Closing remarks by Director of Markets Supervision Gareth Murphy at the Central Bank of Ireland conference on Effective Banking and Securities Regulation

11 October 2013 Speech

Why choose "Effective Banking and Securities Regulation" as a theme?

As I explained earlier this morning, the aim of today's conference is to take stock of some of the big issues arising from the global reform of banking and securities regulation and to ask some hard questions.

As today's concluding speaker, the remarks I will make reflect some of the observations made by today's panellists as well as some of my own personal thoughts.

The Deputy Governor set the scene for today's conference by reminding us about the commitments to regulatory reform made at the G20 summit in Pittsburgh in September 2009.

He explained that regulation has many dimensions. I would like to add one more. Regulatory intervention can take many forms ranging from

  • data collection, analysis and policy formation,
  • to rule writing and supervision, and
  • possibly enforcement and resolution .

For those of you who were counting - that's seven steps in increasing order of intrusion. But having good data is the starting point. Kathleen Casey stressed this point when she highlighted the need for empiricism as a key principle underlying a disciplined approach to regulation.

So what can we say about panel discussions at today's conference?

Panel 1: What does success look like?

Our first panel addressed a simple, yet intriguing, question: what does successful banking and securities regulation look like - a question that attracts many different answers?

What does success look like?

At the outset, I asked panellists to consider a number of possible definitions of success:

  • Is it zero failure?
  • Is it successful failure?
  • Is it measured by the number of public sanctions?
  • Is successful regulation a careful blend of hard rules and soft rules?
  • Is it measured by the size of supervisors boots and the thickness of their eyebrows?
  • And to what extent can financial stability be delivered without having the public purse as a backstop?

‘Successful failure’

Our panellists agreed that 'successful failure', where the taxpayer is insulated from the consequences of that failure, is a key element of a successful regulatory regime. (Though I would note that a panellist in a later session remarked that it is the role of government to be insurer of last resort when things go wrong.)

In my view, a supervisory model which does not envision the failure of firms is likely to be much too costly for industry and for the taxpayer. Such a model is likely:

  • to nurture a moral hazard which may materialise as undisciplined management of financial entities,
  • undue lack of due diligence by creditors and customers and
  • unrealistic expectations of investors, consumers and the public at large.

Supervisory resources are limited and they must be prioritised. The Central Bank's PRISM supervisory framework clearly sets out a minimum level of supervision based on the adverse impact of the failure of a firm. Within this framework, supervision can be ramped up when the risks that firms are running are perceived to be high so as to reduce the probability of failure or else ensure that failure is orderly if it cannot be avoided.

Failure is only acceptable (a) if there are efficient mechanisms to ensure that deposits and client assets are protected and (b) if there are plans in place to ensure continuity of financial services to customers of the failed firm. Firms also need to play a role by envisioning the worst and writing workable wind-down plans. Most importantly, the requirement for effective resolution, administration and liquidation regimes for financial services firms cannot be understated. The examples of Lehman Brothers International Europe in the UK and, closer to home, Morrough Stockbrokers and Customs House Capital are reminders of the damage to investors when these powers are lacking. And let's not forget the greater challenge which remains, namely, the delivery of cross-border resolution frameworks for bank- and non-bank financial firms. More on this, a little later 2

'Value for money' and cost-benefit assessments

Banking and securities regulation is a costly activity which is, typically, financed by taxpayers and/or industry. 'Value for money' is a key criterion for success but, in some cases, it is also an elusive concept as many of the benefits of regulation are the avoidance of market failures big and small, frequent and infrequent and perhaps unobservable. Very often, only the costs are looked at because the benefits are hard to measure. But a disciplined policy formation process must invest resources in analysing the benefits of regulation (in terms of the mitigation of market failure).

That said, measuring a counterfactual is tough when it comes to avoiding systemic events which are either hard to model or hard to imagine. And 'Black Swan' events are, by definition, difficult to anticipate. Financial regulation needs to strike a balance between minimising the probability of systemic events that burden taxpayers for generations whilst providing an orderly environment for the financial services industry to meet the present and future needs of the real economy. Getting that balance right is often a political call.

Challenges to success

Well designed regulatory regimes may face a number of challenges:-

Multiple regulatory objectives

The first panel discussion noted the potential conflicts between macro-prudential, micro-prudential and consumer protection objectives. Andrew Haldane, in his speech, highlighted that the Bank of England has also to consider the interaction between monetary policy and its macro-prudential and micro-prudential objectives. The second panel discussion presented the additional challenge of co-ordinating bank resolution objectives with these other objectives.

Pursuing more than one regulatory objective under one roof is a challenge. However, there was broad consensus from panellists that regulatory architecture is not a key ingredient for a successful regime.

