 7).























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Since those long rates were set in world capital markets by the interactionbetween the demand for investment and the (very large) supply of saving,only a strategy of persistently higher interest rates at home than overseas

–which to some extent we did follow –would have prevented a significantrise in asset prices, thus reducing some of the upward pressure on creditgrowth.

Such a strategy might have brought some benefits for financial stability.

It is possible that without rising asset prices we might have kept expectations of future incomes on a more modest path that did not later require a correction.

Higher rates and the resulting recession and unemployment might have

reminded firms, households and financial markets that the economy wasnot guaranteed to experience continual steady growth, and thereby havedisrupted the dynamic I described earlier in which stability leads tooverconfidence and eventual instability –by stressing the economy inorder to promote its―antifragility‖, in Taleb‘sphrase.

And higher domestic interest rates might have alleviated some of the‗search for yield‘ that probably followed a period of low rates.

But leverage and the growth rate of credit may be relatively insensitive to

interest rates, especially once a self-reinforcing cycle of optimism andcredit expansion is underway.

And this financial crisis was a global one; the United Kingdom could notalone have stopped it happening.

We would still have suffered greatly from the very sudden and sharp fall inworld output and trade in 2008-09.

We might still have experienced a banking crisis and a domestic ‗cr editcrunch‘because, as my colleague Ben Broadbent has described, lendingto the UK real economy contributed only a small share of the rise inleverage of the largest UK banks which reflected more an expansion of lending within the financial sector and overseas (see Table 4).























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Three quarters of UK banks‘ losses to date have been on their foreignassets.

The search for yield that prompted excessive risk-taking was the result of low long-term interest rates around the world, not simply rates in the UK.

So what would have happened had we adopted the counter-factual policyof higher levels of Bank rate?

Of course, it is impossible to know with certainty.

And much depends on what would have happened to the exchange rate.

On the MPC, two views were discussed.

One was that by setting interest rates at a much higher level, sodampening domestic demand and output growth, expectations of thelong-run exchange rate consistent with a sustainable path of domesticdemand might be dislodged and ‗ jolted‘down to a lower equilibrium level – from A to B in Chart 8.























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Certainly, there seemed good reason at the time to imagine that slower growth at home might mean that hot money would return to countriesexperiencing stronger growth.

As a result, the current exchange rate would have fallen from O to P inChart 8 and then been expected to follow the path PB consistent withuncovered interest rate parity.

The result would have been higher external demand to offset weaker domestic demand.

After a time, we might have attained ‗one-speed‘growth, so avoiding theunpalatable choice between ‗two-speed‘and no growth.

The other view was that higher interest rates would not have altered theexpected long-run equilibrium value of sterling, but would have led to animmediate upwards jump in the exchange rate, as the greater interest ratedifferential with other countries would have shifted up the uncoveredinterest rate parity path from OA to QA in Chart 8.

That would have meant even weaker external demand, and a moredepressed domestic economy.























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Higher interest rates would have moderated domestic credit growth andasset prices, but only at the expense of slower output growth, risingunemployment and a prolonged undershoot of the inflation target.

Everything would have hinged on the success of the strategy in bringingdown the expected equilibrium level of sterling in the long run to avoid afurther rise in sterling in the short run and a damaging recession.

At best, persistently higher interest rates would have implied an initialslowing of growth, a deliberate attempt to weaken sterling, and anunder-shooting of the inflation for a period.

At worst, we would have seen the exchange rate appreciate further.

The decade would have been characterised by rising unemployment andvery low inflation.

To have deviated from our statutory remit in a direction that would haveimposed real costs to output and employment would have been a biggamble.

But the costs of the ensuing crisis have been so great that we cannot stopthere and say that nothing could have been done.

Was there a better alternative to a strategy of higher interest rates?

The natural first line of defence against financial crises ismacro-prudential policy.

In principle, such policies can shift the Minsky-Taylor curve closer to the original Taylor curve.

With hindsight, before 2007 there should have been a cap on the leverageof banks (see Chart 9).























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And the cap should have tightened as asset prices increased and the likelyexposure to losses increased.

That is why we now have a macro-prudential policy regime in the UK.

It will be overseen by the Bank of England‘sFinancial Policy Committee,which will have the power to direct, and make recommendations to,regulators about capital and leverage in the UK financial system.

In my judgement, the big challenge to monetary policy before the crisiswas a serious mis-pricing in long-term interest and exchange rates, andthe imbalances that resulted.

Much of this was outside the control of UK policy-makers and reflecteddevelopments in the world economy.























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It is arguable, though not certain, that in the absence of a

macro-prudential regime or tighter fiscal policy, persistently higher interest rates might have been a second-best strategy.

It would, though, have been a big gamble.

As the Chairman of the Federal Reserve, Ben Bernanke has remarked,―the issue is not whether central bankers should ignore possible financialimbalances – they should not –but, rather, what is ‗the right tool for the

job‘ to respond to such imbalances‖.

So it is vital that macro-prudential tools and micro-prudential regulationare part of the armoury of a central bank to mitigate, if not prevent, thebuild up of excessive leverage and risk-taking in the banking and wider

financial sector.

From next year, the Bank of England will have those responsibilities, andthe new Financial Policy Committee is already up and running.

But macro-prudential tools deal with symptoms rather than theunderlying problems of misperceptions and mispricing.

Although we think the new tools given to the Bank would have helped toalleviate the last crisis, it would be optimistic to rely solely on such tools

to prevent all future crises.

It would be sensible to recognize that there may be circumstances inwhich it is justified to aim off the inflation target for a while in order tomoderate the risk of financial crises.

Monetary policy cannot just ‗mopup‘after a crisis.

Risks must be dealt with beforehand.

I do not see this as inconsistent with inflation targeting because it is thestability of inflation over long periods, not year to year changes, which iscrucial to economic success.























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The key principles underlying flexible inflation targeting are credibility,predictability and transparency of decision-taking, and they will remainthe cornerstone of successful monetary policy in the future.

Conclusions

Governor Leigh Pemberton‘s1992 lecture concluded with a message for the LSE: ―ina world of price stability you might not think of inviting theGovernor of the Bank of England to address you‖.

Had price stability guaranteed financial stability, and had I achieved mylong-held ambition of being boring, that might have been true.

Unfortunately, it is not how things have worked out!

What I have tried to show tonight is that the case for price stability is asstrong today as it was twenty years ago –both in theory and in practice.

The clarity and simplicity of the inflation target helps to anchor inflationexpectations on the target.

We forget the lessons of the 1970s and 1980s at our peril.

In the end, the essence of central banking is to maintain confidence in,

and the value of, paper money.

