Address by Director of Policy & Risk, Gerry Cross, at the Corporate Treasury & Cash Management Conference

16 November 2016 Speech

European Regulation and Impacts for Irish Financial Firms

Introductory comments

Many thanks to the IACT and to Ronan for the invitation to speak here this morning.

The topic you have asked me to speak about - European Regulation and Impacts for Irish Financial Firms - is not only a very interesting and important one in itself. It is also well timed.

We are now eight years after some of the key moments of the global financial crisis. Work is underway to finalise the calibration of Basel III. There is a focus on the role of financial services and markets in ensuring the effective funding of the economy. And consideration is being given to the cumulative effects of post-crisis financial regulation.

There are also, of course, a number of other factors that add to the relevance of a discussion of impacts. These include the prevailing low interest rate environment which is expected to continue for the period ahead, continuing challenges to bank profitability including elevated, if declining levels of non-performing loans, and of course the implications of the UK Brexit referendum outcome. To which now we must add further potential uncertainties arising from the US Presidential election outcome.

Post-crisis regulatory reforms have given us a feast of acronyms: CRD IV, MiFID 2, EMIR, Solvency II, BRRD amongst others. These are changing financial firms’ business models and operations, and the way financial markets operate. There have been claims and concerns that the recent wave of reforms is impacting on the ability of non-financial firms to fund themselves, manage risk and manage liquidity effectively.

At the outset I should state that at the Central Bank, we believe that the body of regulation implemented since the crisis represents a significant achievement, that it is necessary for confidence and stability, and that it is on the whole well-calibrated. We also agree that we need to continue to work to understand further the cumulative effects and interactions of those reforms.

Understanding impact

Calibrating regulation requires us to have a clear view of what it is that the level of observed impact should be judged against.

For example, if the only objective of financial regulators was to ensure that financial firms did not fail or that taxpayers did not bear losses in the event of their failure, then it could be hard to ever say that the burden of financial regulation was too high. In general terms the more stringent the financial regulation the safer the system, and therefore if there was just a single objective of safety the assessment would be a very straightforward one.

On the other hand, if we wanted to avoid any impact on the pricing of risk and therefore the cost of funding we would have to give up financial regulation as a bad job.

But clearly, neither of these is the case. The goal of financial regulation is not simply to prevent all business failure or losses to taxpayers. Nor is it to be cost neutral in its outcomes. It is a much more complicated one than either of those taken alone suggest.

Financial regulation is of course about preserving financial stability. As we know in Ireland only too well, this is an objective which is of major national, regional and global importance. If we get that wrong then the price can be enormous.

It is also about protecting consumers. In their dealings with financial firms consumers should be treated in accordance with rules and standards that ensure that they are treated fairly, that they are provided with all of the information they need in an appropriate and understandable form, and that the products they are sold are suitable.

There is also the important aim of ensuring that financial services and financial markets operate in such a way that they support the functioning of the economy and the achievement of sustainable growth. This means that financial regulation and supervision are also about ensuring that the system of financial services and markets itself functions effectively and well and in a way that supports optimal and sustainable economic activity in a particular jurisdiction or region.

Let's look at capital requirements imposed upon banks. What are the relevant considerations in setting these?

Firstly, there is the aim to ensure that each bank, as part of the overall financial and banking system, is well-enough capitalised to ensure that if things turn sour, firstly there is only a very small chance that it will fail; and secondly that if it does fail it will be able to exit the market in an orderly fashion without loss to taxpayers. In this regard such requirements are designed to protect financial stability at the systemic level.

Secondly, capital requirements are designed to ensure that each individual firm is run on a sound and sustainable basis. This seeks to ensure that clients and customers of financial firms can be confident that their money will not disappear because the firm fails taking the client's money with it. This both protects consumers but also ensures that there is in place the strong foundation of confidence that is necessary for financial services to work well.

Thirdly, there is the aim to ensure that capital requirements are sufficient but not excessive. If they are set too high, then this can impact bank profitability. It will make it difficult for them to make loans and provide other services at prices that borrowers and counterparties are willing to pay and thus reduce below optimal levels the flows of funding into the economy. This is why, in order to achieve the third objective of financial regulation, that of a well-functioning system supporting a sustainably growing economy, it is important that regulatory requirements are both strong enough to achieve their preventative aims but well-enough calibrated not to cause unintended harm.

Now let's consider the requirement that financial firms do not seek to sell to individuals financial products that are not suitable for their needs. Again the primary goal of this requirement is to ensure that individuals are appropriately protected. That they are not subjected to the risk of loss and damage as a result of inappropriate practices by financial professionals who have a significant knowledge and experience advantage. But as well as this primary damage-prevention goal, there is the overall goal of ensuring that people do not feel distrustful and doubtful when they go to purchase some financial service or product. That they have trust and confidence in engaging with the financial system.