In my view, institutional arrangements which remove conflicts of interest by dividing responsibilities between separate authorities may still face considerable challenges when regulatory outcomes have significant political dimensions. Indeed, in situations, where there are clashes between, for example, conduct authorities and prudential authorities, problems of co-ordination may emerge and regulatory independence may be lost when finance ministries step in and attempt to arbitrate the situation.


One additional complicating objective which I would add is the responsibility for promoting the local financial services industry. The financial crisis highlighted the dangers of adding the promotion of industry to the list of responsibilities of financial regulators. Whether it is the vetting of new firms for authorisation or the delivery of public sanctions in response to rule breaches, the incentive for regulators to maintain the integrity of the regulatory regime may be undermined when the promotion of local industry is a regulatory objective. The financial crisis has taught us enough about the damage to national and international financial stability arising from having such a regulatory objective. The concept of a level playing field in financial regulation is not just 'a nice to have' in a single market which envisions the harmonious movement of goods and services. It is a global imperative in a world where the consequences of financial instability can be catastrophic. As long as different jurisdictions require local regulators to pursue such a local promotional role, the playing field amongst regulators will not be level. And regulation will not be effective.

Differences between Banking and Securities Regulation

There are differences between banking and securities regulation - and for good reason.

The Deputy Governor noted that securities regulation focusses on the chain of activity (often involving many market participants) which links end-issuer to end-investor. By contrast, banking regulation is typically focussed on activities conducted under one roof.

As a securities regulator, I am always conscious that securities markets are all about taking investment risk. Securities regulation seeks to ensure an orderly environment in which investors can make their decisions and monitor their investments.

By contrast, in the banking world, their is an aversion toward risk: deposits are expected to be safe, reliable and insensitive to information3 about the deposit-holding bank or the banking system. Indeed, banks' liabilities are different from many other (non-debt) securities given the role of deposit protection is to minimise the probability of runs 4 and the role of central bank support to maintain the liquidity of solvent banks 5.

There is a danger that some will argue that successful securities markets regulation requires that the risk for investors be minimised. It is important to understand the meaning of failure in the securities world. Loss arising from investment risk is not regulatory failure. But securities regulation does seek (amongst other things) to ensure adequate disclosure to investors and proper custody and valuation of assets. That said, (as panellists at the third session noted) financial innovation poses many challenges as the incentives of product distributors may not be aligned with the incentives of investors.

One of the challenges of financial innovation is that it invites regulation to go beyond the classical role of ensuring adequate disclosure. The complexities of certain financial products challenge (a) the expertise of investors and (b) often their cognitive abilities to process large volumes of information contained in disclosure documents. Indeed, the sheer variety of investment products is a challenge for investors. There are legitimate questions as to whether the universe of products is too broad and too complicated for investors and investment advisors to understand. (And these questions might also apply to mortgage and insurance products as well.)

Other challenges to regulation

Lastly, to the list of regulatory challenges, I would add the problems of data-gaps (which compromised the regulatory response to the financial crisis), the pressures of political cycles (which may lead to policy overload) and the perennial task of regulators having to compete with industry and retain the best staff.

Panel 2: How far do we need to go with cross-border cooperation

Our second panel discussed banking and securities regulation in an international context. This discussion continued the theme of effective resolution and successful failure but from a cross-border perspective.

Making cross-border resolution work

It was noted that successful resolution regimes require that multinational financial services groups need have appropriate capital structures which make local resolution arrangements workable. Where the group holding company makes sub-ordinated loans to local subsidiaries, it is more likely that the local subsidiary can be put into a successful resolution without damaging the claims of local customers or the taxpayer.

Non-bank resolution

With the EMIR and Dodd-Frank OTC derivatives reforms, it was noted that the failure of central counterparties (CCPs) would require cross-border resolution arrangements and that the resolution tools which were used may not, necessarily, be the same as the tools used for bank resolution.

Other modes of cross-border cooperation

I would like to add that regulatory co-operation may happen at different levels. The spectrum of cooperation spans the agreement of bilateral MOUs with limited mutual burdens (such as information sharing, on-site inspections and evidence gathering) to the formation of supra-national institutions which have powers which supersede sovereign jurisdictions.

We have seen certain parts of this spectrum fill out as the regulatory reform agenda has evolved. By accident or by design, the extraterritorial elements of AIFMD and the OTC derivatives reforms have prompted intensive engagement between supervisory authorities around the world and the creation of new modes of co-operation.

Patrick Pearson, in his speech, remarked on the debate between US and EU authorities on appropriate solutions to avoiding regulatory overlap between Dodd-Frank and EMIR. He referred to the US preference for substituted compliance where host countries must supervise home country rules - which is a form of 'regulatory outsourcing' - and contrasted it with the EU preference for similar regulatory regimes to be recognised as being mutually equivalent.