It is far too soon to bury inflation targeting.

Together with central bank independence, it played a key role inbringingprice stability to the UK.

As the Times reported 20 years ago, ―the pound's firmer tone, and softer German money market rates, could tempt the Chancellor to shave half a

point off base rates to coincide with the Prime Minister's speech atBrighton today‖.

The party conference season is no longer a time for speculation aboutchanges in interest rates.























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No doubt we shall learn a great deal about the appropriate allocation of responsibilities to monetary policy, on the one hand, and

macro-prudential policy, on the other, over the next twenty years.

But we should not throw out the baby with the bathwater.

Low and stable inflation is a pre-requisite for economic success.

Much of what I have said is, I hope, a call to arms for economists, andespecially younger economists, to rethink the foundations of our macroeconomic theories.

Not to abandon rigorous modelling – after all, in the words of last year ‘sNobel Prize winner Tom Sargent ―it takes a model to beat a model‖ –but

to recognize that in our present models the way we think of humanbehaviour in the face of irreducible uncertainty is seriously incomplete.

Ideas matter far more than is usually recognised in the public discussionof monetary policy which concentrates too much on personalities.

Keynes and Stamp both knew that.

In February 1929, Josiah Stamp went to Paris as a member of the YoungCommittee to assess whether the reparations debts run up by Germany

could be repaid – the similarities with the present situation in Europe aretoo poignant to dwell on.

In a letter to Keynes, Stamp compared these international meetings to aconjuror trying to pull a rabbit out of the hat:

―It is still a madhouse, in a way –but all are mad in a very genteel way, themain occupation being elaborate proofs, from different angles, of sanity.

One half sit round a hat saying with Coué reiteration: there is a rabbit – there is.

The other half try to make a noise like a succulent lettuce.























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There is a general conviction that the more eminent the conjurorsconvened, the more certainty is there of the existence of the rabbit‖.

The only escape from madness is the power of ideas.

Today, we understand less than we would wish about how the economyworks.

The challenge of trying to understand more, and of developing those newideas, belongs to you – the next generation of students and academics atthe LSE and elsewhere.

Go to it!























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Statement by theHonorable, Mr. Koriki

Jojima Minister of Finance of Japan

and Governor of the IMF for Japan

Twenty-Sixth Meeting of the International Monetary and FinancialCommittee, Tokyo, Japan, October 13, 2012

I.OPENING REMARKS AS TH E HOST OF THEMEETINGS IN TOKYO

We are delighted to host the IM F /World Bank Annual Meetings andIM FC meeting here in Tokyo for the first time in 48 years.‘

II. THE JAPANESE AND GLOBAL ECONOMIES

The Japanese Economy

In response to the devastating damage caused by the Great East JapanEarthquake, the Government of Japan, in July last year, designated the

five years through fiscal 2015 as a ―Concentrated Reconstruction Period.‖

Japan will implement budgetary measures for reconstruction worth a totalof 19 trillion yen, equivalent to 4 percent of GDP, over this five year period.

The government has already carried out post-earthquake restoration andreconstruction projects worth a total of approximately 17 trillion yen(equivalent to 3.6 percent of GDP), as included in three supplementarybudgets for fiscal 2011, as well as the annual budget for fiscal 2012.

Supported by such reconstruction-related demand, domestic demand inJapan has stayed firm on the whole.























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Japan‘sGDP recorded an annualized growth rate of 5.3 percent in the firstquarter of this year and an annualized growth rate of 0.7 percent in thesecond quarter on a quarter-on-quarter basis.

If downside risks subside, including the instability of the financial marketand global economic slowdown due to the European sovereign debt crisis,we expect that Japan‘sGDP will grow about 2 percent in fiscal 2012.

In the medium term, the government will strive to invigorate the Japaneseeconomy by implementing the Comprehensive Strategy for the Rebirth of Japan, which includes measures to strengthen the growth potential insuch fields as energy and environment, health and agriculture, forestryand fisheries.

Japan‘s Fiscal Consolidation

Now, I would like to explain Japan‘s efforts toward fiscal consolidationsince this spring.

In March this year, the government submitted a bill for theComprehensive Reform of the Tax System, which is intended tosimultaneously achieve fiscal consolidation and secure a stable source of revenue for enhancing and stabilizing the social security system in order to deal with an aging society coupled with a declining birth rate.

This bill was enacted in August this year.

Under the new law, the consumption tax rate is supposed to be raisedfrom the current 5 percent to 10 percent in two phases by October 2015.

Japan expects to achieve the goal of halving the ratio of the primarybudget deficits of the national and local governments to GDP by fiscal2015 in accordance with the commitment made at the G20 Summit in

Toronto.

This will be accomplished by steadily implementing the new law and byundertaking both revenue- and expenditure-side measures, as prescribed























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by the Medium-term Fiscal Framework, which was revised in August thisyear.

This will be a significant first step toward future fiscal consolidation.

However, Japan recognizes that, as the IM F has pointed out, it is

necessary to make further efforts to bring the primary balance for the

national and local governments into surplus by fiscal 2020.

Therefore, Japan is resolved to continue to steadily implement measuresto achieve fiscal consolidation.

The Global Economy

The global economy is showing growing signs of a slowdown on thewhole.

While we must keep a careful watch on the risk of the U.S. fiscal cliff, thegreatest cause for concern is the debt and financial-sector problems inEurope.

The negative spillover effects of such problems are starting to spreadbeyond Europe.

In order to prevent a further economic downturn, it is essential to quicklytake measures to resolve the European sovereign debt crisis.

As for the European situation, it is first and foremost important for Europe itself to take responsibility for doing its utmost.

Europe needs to quickly implement all of the measures that have beenagreed upon and announced to date.

In early September, the Outright Monetary Transactions program, a newbond purchases program, intended to ensure the effectiveness of monetary policy, was introduced.























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In mid-September, the European Commission‘sdraft plan for amechanism of unified banking supervision was announced.

The European Stability Mechanism has just been launched on October 8.

We welcome such positive developments.

Japan is ready to make contributions as necessary while keeping watch onthese European efforts.

I I I. EXPECTATI ONS FOR THE I MF

Next, I would like to explain Japan‘s expectations for the IMF.

Establishment of a Global Financial Safety Net

Amid the continuing uncertainty over the global economy and thefinancial market, the IMF has an increasingly important role to play inensuring stable growth of the global economy in the future.

First of all, providing a global financial safety net is one of the importantroles of the IMF.

In this respect, Japan has taken initiative to announce its intention toprovide a new line of credit of US$60 billion for the enhancement of IMFresources, and has called for other countries to follow suit.