What all of this is saying is that there are multiple sides to financial regulation: systemic stability, the soundness of individual firms, the protection of consumers, the supporting of confidence, and the effective functioning of the economy. They are all closely connected but different. And it is by keeping them all in view and ensuring that they are kept in appropriate equilibrium that we are able to assess whether or not we are achieving the correct impact.

Assessing the impact

I said I would return to the issue of assessing impact. It is obvious from the discussion that assessing the impact of financial regulation is a complicated and difficult business, but an important one.

Regulators have gone to considerable length to assess the impact of the various regulatory initiatives. Just look at the quantitative impact assessments that have been undertaken. In terms of the requirements of the individual measures therefore, I think we can be confident that they are well calibrated.

Perhaps a little less well understood however is the totality of the ways in which all of these new regulations may interact over time and their cumulative effects. So we support the European Commission in its efforts to develop further understanding in this area. But this is by no means an easy task. The interactions are multifarious and evolving, the dynamics complex, and the extrication of causes and effects extremely challenging. For this reason, we consider that the assessment of the cumulative effects requires a longer term perspective and a continuing effort. It is not something that can be done quickly in the short term, or on the basis of a point-in-time approach.

Judging the impact

In the meantime, while we undertake this longer term task of understanding the cumulative impact of the programme of regulatory reform, it is appropriate to consider whether there are specific aspects that appear to need correction in the short term.

I have taken a look at the response that the UK Association of Corporate Treasurers made in response to the Commission's consultation. Amongst their points were the following:

  • High levels of regulatory uncertainty;
  • The extension of financial regulation to non-financial firms
  • Impact on banks' activities including lending and market making, and pricing

Let me say a little about each of these.

Regulatory uncertainty

As concerns the question of regulatory uncertainty, I would very much agree that this has the potential to be a disruptive feature. We have had a long period of uncertainty which was due to the necessity to significantly change the governing regime post-crisis. For many firms of course this has now been compounded by the major levels of uncertainty introduced by the UK's Brexit referendum (and now, in addition, the US election outcome).

All I can really do therefore is to concur with the view that we need to minimise now any remaining regulatory uncertainty. Certainly in those areas which have been a key focus over the post-crisis period. I would refer you to the Mansion House speech a couple of weeks ago by Sam Woods, the new Head of the UK's PRA entitled "The revolution is over; long live the revolution”. I agree with what Sam said there that, subject to the necessity to complete a few outstanding pieces of work that are in the process of finalisation, the period of intense post-crisis revolution in prudential standards has reached the end and we have now entered the phase of implementation and calmer more predictable evolution as firms and markets develop.

It is also of course important to note that outside the area of prudential regulation in its traditional sense, there are important other areas of work that are ongoing and that are of consequence. To a certain extent these reflect the need to address the second order effects of post-crisis changes – for example the need to consider the question of systemic risk in investment funds; the need to address recovery and resolution in central counterparties. There is also unfinished work such as in the area of Money Market Funds or Packaged Retail and Insurance-based Investment Products.

There is also the whole area of work that is underway in respect of Capital Markets Union, which the Central Bank supports. Enhanced diversification of funding sources. Enhanced investment opportunities for savers. Enhanced integration of European financial markets. These are valuable goals. While CMU may involve some new regulation, it does not give rise to regulatory uncertainty. Both because the Commission is looking for industry-led solutions where possible, and because any resulting regulation will be much more on the facilitative rather than constraining side.

I would say of course that this works both ways, if we don't need a continued period of regulatory reform, nor do we need a period where questions that have been closed and dealt with are constantly re-opened. Subject to the need to evolve in an orderly manner, and to review and understand impacts in an orderly manner, we should refrain from a sense that there will be a continued period of flux and review.

Non-financial firms

On the question of the extension of financial regulation to non-financial firms, one of the issues that has been raised with us is the issue of the transaction reporting requirements that have been imposed on non-financial firms.

We currently have dual sided reporting in the design of EMIR reporting (but not in the design of the Securities Financing Transactions Regulation (SFTR) reporting). In principle, we should not need dual sided reporting. After all what we need are the facts, we do not need the facts twice. However, that requires a high level of confidence in the reports received. The truth is that we continue to have material concerns around the quality of these reports. This is not just about passing the validation tests. It is also about capturing the substance of the trading activity in the reports.

This leads us to have some hesitation in supporting moving away from dual-sided reporting. The way I would put it is this: it would be valuable for industry to develop a model of quality assurance of reports which would provide a basis for public authorities to develop more confidence than they currently have that the information being reported is both correct and comprehensive and comprehensible.

There needs to be a strong level of assurance that the data is correct and is being subject to comprehensive validation checks which tackle the substance of the reporting quality issues. Where errors are identified, there needs to be evidence of committed follow up to trace the causes of the errors and to fix systems so they don’t recur. That can be at the entry point to the trade repository. It can be within the dealers systems or within the end-user's systems where relevant. I suspect that until we get that, many regulatory authorities will hesitate to support the switching off of dual sided reporting.