In my view one could imagine, in an ideal world, a single global rule book but the policy formation and rule-writing processes guiding primary legislation are ultimately the province of sovereign legislators who are influenced, amongst other things, by different local industries and political priorities6    The global standard setters - the Basel Committee for Banking Supervision (BCBS), the International Association of Insurance Supervisors (IAIS) and the International Organisation of Securities Commissions (IOSCO) - do have a role in this. Certainly, they can develop common frameworks for cooperation agreements, develop high-level principles for how regulations should work, eg benchmark setting, and provide clarity on emerging definitional issues. But the question remains, do these bodies need a stronger mandate determined by empowerments delivered from national parliaments?

Mark Carney recently said that the core message from the FSB to the G20 was "that what the G-20 actually does on financial reform will ultimately determine the openness of the global – not just financial, but trade – system." At the heart of this discussion is a simple reality: 21st century financial markets operate in an environment where there are very few instances of capital controls, where there is considerable freedom of the movement of goods and services and where companies can create large operations spanning the globe which locate activities so as to optimise market opportunity, tax and regulation.

For banking and securities regulation to be effective, the collection of regulatory regimes around the globe must avoid spillover effects and deter opportunities for regulatory arbitrage. That requires a global approach. At a minimum, rule books must follow similar principles and adopt similar concepts and definitions. But it is more likely that we must go further and intensify the degree of inter-regulator cooperation. The financial crisis has presented a gilt-edged opportunity to establish momentum in the task of melding cultures and pooling sovereignty in regulation. But the interactions between the EU and US illustrate the challenges. And what happens when Asian (other regional) regulators get in on the act? Unless activity in national economies retreats behind national borders, the future of financial regulation is global and it is likely that new institutional arrangements will need to evolve to deliver it. Whether that happens as a result of G20 processes or as part of global trade agreements remains to be seen.

Panel 3: The challenges for banking and securities in the 21st century?

The third panel looked forward and considered the challenges for the future. The issues of trust, culture and financial innovation were considered at length. Trust in financial services providers has declined over the years. It was agreed that this is a key ingredient to ensuring that the weight of regulation is properly calibrated. However, there was disagreement as to how the challenges of financial innovation should be addressed. Trust had been lost in financial product providers and distributors. However, there were risks that regulatory vetting of products would be too onerous and, ultimately, unsuccessful. Aligning the incentives of product producers and distributors with those of investors is crucial.

I believe it is important to have an eye on the past when looking forward. The financial crisis took place in the first decade of the 21st century but the aftermath of it is likely to set the scene for the delivery of financial services for the rest of the century - just like the Great Depression lead to US financial reforms which lasted until 1998.

At present, a number of significant trends will define the financial services industry of the 21st century:

  • people are living longer;
  • nominal interest rates are low;
  • economic growth (in the west) is anaemic;
  • defined benefit pension schemes are closing;
  • the range of financial products is bewildering; and
  • the financial services are being passported from country to country;
  • the boundaries between the banking and the securities sectors (and indeed insurance sector) are becoming more and more blurred.

The purpose of financial regulation is to support economic activity.  It exists, first and foremost, to address market failures or imperfections which undermine the flow of economic activity.  The current regulatory reform agenda must address the gaps exposed by the financial crisis without stifling the capacity of financial services industry to support the real economy.

In the wake of the financial crisis, a number of new strands of thinking have emerged such as (i) macro-prudential regulation, (ii) behavioural economics and (iii) the role of culture and pro-sociality.

Let me say something about each of these areas.

Macro-prudential Regulation

As Andrew Haldane explained, the emergence of  frameworks to deliver macro-prudential regulation reflects the fact that whilst an economy is the sum of the parts, regulating the parts may not lead to stability of the sum.  Systems matter.  The tools of macro-prudential policy are evolving.  Challenges remain in terms of understanding the impact of these tools.

I would also question the extent to which they can be used without interference from  finance ministries or other government departments.  For example, what would a mortgage loan-to-value limit do to the the supply of credit to households and the access of people to housing?  And if the macro-prudential regulator requires banks to raise more capital, can the market provide it or will the finance ministry need to step in with a cheque book on behalf of the taxpayer?  I would expect that in the coming years, these tools will honed and developed in the light of experience.  It will be interesting to see whether financial authorities can preserve their independence as these tools are flexed more often.

Behavioural Economics

Much can be said about behavioural economics.  It is like a new religion which, pre-crisis, was practised by some anonymous academics who have now been thrust into the limelight.  The reality is that it has been a thriving discipline for well over fifty years but was crowded out by the doctrines of market efficiency and rational expectations.  Whether it is the risk management of banks, the assessment of loan underwriters, the due diligence of investors or the judgement of derivatives traders, behavioural economics has something important to say about why people behave in ways that do not seem rational (or do not conform to classical economic models).  At the heart of this discipline is an understanding that human beings struggle to make decisions when faced with complex tasks, uncertainty and information of varying degrees of quality and quantity.  The current regulatory debate is already influenced by these ideas.  Witness the debate over whether Basel risk weights are too complex and whether a simple leverage ratio should be the binding regulatory capital constraint.  Or witness the development of the Key Investor Information Document for UCITS which attempts to provide concise disclosure to investors.  For sure, these insights will leave their mark on 21st century banking and securities regulation.