We are pleased that as a result of such Japanese leadership, an agreementwas reached on an increase of more than US$450 billion in IMF resourcesat the G-20 Summit in Los Cabos in June this year.

Cooperation between Regional Financial Safety Nets and theIMF

To complement global institutions such as the IMF, Japan has beenpouring efforts into enhancing regional financial safety nets in Asia.























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Regarding the Chiang Mai Initiative Multilateralization (CMIM), whichhas been promoted under the framework of ASEAN+3, it was agreed atthe ASEAN+3 Finance Ministers‘and Central Bank Governors‘Meetingin May this year that the total size of the CMIM would be doubled fromUS$ 120 billion to 240 billion.

It was also agreed that a crisis prevention facility would be introduced.

The strengthening of regional financial cooperation will provide a greater

sense of regional ownership regarding crisis prevention and resolutionefforts and will enhance global financial safety nets by complementing

global institutions such as the IMF.

In addition, ASEAN +3 is striving not only to enhance the CMIM but also

to strengthen the organization of AMRO (ASEAN+3 MacroeconomicResearch Office), which is the macroeconomic surveillance unit of thisregion. Japan is hoping that cooperation between AMRO and the IMFwill deepen in fields of activity such as economic surveillance

Enhancement of the IMF Governance

Providing policy advice based on high-quality surveillance is also animportant role of the IM F.

To perform that role in an effective manner, it is important for the IM F tosecure member countries‘ trust.

To that end, it is necessary to ensure that each member country‘s voiceand quota share better reflect the member ‘s relative position in the worldeconomy.

Regarding the IM F quota and governance reform that was agreed upon inDecember 2010, the goal was to put the amended Articles of Agreement

into effect before this Annual Meeting.

To our great regret, however, only countries which together hold 68percent of the voting power have accepted the amendment so far.























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We hope that the countries that have not yet completed the necessarydomestic procedures for the amendment will speed up the process.

Increasing the IMF‘sstaff diversity is also important so as to enhance theFund‘s legitimacy, effectiveness, and credibility.

Japan is ready to make as much contribution to the Fund in terms of human resources as it does in terms of financial resources.

Quota Review

With regard to the ongoing quota review, Japan, once again, would like tostress the importance of giving appropriate consideration to member countries‘past records of financial contributions.

Needless to say, quotas constitute the basis of IMF resources, and yet wemust not make light of the fact that the IMF‘s main activities in recentyears, such as addressing the global financial crisis, supporting

low-income countries and providing technical assistance, could not havebeen conducted without voluntary financial contributions made by member countries.

In light of this reality and in order to increase the incentive for member countries to make voluntary contributions and secure stable financialresources for the IMF, voluntary financial contributions by member countries should be appropriately reflected in the current quota review.

It should include financial contributions to the New Arrangements toBorrow (NAB), bilateral loans, interest subsidies and loans for concessional finance for low-income countries, and technical assistance.

Some argue that if consideration is given to the past records of financialcontributions, the quota shares of emerging and developing countries

would be unduly lowered.

However, Japan believes that it is possible to take into consideration boththe past records of financial contributions and the quota shares of emerging and developing countries.























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Of course, it is also important to appropriately protect the voices of leastdeveloped countries.

Support for Low-Income Countries

Finally, we must not forget the importance of supporting low-incomecountries in Africa and other regions.

In this respect, the IMF has an important role to play.

The IMF has been providing concessional loans to low-income countriesthrough the Poverty Reduction and Growth Trust (PRGT).

Japan has also consistently assisted the I MF‘s support for low-income

countries by making contributions such as the provision of loans andinterest subsidies.

In response to the global financial crisis that broke out in 2008, we agreedin 2009 to increase the PRGT‘s resources to enhance support for low-income countries.

Based on this agreement, in May this year, Japan expressed an intentionto contribute its share of the windfall profits from the IMF gold sales tothe PRGT‘s interest subsidies.

We welcome the progress made now that the number of commitments bymember countries has reached the necessary level.

Even if the windfall profits from the IMF gold sales mentioned above aretransferred to be used as interest subsidies based on the 2009 agreement, afurther expansion of the interest subsidy account will be necessary inorder to fully satisfy the needs for support for low income countries in andbeyond 2015.

Japan is ready to further contribute to interest subsidies for PRGT oncondition that member countries act in concert based on the newagreement reached by the IMF Executive Board























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Communiqué of theTwenty-Sixth Meeting

of the IMFC Chaired by Mr. Tharman Shanmugaratnam, Deputy Prime Minister of

Singapore and Minister for Finance

Global growth has decelerated and substantial uncertainties anddownside risks remain.

Key policy steps have been announced, but effective and timelyimplementation is critical to rebuild confidence.

We need to act decisively to break negative feedback loops and restore theglobal economy to a path of strong, sustainable and balanced growth.Advanced economies should deliver the necessary structural reforms andimplement credible fiscal plans.

Emerging market economies should preserve or use policy flexibility asappropriate to facilitate a response to adverse shocks and support growth.

Advanced economies

There is a need to secure a sustained recovery from the crisis.

Further monetary easing has created more accommodative financialconditions.

The implementation of credible medium-term fiscal consolidation plansremains critical in many advanced economies.

Fiscal policy should be appropriately calibrated to be as growth-friendlyas possible. In the euro area, significant progress has been made.

The ECB‘sdecision on Outright Monetary Transactions and the launchof the European Stability Mechanism are welcome.

But further steps are necessary.























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We look forward to timely implementation of an effective banking and astronger fiscal union to strengthen the monetary union‘s resilience, andstructural reforms to boost growth and employment at the national level.

In the United States, resolving the fiscal cliff, raising the debt ceiling, and

making progress toward a comprehensive plan to ensure fiscalsustainability are essential.

In Japan, securing funding for this year ‘s budget and further progress inmedium-term fiscal consolidation are needed.

Emerging market and developing countries

Activity is slowing in emerging market and developing economies,reflecting weaker external and domestic demand and, in some cases,

policy tightening to address inflationary pressures.

Risks are compounded for some countries by falling prices for non-foodcommodities and upward price pressures on some food items.

These economies will need to ensure flexibility in policy implementationto support growth, consistent with global rebalancing.

The potential impact from large and volatile cross-border capital flowsshould be closely monitored.

The Fund has increased its support for Arab countries in transition andcontinues to work with these authorities as they develop home-grownnational reform strategies to deliver inclusive growth and jobs.

We call on the international community to provide broader support for this region.

We welcome the increased engagement of the IMF with small states andlook forward to further work in this area.

