COMMITTEE OF EUROPEAN BANKING SUPERVISORS

Work Programme 2009
Progress made in 2008
1. The activities undertaken by CEBS in 2008 were very much focused on four topics:
• Dealing with the unfolding crisis situation on the financial markets, amongst others by addressing the projects mentioned in the EU roadmap on the market turmoil and facilitating our members;
• Addressing the follow-up work from the conclusions of the Lamfalussy review, especially with regard to the strengthening of the role of CEBS as a level 3 committee as set out in the EU roadmap on financial institutions;
• Providing technical advice to the EU Commission on CRD-related issues, including the finalisation of the advice on own funds, large exposures, liquidity, national discretions and the work on the impact of the CRD in the economic cycle;
• Giving further guidance in the delivery of the Capital Requirements Directive by our members which has now been implemented by our members.

2. On the unfolding crisis situation CEBS has stepped up its co-operation amongst members, facilitated swift information exchange (e.g. by means of conference calls), developed guidance as endorsed by the ECOFIN on the disclosures by banks as the crisis situation was unfolding, monitored the implementation of this guidance, analysed the problems associated with the valuation of assets that became illiquid, provided recommendations, as endorsed by the ECOFIN, to banks and accounting standard setters on this topic, provided comments on the proposals made by the EU Commission on regulatory changes, developed a process for delivering periodic risk assessments to the EU institutions and provided a first assessment mid this year to the EFC-FST. In addition, CEBS has contributed to the development of the MoU that has been established between supervisors, central banks and Ministries.

3. On the implementation of the EU roadmap on the Lamfalussy review, CEBS has agreed mid 2008 to implement Qualified Majority Voting, established its Review Panel, has facilitated the co-operation and co-ordination within colleges of supervisors and the monitoring of their functioning and developed a time-line for the delivery of a fully harmonised supervisory reporting system by 2012.

4. With regard to the advices to the EU Commission CEBS finalised its advice on own funds with a special focus to the treatment of hybrid capital instruments, issued an advice on the large exposures rules in the EU which is geared towards managing the idiosyncratic risk of a default of individual counterparties, has issued an advice on liquidity and will advise the EU Commission on the deletion of national discretions and options that are now part of the CRD but hinder a sufficiently converged treatment amongst EU member states.

5. On level 3 guidance, CEBS prioritised its work such that planned activities linked with the implementation of the EU roadmaps were given the highest priority whereas other areas have been postponed. Key areas on which level 3 guidance has been developed, were operational networking and colleges of supervisors, liquidity risk management, transparency and disclosure and valuation of illiquid assets.

6. Given the need to prioritise, Pillar 2 implementation issues, especially those related to diversification benefits arising from internal economic capital models (ECMs), based on assessments conducted by joint examination teams on a sample of EU groups, and on the level of application for Internal Capital Adequacy Assessment Processes (ICAAPs) have been postponed until 2009.

7. In developing its initiatives, CEBS has further intensified its dialogue with its external stakeholders. More specifically, for key areas on which CEBS developed initiatives, industry expert groups have been set up that provided technical expertise in the process. Furthermore, the dialogue with its Consultative Panel has intensified and CEBS has held hearings on every important topic.


Projects for 2009

Prioritisation

8. CEBS has identified the topics it needs to work on in the future. In order to be able to react swiftly to the changing situation on the financial markets, CEBS will utilise a strict prioritisation scheme in planning and executing its activities. To this end, a distinction is made between:
• Priority 1: these activities are key and need to be delivered within the agreed upon time schedule. Resources will firstly be allocated to these priority 1 activities.
• Priority 2: these activities are important for CEBS to deliver but could to some extent be postponed, if necessary.
• Priority 3: these activities will only be undertaken in as far they do not conflict with the resources needed for priority 1 and 2 activities.
Given the changing developments in the financial markets, priorities can be changed in the course of 2009. Both the Extended Bureau and the Consultative Panel will be instrumental in this re-prioritisation exercise and changed priorities will be formally agreed upon at CEBS main committee meetings. Priorities in the work programme have already been revised to take account of the G20 roadmap, for which CEBS has been tasked with a number of deliverables at the European level.

Key activities for 2009

9. The highest priority has been given to CEBS’ activities in relation to the current crisis situation and to CEBS’ deliverables connected to the EU roadmaps. More specifically, CEBS has identified the following projects as being high priority projects for delivery in 2009:

• Crisis management: Given the current market situation it goes without saying that crisis management is paramount to CEBS and its members in our day-to-day supervisory practise. CEBS will continue facilitating as far as possible adequate information exchange between members and will provide guidance on topics of common concern and/or interest. In this regard, CEBS plans:
• to set up recommendations on the functioning of colleges of supervisors in a crisis situation,
• to implement practical tools at the level of the CEBS secretariat to facilitate information exchange between members in the current crisis situation,
• to analyse the supervisory implications of the national “rescue plans” and to look at crisis events by analysing the approaches taken by supervisors and supervisory tools applied.
Due to the unfolding of the crisis, the crisis management exercise in which CEBS would participate has been postponed.