Culture and pro-sociality

One of our panellists said that "culture is not something that you see on a balance sheet but bad culture will eventually damage it".

Often we hear commentators speak of how the culture of finance has changed for the worst in the last thirty years and how trust has declined between investors and financial services firms.  The result includes new regulations which for example, focus on how product distributors get paid and how risk-takers in financial institutions are remunerated.

Trust matters.  It is well understood that contracts cannot be written to deal with every eventuality without incurring excessive legal costs between counter-parties.  At a certain point, it pays to rely on non-contractual resolutions to situations which the lawyers did not anticipate.   However, the basis for such non-contractual resolutions is an expectation that either both parties can settle their differences and avoid recourse to the courts to resolve the matter.  It is not surprising that in some Asian business cultures, great emphasis is placed on sizing up new clients and business partners in informal settings before making a commitment.  Just as trust complements contractual negotiations, equally it is true that trust plays an important role in financial regulation.  (Indeed, this point was made by a former banking regulator during the first panel session).  And indeed, some would argue that pro-social behaviour which engenders trust is economically optimal.8

In the absence of certain social norms, market conventions and institutional approaches for doing business 9, we are faced with a world where the gaps may be filled by many detailed rules.  This, indeed, is very expensive for both financial authorities and for industry.  But these other modalities for regulating human behaviour stem from social and political processes which lie beyond the remit of humble regulators and technocrats.  It is not for me to predict how strong a role these modalities will play in the decades to come but there is enough evidence to suggest that they should be part of the solution to deliver healthy economic environment for financial services.  

Bringing it all together

To conclude this conference, I would make the following points:

Banking and securities regulation emanates mostly from G20 and EU policy agendas.  As with most other EU countries, in Ireland, we have very limited national discretion;

The free movement of capital and financial services necessarily means that effective regulation can only be delivered with some form of international cooperation and that means that a certain level of sovereignty must be ceded if spillovers and regulatory arbitrage are to be avoided;

We need to think about getting the balance right between formal rule books and other modalities for regulating behaviour such as social norms, market conventions and institutional arrangements, but that is a task for society at large;

Regulatory engagement is a discipline in its own right.  Where there is a lack of discipline, execution risk and regulatory failures are more likely.

Regulatory engagement takes a variety of forms but effective and efficient monitoring of financial activity through regulatory returns should be starting point as this underpins analysis, policy formation, rule-writing, supervision, enforcement and resolution;

And finally, financial regulation is a global trade issue.  Regulation can be used as a barrier to entry.  But it can also be used as a tool for competitiveness.   However, there are significant financial stability risks when jurisdictions lower the bar and lead the race to the bottom.

Much has been done over the last five years.  But there is still much more to do.  Thank you.


Allen, F. and Herring, R., (2011), "Banking Regulation versus Securities Market Regulation", Financial Institutions Centre, The Wharton School.

Bagehot, W., (1873), "Lombard Street: A description of the money market", reprinted Wiley 1999.

Dang, T. V., Gorton, G., Holmstrom, B., (2010), "Financial Crises and the Optimality of Debt for Liquidity Provision".

Diamond, D., and Dybvig, P., (1983), "Bank runs, deposit insurance and liquidity", Journal of Political Economy.

Gorton, G., (2009), "Slapped in the face by the invisible hand; banking and the panic of 2007", Prepared for the Federal Reserve Bank of Atlanta’s 2009 Financial Markets Conference: Financial Innovation and Crisis.

Jackson, H., (2007), “Variation in the Intensity of Financial Regulation: Preliminary Evidence and Potential Implications”, Yale Journal on Regulation.

Lessig, L., (1998), "The New Chicago School", Journal of Legal Studies, University of Chicago Press.

Moloney, K. and Murphy, G., (2013), "The Spectrum of Regulations Engagement", Law and Financial Markets Review.

Stigler, G., (1971), "The theory of Economic Regulation", Bell Journal of Economics and Management Science.

Stout, L., (2010), "Cultivating Conscience: How good laws make good people", Princeton University Press.

Wright, D., (2012), Remarks delivered at the The Atlantic Council, Washington.


1 See Moloney and Murphy (2013)

2 See Wright (2012)

3 Gorton (2010) and Dang et al (2010)

4 Diamond and Dybvig (1983)

5 Bagehot (1873)

6 See Stigler (1971)

7 See Wright (2012)

8 Stout (2010)

9 Lessig (1998)