Low-income countries

While growth remains buoyant in most low-income countries, fiscal andreserve positions have weakened and buffers need to be restored.























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In the near term, the Fund is adequately resourced to provide additionalfinancial support to low-income countries, should the need arise.

We welcome the IMF Executive Board‘s decision on the use of US$2.7billion in remaining windfall gold sales profits as part of a strategy to

ensure the long-term sustainability of the Fund‘sconcessional financingfacilities.

This comes on top of the receipt of the assurances needed for the use of US$1.1 billion in resources linked to gold sales profits to bolster PRGTresources in the near term.

We call on members to expedite the unlocking of this financing.

Global Policy Agenda

We welcome the directions set forth in the Managing Director ‘s GlobalPolicy Agenda and share its emphasis on the need to address the currentcrisis and build a strong foundation for future growth.

Policies for jobs and growth, debt sustainability, repair of financialsystems, and reducing global imbalances are key priorities.

We will review progress on implementing these measures at our nextmeeting.

We are committed to strengthening domestic sources of growth insurplus economies, boosting national savings while enhancing exportcompetitiveness in deficit countries, and fostering greater exchange rateflexibility, where appropriate.

We reaffirm our commitment to avoid any form of trade and investmentprotectionism.

Surveillance

We welcome the strengthening of the IMF‘ssurveillance frameworkthrough the adoption of a new Integrated Surveillance Decision, aFinancial Surveillance Strategy as well as the launch of a pilot ExternalSector Report.























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These initiatives will bring together bilateral and multilateral perspectivesin the Fund‘spolicy advice and support better assessment of global andcountry-level risks and spillovers to economic and financial stability.

We look forward to the evenhanded and effective implementation of the

strengthened surveillance framework and will assess progress at the nextAnnual Meetings.

Resources

Members have significantly augmented Fund resources.

Pledges have been received from more members since April to increasethe borrowed resources available to the Fund by US$461 billion.

We welcome the signing of the first batch of bilateral borrowingagreements and encourage the conclusion of the remaining borrowingagreements soon.

2010 Quota and Governance Reforms

We have made considerable progress in ratifying the 2010 quota andgovernance reforms.

Most of the conditions required for the entry into force of the reformshave been achieved.

We reaffirm the urgency of making these important reforms effective andcall on members who have yet to complete the necessary steps to do so.

Quota Formula Review

The comprehensive review of the quota formula is well underway.

The key issues and differences have been clearly identified.

We call on the membership to develop the consensus needed throughfurther engagement of the IMF Executive Board, with input from theIM FC Deputies after their meeting in December, to complete the reviewby January 2013.























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We reaffirm our commitment to conclude the Fifteenth General Review of Quotasby January 2014.

IMFC meeting

We would like to express our gratitude to the government of Japan for hosting these meetings.

The next I MFC meeting will be held in Washington D.C. on April 19-20,2013























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To: Banks

Bank Holding CompaniesFederally Regulated Trust and LoanCompanies

Cooperative Retail Associations

Subject: New Required Interim Public Capital DisclosureRequirements related to Basel I I I Pillar 3

On June 26, 2012, the Basel Committee on Banking Supervision (BCBS)issued its final rules on the information banks must publicly disclosewhen detailing the composition of their capital.

Entitled, Composition of capital disclosure requirements –Rules text (theBCBS Disclosure Rules), the publication sets out a framework to ensurethat the components of banks‘capital bases are publicly disclosed instandardised formats across and within jurisdictions for banks subject toBasel I I I, which in Canada includes all banks, bank holding companies,federally regulated trust and loan companies, and cooperative retailassociations (collectively institutions) regardless of size or public listings.

As noted in the BCBS Disclosure Rules,―During the financial crisis,

many market participants and supervisors attempted to undertakedetailed assessments of the capital positions of banks and comparisons of their capital positions on a cross jurisdictional basis.

The level of detail in the disclosure and the lack of consistency in the waythat it was reported typically made this task difficult and often made itimpossible to do with any accuracy.

It is often suggested that lack of clarity on the quality of capital

contributed to uncertainty during the financial crisis.‖

Accordingly, the new public capital disclosure requirements are intendedto improve both the transparency and comparability of institutions‘capitalpositions.























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This letter provides clarification on theimplementation of the BCBS DisclosureRules for all institutions for Q1-2013 andQ2-2013 (the ―Interim Period‖) andbuilds on OSFI‘s November 2007 Advisory on Pillar 3 Disclosure Requirements.

1)Scope of Application

Given that all institutions are required to implement the Basel I I Iframework, the new composition of capital disclosure requirements alsoapply to all institutions.

For greater certainty, these public disclosures are required, regardless of

the size of the institution and whether the institution is publicly listed(i.e., public disclosure is required for wholly-owned institutions, foreignbank subsidiaries and all other institutions that might not be publiclylisted).

Exemption from disclosures applies to institutions that continue to meetthe exemption criteria outlined in Part 1 of OSFI‘s November 2007Advisory on Pillar 3 Disclosure Requirements.

2) Interim period –Q1 2013 and Q2 2013

To facilitate comparability and to provide financial statements users withBasel II I information in the interim period, OSFI requires institutions tomake modified minimum composition of capital disclosures for Q1 2013and Q2 2013 (the ―Interim Period‖) as described below.

Institutions can disclose additional information at their discretion.

3)Disclosures, Common Template relating to the components

of regulatory capital OSFI Modified Transitional Template

The Transitional Template, described in Section 5 and illustrated inAnnex 4 of the BCBS Disclosure Rules, is a modified version of the Post























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January 1, 2018 Template that discloses the components of capital that arebenefiting from transitioning.

During the Interim Period, OSFI requires institutions to disclose amodified version of the BCBS Transitional Template.

This ―OSFI Modified Transitional Template‖, appended to this letter,discloses regulatory adjustments from Common Equity Tier 1 (CET1),Additional Tier 1, and Tier 2 capital on a condensed basis, rather thanindividually as prescribed under the BCBS Transitional Template.

Further, the OSFI Modified Transitional Template omits certain lineitems prescribed under the BCBS Transitional Template relating to theamount of CET1 applicable to the various capital buffers as well as details

relating to the applicable caps on the inclusion of provisions in Tier 2 andthe amounts below thresholds for deduction.

The OSFI Modified Transitional Template also requires institutions todisclose their capital ratios on an all-in basis.

Other Pillar 3 disclosures during the Interim Period

During the Interim Period, OSFI expects institutions to continue tocomply with the original Pillar 3 requirements (including Table 2 (Capital

Structure) qualitative disclosures) along with the Pillar 3 enhancementsand revisions, and the enhanced remuneration requirements.