One thought that occurs to me is that if the reports which were sent in were the definitive evidence as to contractual terms, then more effort would go into getting them right.

Impact on bank activities

Insofar as concerns impact on banks' lending and other activities: It is of course the case that the regulatory requirements imposed on banks in the wake of the crisis have increased significantly.

The Modiglani-Miller proposition of course suggests that ultimately it makes little difference whether a bank is funded by equity or debt, as an increase in the former reduces the cost of the latter. Whether this holds in real-world conditions, which include both differential tax treatments for equity and debt and different current remuneration expectations, remains an open question.


Last week Governor Lane spoke about the financing of the SME sector. He noted that the funding environment for SMEs remains impacted by post-crisis conditions. In particular, he noted that funding of new investments is more likely to come from retained earnings than from bank financing. And that cost of bank financing remains at higher levels in Ireland than elsewhere in the EU.

Two points can be made. Firstly, the position is improving: the share of non-performing loans has declined. Overall levels of leveraging in the sector have declined significantly and rejection rates have been declining steadily.

Secondly, in so far as the cost of SME lending in different countries is concerned, this has been the subject of recent research at the Central Bank[i]. This shows that the factors that impact the cost of lending are high levels of non-performing loans and the degree of banking sector concentration. Interest rates are also higher where bank stress is high and where unemployment is above historical levels.

The suggestion is that to the extent that challenges exist in relation to funding businesses, it can be too easy to turn to regulation as a cause. As we see here, in fact the causes can be other than that and many and varied.

And indeed I would mention in this regard that in December, we released new regulations on SME lending. The regulations aim to strengthen protections for SMEs, while also facilitating access to credit. The regulations provide for greater transparency around the application process and the reasons for refusing credit applications, greater protections for guarantors and an expansion of the grounds for an internal appeal.

Market liquidity

The issue of market liquidity has also been the subject of considerable attention in recent times from public authorities, research institutions, academics and market participants.

The introduction of new rules, such as the leverage ratio, higher risk-weighted capital requirements, restrictions on proprietary trading and increased margin requirements is argued to be impacting market liquidity.

At the same, there are other drivers of developments in market liquidity such as post-crisis deleveraging, advances in technology and the conduct of monetary policy in major currency areas.

While it is difficult to quantify the forces that may be impacting market liquidity in recent times, the first question is whether or not market liquidity, considered in all its dimensions, is changing, and if so how. What are the key aspects that we should monitor and consider?

A noteworthy report is a recent study by the Bank of England on the resilience of fixed income market liquidity[ii]. The key finding of this study was that the ‘normal’ level of liquidity in markets that are less reliant on core intermediaries appears to have increased, but this may have been at the expense of resilience in some cases. Conversely, the study found that the ‘normal’ level of liquidity in markets which are strongly reliant on core intermediaries appears to have reduced, but this is in conjunction with a likely increase in the resilience of those markets via a strengthening of the resilience of the core intermediaries themselves.

This finding encapsulates the key issue in this debate – market liquidity must be assessed in terms of both current and materially changed conditions. To do otherwise is to miss the point as any reduction in market liquidity - which is not yet proven - must be offset against any corresponding improvement in the resilience of market liquidity, particularly in times of stress.

While it remains an open question, it seems not unlikely that the post-crisis regulatory reform programme will be found to be having some impact on market liquidity. Not unlikely and not surprising, the mispricing of liquidity risk was one of the failures that led to the financial crisis. Regulation designed to address this failure, amongst others, should not be negatively judged on the basis of divergences from immediate pre-crisis benchmarks.

And this comes back to the point that the liquidity debate needs to be well differentiated. We need to consider not just levels of liquidity in current circumstances but also resilience and that both in current and materially changed scenarios. And we need to keep fully in mind the benefits that we are seeking to embed.


In conclusion let me say the following: financial regulation has a number of objectives. These include financial stability, soundness of individual firms, consumer protection, and well-functioning financial services and markets.

Post-crisis regulatory reform has sought to achieve the right balance amongst these objectives. At the Central Bank we believe that this has been and is being achieved. While it will be important to continue to work to understand the cumulative effects of these reforms, we should recognise the significant achievement that this represents and the contribution that it has made and continues to make to the recovery of the Irish economy.

My thanks to Vincent O’Sullivan for his contribution to this speech.


iCarroll, J. & McCann, F. Understanding cross-country interest rate variation in Europe Central Bank of Ireland Quarterly Bulletin, 2016, 2, April.

iiAnderson N, Webber L, Noss J, Beale D, Crowley-Reidy L., “The Resilience of Financial Market Liquidity”, Bank of England Financial Stability Paper, 2015 Oct; 34.