Issues of non-compliance will continue to be addressed on a case-by-casebasis through bilateral discussions with institutions.

4) Location

While the BCBS Disclosure Rules mandate that certain, rather than all, of

the disclosures should be publicly available on institutions‘websites,OSFI continues to encourage institutions to make all Pillar 3 disclosuresavailable on their public websites in a central location so as to enhancetransparency and comparability.























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5) Post Interim period –Q3 2013 and after

OSFI expects all institutions to fully implement the BCBS DisclosureRules starting in Q3 2013 (i.e., July 31, 2013 for institutions with October

31st year ends and September 30, 2013 for institutions December 31st year ends).

OSFI will issue separate guidance on these requirements in due course.

Mark Zelmer

Assistant Superintendent, Regulation























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Hearing before the

Committee on Economic and Monetary Affairs of the European

Parliament Introductory statement by , Chair of the ESRB, Brussels

Dear Madam Chair,Dear HonourableMembers,

I am very pleased to appear before this Committeetoday to inform you about

the activities of theEuropean Systemic RiskBoard (ESRB).

As you know, the ESRB complements the know-how of central banks,national supervisors and the three European Supervisory Authorities bydelivering what has come to be called a macro-prudential perspective.

What this means is the capacity to analyse risks across market segments,to address vulnerabilities –which currently lie mainly in the bankingsector – and to examine medium-term risks in the financial system as awhole.

Based on such analysis, combined with proposals for remedial action byway of warnings or recommendations, the ESRB will help to protectEurope‘seconomy from fragility in the financial system.

An important step in the ESRB‘s work was the publication of the first riskdashboard on 20 September 2012.

The dashboard was requested by this Parliament in the legislative processestablishing the ESRB.























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It consists of a set of quantitative and qualitative indicators aimed atidentifying and measuring systemic risk.

The risk dashboard has been produced in cooperation with the EuropeanCentral Bank (ECB) and the three European Supervisory Authorities(ESAs).

It is one of the inputs considered by the ESRB‘s General Board in itsdiscussions of risks and vulnerabilities in the financial system.

The dashboard, which will be updated quarterly, looks at six differentcategories of risks, sectorally and across the financial landscape.

It should be considered an information tool that orients further analysis

on systemic risk, rather than a fully-fledged early warning system.

The General Board has decided to publish the dashboard and itsunderlying data on the ESRB‘s website.

Risks in the banking sector

Let me turn to the current situation.

The European economy and financial system continue to face

challenging times – and it is vital always to be mindful of systemic risks.

But there are also reasons to be confident, provided that policy-makerscontinue to implement agreed measures with determination.

These measures include macroeconomic and structural reforms to ensurecompetitiveness and sustainable public finances.

They include continued financial reform to ensure a resilient andwell-functioning financial system.

And they include further development of Europe‘s institutionalframework.

From a macro-prudential perspective, there are three main possible risks.























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First, the risk of setbacks in the implementation of agreed measures.

Second, the risk of downside macroeconomic news with implications for banks‘asset quality, profitability and funding.

And third, the risk that feedback loops between these two factors mayaffect the supply of credit, which in turn will affect the real economy.

Revitalising the supply of credit is crucial for the recovery.

Notwithstanding some reductions in market tensions, financial activity remains impaired in various parts of the system.

At this time, the role of macro-prudential policy is primarily to restoretrust in the financial sector.

To rebuild investors‘confidence in banks, it is necessary to reassure themabout asset quality.

There are a number of options that authorities can consider. One isenhanced disclosure, for example, on the level of provisioning.

A second option is supervisory assessments of asset quality, possiblyincluding peer reviews by supervisors and third party assessments and athird option, where necessary, is the setting up of separate entities to deal

with low quality assets.

Important work is already being done by the European Banking Authority(EBA), assessing forbearance in the banking sector, promotingcoordinated reviews of asset quality and harmonising definitions of keyvariables – such as non-performing loans.

The ESRB plans to make further proposals for macro-prudential policy,particularly on vulnerabilities linked to bank funding.

In light of the impairment of some credit and interbank markets, theESRB, together with the EBA, is reviewing asset encumbrance andcomplex funding instruments such as synthetic exchange-traded fundsand liquidity swaps.























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The aim is to identify sources of systemic risk and policy actions tomitigate them.

I intend to present the results of this process at the next hearing in thefirst half of 2013.

Risks in financial markets

The ESRB‘s examination of the financial system extends well beyond thebanking sector.

Today, I would like to focus in particular on developments in the field of central counterparties (CCPs) and over-the-counter (OTC) markets. I willoutline the analytical work done by the ESRB and the policy advice it hasgiven.

The implementation of the G20 commitment to central clearing for allstandardised OTC derivatives has important consequences for the EUfinancial system.

The ESRB started to assess the systemic implications of the moreprominent role for CCPs that they will become a crucial node within thefinancial system.

Macro-prudential examination of CCPs relates, in particular, to thepro-cyclicality of margining and haircutting practices. Such practices

have an important bearing on financial conditions in the economy.

While the more prominent role for CCPs reduces counterparty risk, itinevitably implies an increase in concentration risk.

Therefore, the ESRB issued advice to the European Securities andMarkets Authority (ESMA) on two aspects regarding the systemicresilience of CCPs.

On collateral, the ESRB advised the ESMA to increase the systemic

resilience of CCPs by better defining the type of eligible collateral and theconditions under which commercial bank guarantees may be accepted ascollateral by CCPs.























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The ESRB also advised that risks related to cross-collateralisation shouldbe adequately taken into account.

On clearing among non-financial corporations operating in derivativemarkets, the ESRB advised the ESMA to restrict the possibilities for such

corporations to settle outside CCPs, so as to reduce counterparty risk.

Regrettably from a macro-prudential viewpoint, there is a risk that thesystemic vulnerabilities identified by the ESRB will remain at least partlyunaddressed.

This is due to an interpretation of the EM IR legislation that has made itdifficult to translate fully the ESRB‘s advice into technical standards.

On OTC markets more broadly, the ESRB is examining potential risks

stemming from market practices that have become very common in theso-called ‗shadow banking‘sector.

For example, collateral pledged by a client may be re-used by a lender for own borrowing needs.

This pattern, which is called re-hypothecation, may be repeated severaltimes for the same collateral.

It can therefore create a contagion chain in case any party fails to deliver.

In other cases, when collateral for securities lending transactions isrepresented by cash, that cash may re-invested by the lender.

In case such re-investment takes place in a risky asset or for a longer maturity, there are risks of so-called reuse of cash collateral in securitiesfinancing transactions.

Macro-prudential policies in the EU

Banking union and the role of the ESRB

The ESRB has also reviewed the current plans on the banking union andwelcomes the European Commission‘sproposal.























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Board members consider that the macro-prudential benefits of the SingleSupervisory Mechanism (SSM) would be enhanced if an adequateresolution regime for banks were implemented without substantial delay.

The Commission‘s initiatives for establishing a ‗single resolution

mechanism to resolve banks and to coordinate the application of resolution tools to banks under the banking union‘are to be encouraged.

The ESRB is reflecting on the implications of the proposed SSM for itsown work.

The Commission‘sproposal directly affects macro-prudential policy andits implementation – suggesting for the ECB exclusive competencewithin the euro area ‗to set counter-cyclical buffer rates and any other measures aimed at addressing systemic or macro-prudential risks in the

cases specifically set out in Union acts‘.

The ESRB has repeatedly stressed that macro-prudential policies shouldbe sufficiently flexible to prevent the build-up of systemic risks.

Policy-makers should be encouraged to mitigate emerging risks as soonas they are identified, rather than fostering a bias towards inaction.

Flexibility can be balanced by members‘coordination to safeguardagainst potential negative externalities or unintended consequences.

The ESRB is working on a general framework for the coordination of macro-prudential policies in the EU. First results can be expected in thecoming year.

Meanwhile, a review of the mission and organisation of the ESRB itself will take place in 2013.

Three members of the ESRB Steering Committee –Stefan Ingves, Chair of the Advisory Technical Committee, André Sapir, Chair of the Advisory

Scientific Committee, and Vítor Constâncio, Vice-President of the ECB – will examine the functioning of the ESRB, including in light of theforthcoming banking union.























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Follow-up on ESRB recommendations

The ESRB is also working on first implementation of the ‗act or explain‘ mechanism set out in the ESRB Regulation to ensure that addresseesrespond properly to ESRB recommendations.

The first set of deadlines for replies to the ESRB recommendations issuedin 2011 expired in June 2012.

The current review suggests that the ‗act or explain‘mechanism hasfunctioned smoothly.

At the same time, more work lies ahead to enhance our assessmentframework.

The ESRB Secretariat has contacted relevant European and internationalinstitutions – such as the Commission, the IM F, the OECD, the FSB andthe Bank for International Settlements – to learn from their experience.

Conclusions

In concluding, I would like to emphasise that there is substantial progressin the understanding of systemic risks and the design of macro-prudentialpolicies in the EU.

This would not have been possible without the active involvement and

dedication of all ESRB member institutions and committees.

On the occasion of the rotation of the Chair of the Advisory ScientificCommittee, I would like to thank in particular its first Chair, MartinHellwig, and to wish all the best to the new Chair, André Sapir.

I understand that you will have the opportunity to exchange views withthe Chair and Vice-Chairs of the Committee very soon. Thank you verymuch for your attention. I am now at your disposal for questions.























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Capital and Adventure: The Auditor‘s Role in the Modern Corporation

James R. Doty, Chairman

International Forum of Independent AuditRegulators (IFIAR) London, England

It is a genuine honor to be with you today.

I want to thank Stephen H addrill, Paul George, the U.K. delegation andthe many members of the Financial Reporting Council for hosting thistwelfth congregation of what is now 43 national audit regulators hailing

from Europe, the Americas, Asia, Africa and the Middle East.

In addition, Paul, you have my gratitude and admiration for your leadership these last two years as Chairman of IFIAR.

In addition, on behalf of my fellow board members who have joined mehere— Lew Ferguson, Vice Chair of IFIAR, and Steve Harris, who chairsIFIAR's Investor Working Group— I want to thank you, Stephen andPaul, for the extraordinary partnership we have enjoyed since our firstmeeting.

Together, in our joint inspections and our work on audit reform, we haveadvanced the interest of the public in global cooperation to improve therigor of audits and cast new light into the interstices of regulatory gapsthat attract fraud and self-dealing.

It is appropriate now to say that the remainder of my remarks today aremy own and should not be attributed to the PCAOB as a whole or anyother members or staff.

We meet in London on this occasion, not only because the FRC is a greathost. As in so many other examples in history, London is a place where

journeys begin.























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I began a personal journey of my own, about one hundred kilometersfrom here, at Merton College at Oxford, where I read modern history.Under the tutelage of the late John Morris Roberts, I awoke to the value of debate in critical thought and analysis.

Some of you may remember his BBC series on Western history. H e wasalso a prolific writer.

He introduced me to a generation of historians deeply rooted in thepractical details of the past—As a Briggs, Richard Cobb, and others.

They saw the big ideas that lurked in the everyday patterns of contemporary life, and drew out those grand themes to guide us forward

— a difficult task.

As John said, "It will always remain true that the closer we get to our owntimes, the harder it is to see what is the history that really matters."

John remained a lifelong friend until his death in 2003. But after my twoyears at Oxford, I returned to the United States to study law andspecialize in corporate and securities law.

I. The History of the Corporate Form is a Story of IrrepressibleInnovation to Suit the Needs and Opportunities of Investors.

But Oxford was hard to shake off. My history lessons traveled with me.One of the grand themes was an understanding of the fact that thecorporate paradigm is not immutable.

It lurches forward, toward a transient solution for a moment's purpose.

As the moment passes, we change it to suit the next.

The modern corporation spawned from the quite basic and ancientcommercial need to amass large sums to finance high-risk tradingexpeditions across oceans.

Many such voyages, as you know, were financed by the various European























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states.

A.Merchant Adventurers Pooled Resources to Capitalize onState Monopolies.

Others were financed privately, by merchant adventurers or what wereknown as "regulated companies" that had been granted a royal or Parliamentary charter to monopolize trade.

In the 14th century, England began exporting manufactured goods toPrussia, the Netherlands, and Scandinavia.

Many think of globalization as a 20th century phenomenon. But asEuropean nations transformed from agricultural economies to mercantile

and manufacturing activities, private international trade burgeoned.

Thus, centuries ago, in Britain, long-distance trade became moresignificant economically than domestic trade.

The records of early regulated companies show that they were audited.

And that those audits were generally conducted by a committee of directors or participants in the company.

B.Joint Stock Companies Allowed Passive Investors toParticipate in Voyages and Other Ventures.

Fast forward: in the 16th century, a new corporate form emerges toconduct overseas trade— joint stock companies.

This was the precursor to the modern-day public company.

In regulated companies, all members enjoyed and participated in the

monopoly together, but each supplied his own ships and inventory to theventure.

In joint stock companies, officers are appointed to trade on behalf of the























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members, some of whom, to a greater and greater extent as the centuriespassed, are passive investors.

Over time, investors find means to transfer shares of joint stockcompanies.

Again, these joint stock companies were audited by committees of shareholders.

The use of auditors was also prevalent in early America. For example, theMassachusetts Bay Company was a joint stock company chartered in1629.

Responding to an early liquidity crisis, it used an audit committee of

"eight Adventurers" to "clear up the confused state of [its] accounts"after ship purchases depleted the Puritans' initial funds.

C. 19th Century European Legislation Provided for LimitedLiability Partnerships, Incorporation Outside of CrownMonopolies and Transfer of Shares, and Use of ProfessionalAuditors.

Fast forward again, and we find other countries also develop

sophisticated forms for group enterprise.

Notably, Napoleon's 1807 Code introduced a significant innovation byallowing limited liability partnerships.

Half a century later, the UK Parliament allowed private incorporation of joint stock companies by registration— that is, without the need for aroyal or Parliamentary charter — through the Joint Stock Companies Actof 1844 and the Companies Clauses Consolidation Act of 1845.

These laws provided for incorporators to appoint auditors to prepare areport for the annual general meeting of shareholders, which in thosedays was a meaningful part of corporate governance.























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Consistent with the prior 600 years of practice, they envisioned theappointment of auditors from among the body of shareholders.

They required that "every auditor shall have at least one share in theundertaking; and he shall not hold any office in the company, nor be inany other manner interested in its concerns, except as a shareholder."

Moreover, I note that the 1845 Act also required rotation of auditors, suchthat one member was required to go out of office after the first ordinarymeeting each year, with eligibility to rotate back on the committee uponre-election.

Of relevance to our endeavors, the legislation also, for the first time,acknowledged the right of the auditing committee to employ accountants

or other persons as they deemed appropriate, at company expense.

Enter the professional auditing assistant, who became a popular resourcenearly overnight.

These two developments— administratively-organized joint stockcompanies and professional experts in auditing who could vouch for agents' management of corporate funds— ushered in yet moreinnovations as the 19th century closed: the floating of new securities andthe advent of securities markets organized for the purpose of trading

shares.

Thus came the earliest of the large U.S. corporations— the Baltimore &Ohio Railroad— in the early 1820s, capitalized by Baltimore merchantseager to exploit the new technology of drawing carriages by horse over railed-roads even before steam power was fully established.

What made railroads modern businesses was the scope of their operationsand the size of their capital requirements, which were far in excess of contemporary, owner-operated enterprises whose financing needs wereseasonal and generally limited to loans.

Like its corporate forbearers, the B&O Railroad used a committee of themerchant investors to audit the financial records on a regular basis. An























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annual report to investors was also required under the corporate charter.

D. The 20th Century Heralded Public Securities Markets,Multi-National Corporations, and New Audit Challenges.

On this groundwork, the 20th Century continued to build massivecompanies on a scale that could not have been imagined as that centurybegan, including companies that were truly international, with operationsin multiple countries.

All the corporate building blocks developed over centuries were required:skilled managers, limited liability for large populations of investors,freedom from political direction or intervention, effective engineeringworks and techniques scaled large for efficient production, and the means

to keep the cost of finance to a minimum.

Unlike the shareholders of the past, the growing class of public investorshad no realistic ability to participate in or even monitor the use of funds.As my friend Bernard Black, a prominent U.S. securities law professor,wrote—

Creating strong public securities markets is hard. That securities marketsexist at all is magical, in a way. I nvestors pay enormous amounts of money to strangers for completely intangible rights, whose value depends

entirely on the quality of information that the investors receive and on thesellers' honesty.

Professional auditors were key to helping investors separate the crediblemanagers from the charlatans. By building confidence, auditors wouldreduce financing costs, and contributed to an efficient allocation of capital to fuel economic growth.

Unlike the auditors of old, modern auditors are not shareholders.

They do not examine accounts to determine their own shares and profits.

Rather, their independence derives from disinterest in the company's performance— both in appearance and in fact.























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Historians remind us that each generation— managers, auditors, auditregulators— we are all in a sense custodians of and fiduciaries for thebest ideas the past has given us.

It is our job to figure out (as Edmund Burke thought) what absolutelymust be kept, and what absolutely must be discarded, to preserve theformer.

(Here, I paraphrase, with your permission.)

I will turn back to a caution learned from professional historians. As myOxford tutor John Roberts advised, "In deciding how to set out the story,the most dangerous, trap, potentially, [is] that of familiarity."

Since the financial reporting debacles at the turn of our 21st century, weaudit regulators have had the opportunity to examine in depth theeffectiveness of this external audit model for public companies.

I feel confident in saying that our work and collective findingsdemonstrate the need for rigorous, skeptical auditing to sustainwide-scale investment by diverse public investors.

Time and time again, we see evidence that auditing makes a difference.

But we also see, as we each deepen our understanding of the various firms

that intermediate our capital markets, that the competitive marketspresent challenges for auditors who are trained for technical excellencebut are subject to pressures to compromise audit quality.

I I . The Investing Public Values Audits.

In this regard, there appears to be a certain current of malaise about the

auditing profession that I believe, based upon deeper examination, ismisplaced.

It focuses on the opinion of some that the audit is a low-value, compliance activity, made further unpleasant by the burdens of























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regulation and enhanced oversight.

It suggests that those attitudes and burdens may repel bright minds fromthe profession and leave us with shrunken public markets.

The argument proves too much. We know audits are relevant, indeedcritical to further economic development.

It is the fact that they are so critical that, I believe, is pushing auditors tochange, that is, to deepen their commitment to the investing public.

Some see venture capital and private equity as a trend that will sweep usup.

They are a throwback to earlier times— co-adventurers who can fittogether within the walls of a coffee house, counting house, or modernconference room to negotiate shares and profits.

They are a partial solution to the problem of agency costs. But I see themas just an eddy.

We will yet see more innovation of the public company.

Fourteenth century consumers desired fine English wools, and English

merchants found a way to satisfy.

Twenty-first century consumers from Delphi to Delhi crave the latestsmartphone, and MNCs find a way to dazzle and deliver.

The individual investors of today seek value and return as restlessly as thesponsors of early voyages of discovery.

Unlike past generations, investors now have you promoting their interests.

Each of you, through IFIAR and in your home country, are engaged inintellectual inquiry about ways to improve the reliability of audits for theinvesting public.

Commissioner Michel Barnier and Director-General Jonathan Faull of the























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European Commission have initiated, in concert with the EU's 27member states, a reexamination of the audit and its role in investor protection.

Leaders of the profession exhibit willingness to embark on initiativessuch as the International Audit and Assurance Standard's Board'sproposal to meet investor needs with an expanded auditor's report.

I believe your interest has accelerated this process.

I applaud IFIAR members for the various, creative initiatives you havetabled at home and at past I FIAR meetings.

I I I. Public Investors Require New Safeguards of Auditor

Independence and Stronger Ties Among Regulators toEliminate Gaps in Auditor Oversight.

Investors have charged us to find ways to make the work of the auditor more useful to investors and to improve audit quality.

This is the organizing question for IFIAR's agenda of meetings thisweek.

For my contribution to the week's debates, I would encourage you todevote attention to two themes to enhance investor protection: (1) thelode star of auditor independence, and (2) the benefits of deepeningcooperation between and among us.

A. Auditor Independence

First, on auditor independence: We need to find appropriate structures toreinforce auditor independence.

In the U.S., we are in the middle of a series of high-level publicdiscussions on ways to enhance auditor independence, including possiblythrough mandatory term limits.























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Could term limits release auditors from the natural incentive to do whatthey think may be necessary to foster and maintain long clientrelationships?

And under what combination of circumstances? Would knowing thatanother auditor will follow cause the first to stand firmer?

What length of term would encourage an audit firm to plan and makeappropriate investments of staff and other resources but at the same timediscourage commitment to the client's success, about which the auditor should be neutral?

We have received constructive suggestions about both the merits of different approaches, as well as ways to minimize potential disruptions.

Would grace periods for extenuating circumstances be appropriate?

Say when there has already been a change in a key participant in financialreporting?

The CEO, the CFO, the internal auditor. Or a key corporate event? Arestatement, a merger, a material weakness in internal control.

Is the appropriate balance a disclosure approach, such as "tender or explain," or "if you retain you must explain"? These are all ideas put

forth in our public meetings.

And how does all of this implicate audit committees and other governance constructs?

In addition, the IAASB and the PCAOB are both actively engaged inconsidering ways to enhance the auditor's report, to make it morerelevant and useful for investors.

I believe appropriate innovations in this regard could also re-orientauditors to see public investors as their client.

Therefore, I see in this project independence-related benefits and seminalimplications for governance and the corporate paradigm.























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B. Close Cooperation Among National Regulators Better Protects Investors Everywhere

The second area I encourage you to consider is how to deepen our

regulatory coordination, which I believe has delivered important investor protections already.

Many investors in the modern, multi-national corporation do not fullyappreciate the fact that most multi-national audits are conducted by aconsortium of affiliated firms.

It is an easy fact to miss, given that it is not explained in the standardauditor's report. When one is aware, though, it is equally easy to see thereare hand-off risks.

At the PCAOB, we have seen first hand the benefits of evaluating thevarious pieces of audits performed by different registered firms inmultiple jurisdictions.

Our inspectors often see more than the principal auditor — or signingfirm— does. In many cases principal auditors rely on high-level reportsfrom subsidiary auditors.

They often don't review the work papers of the other subsidiary auditors,

and their own work papers don't necessarily reveal deficiencies that mayexist in the work of other auditors— or even simply the principalauditor's understanding of the work of other auditors.

When our inspectors have looked directly at the work of subsidiaryauditors, many times they have found problems.

These findings demonstrate why it's so important that we look at theparts of the audit performed by the principal auditor as well as the auditor

of a subsidiary, wherever they are located.

We are all aware of notorious examples of frauds directed by corporateheadquarters but perpetrated in remote locations, beyond the expectedgaze of auditors and regulators.























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If we each looked only at one side of the communication betweenaffiliated firms, we would, collectively, miss these audit errors, despite our significant, but isolated, efforts.

I can say this based on our experience now that, in recent years, we havebeen able to inspect firms that participate in audits of U.S. publiccompanies but are based outside the U.S.

It is an amazing feat of regulatory cooperation that, in the last few years,we have found ways to work together, to inspect the various members of the global networks of audit firms, on behalf of investors in all of our markets.

Working side-by-side with many of you, we have been able to gain

insights about cross-border audits that neither of us would have learnedseparately.

Therefore, let me conclude with this note of urgency for continuing anddeepening our regulatory cooperation. I know that some had envisionedthat after an initial period of trust-building, we would each go back to our national borders.

I know that coordinated inspections are attended by complicatedlogistics and issues of resource allocation.

The more the PCAOB works with another regulator, the more we learnabout how to reduce the logistical complexities and make our worktogether as meaningful as possible.

But now that we have found that working together is effective — that itdoes lead to identification of audit failures we otherwise would miss— why would we turn back ?

Public expectations for regulatory cooperation will likely increase, notabate. How could we turn back?

* * *























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History is made by people confronting emerging challenges with newideas.

As I said at the outset, the corporate paradigm is not immutable. Nor arethe investor protections that attend it.

We may pause to take a bearing. But we do not set anchor. The past yeturges us forward. I t is a journey I hope we will continue together.























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Certified Risk and Compliance Management Professional(CRCMP) distance learning and online certification program. Companies like IBM, Accenture etc.consider the CRCMP a preferred

certificate. You may find more if yousearch (CRCMP preferred certificate)using any search engine. The all-inclusive cost is $297.

What is included in the price: A. The official presentations we use in our instructor-led classes (3285 slides) The 2309 slides are needed for the exam, as all the questions are

based on these slides. The remaining 976 slides are for reference. You can find the course synopsis at: www.risk-compliance-association.com/Certified_Risk_Compliance_ Training.htm B. Up to 3 Online Exams

You have to pass one exam. If you fail, you must study the official presentations and try again, but you do not need to spend money. Upto 3 exams are included in the price. To learn more you may visit:

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www.risk-compliance-association.com/CRCMP_Certification_Steps_ 1.pdf C. Personalized Certificate printed in full color Processing, printing, packing and posting to your office or home.


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D. The Dodd Frank Act and the new Risk Management Standards (976slides, included in the 3285 slides) The US Dodd-Frank Wall Street Reform

and Consumer Protection Act is themost significant piece of legislationconcerning the financial servicesindustry in about 80 years.

What does it mean for risk andcompliance management professionals?It means new challenges, new jobs, new careers, and new opportunities. The bill establishes new risk

management and corporate governanceprinciples, sets up an early warning system to protect the economy from future threats, and brings more transparency and accountability. It also amends important sections of the Sarbanes Oxley Act. Forexample, it significantly expands whistleblower protections under theSarbanes Oxley Act and creates additional anti-retaliationrequirements.

You will find more information at:

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






























Risk Management Presentation October 22 2012

Documents

Transcript of Risk Management Presentation October 22 2012