• Early intervention mechanisms: the EU Commission is developing a white paper on early intervention tools for which a request for assistance has been sent to CEBS. CEBS’s review panel is currently preparing an overview of ‘all pre-liquidation stabilisation measures’ available at national supervisors for achieving timely solutions at a troubled institution as well as under which conditions these measures can be used. There is a genuine interest to EU supervisory authorities to comment on this EU initiative and if necessary to develop policy-recommendations, especially with a view to having a sufficiently streamlined approach for these tools for cross-border operating banking groups.

• Transparency, disclosure and valuation: CEBS presented mid 2008 its good observed practises on adequate disclosures concerning assets that are relevant in the current market situation. In 2009 the major EU cross-border operating banks will for the first time disclose Pillar 3 information. CEBS will assess both the adequacy of the end 2008 disclosures of banks a well as the upcoming Pillar 3 disclosures presented to the market, and will present, if necessary, policy recommendations to increase the quality of these disclosures. CEBS will also assess the progress made by the banking industry in enhancing the transparency of securitisation activities and will follow-up on its 2008 report on issues regarding the valuation of complex and illiquid financial instruments.

• Periodic risk assessments: in 2008, CEBS developed a mechanism on how to perform on a periodic basis focused risk assessments, building upon a macro-economic analysis provided by the Banking Supervision Committee. In 2009, CEBS will continue to deliver these assessments to identify important risk areas, their relevance to banks, the measures banks have taken to mitigate these risks and possible policy responses needed.

• Liquidity risk management: in 2008 CEBS developed recommendations for liquidity risk management and supervision and presented its proposal for regulatory changes. In 2009 CEBS will do the follow-up work, as already announced in its 2008 products. More specifically, CEBS will develop more detailed guidance on the composition of liquidity buffers and the definition of the survival period, as well as on internal transfer mechanisms, will develop criteria for assessing internal methodologies and will explore the possibility of developing a minimum set of common quantitative and qualitative information requirements.

• Colleges of supervisors and other network mechanisms: The current market situation and the actions taken by supervisory authorities demonstrate that supervisory cooperation, coordination and information exchange is of the utmost importance. Promoting supervisory cooperation and coordination through colleges of supervisors has been high on the agenda of CEBS since its inception, by fostering the functioning of colleges of supervisors and tackling issues raised by members or the Industry Platform on Operational Networks. CEBS will draw lessons from the current experiences in order to improve the current cooperation and coordination supervisory mechanisms in place, as well as identify possible other networking mechanisms.

• Guidelines on hybrid capital instruments: As part of the follow up of CEBS proposals on hybrid instruments, which has translated into European Commission’s proposals for revising the CRD, CEBS will elaborate operational guidelines on the precise criteria for hybrids instruments to qualify as capital for regulatory purposes.

• Supervisory reporting: In 2008 CEBS and CEIOPS developed a plan to introduce harmonised supervisory reporting by 2012. This plan has been endorsed by the ECOFIN. In order to have the framework accomplished in the agreed upon timeframe, several deliverables need to be agreed upon already in 2009, both on COREP and on FINREP.

• Training programmes: In 2008, CEBS agreed with the other level 3 committees to develop as of 2009 a number of 3L3 training programmes. To some extent, funds have been provided by the EU Commission to undertake these programmes. 2009 will be a pilot year in which a first 3L3 programme will be run and a structure will be set up within the secretariats to manage the trainings.

• Securitisation: In 2009, the revised CRD should modify the supervisory treatment of securitisation activities. CEBS will work on the implementation guidance of the revised regulation, notably on retention clauses.

• Pillar 2: Pillar 2 is an area in which at the moment there are quite divergent practises amongst member states. In a number of these areas it is felt important to further develop a more harmonised approach, more specifically as regards:
i. Guidelines on the joint assessment process
ii. The range of practices between supervisory approaches to stress testing under Pillar 2
iii. Concentration risk

Priority 2 activities for 2009

10. Besides ongoing topics like the monitoring of accounting & auditing standards, the development of guidance on the implementation of the 3rd EU anti money-laundering directive, the handling of Q&A’s on the implementation of the CRD and COREP & FINREP and the yearly Peer Review exercises, CEBS plans also to address the following topics as priority 2 activities in 2009:

• Pro-cyclicality: CEBS has been invited to work in an EU working group on the topic of pro-cyclicality. CEBS already acts as a joint sponsor of the TFICF (together with the BSC) aiming for analysing the effects of the Capital Requirements Directive on the economic cycle. Also in the BCBS and the FSF work is being undertaken in this area. CEBS plans to liaise as much as possible with these work streams. In addition, CEBS will analyse the impact of declining capital levels.

• Amendments to the CRD: especially in 2008, a number of changes in the CRD have been initiated by the EU Commission to be effected in the coming years. In 2009 CEBS will be monitoring these upcoming changes and might develop level 3 tools, partly as spin-off of work already undertaken in 2008 in the different calls for advice or already announced in these advices. Apart from the work on hybrid capital instruments and the guidelines on securitisation, which are assigned a high priority, areas for which this is planned, are:

i. Large exposures
ii. National discretions and options.
In addition, CEBS will elaborate guidelines on implementing the incremental default risk charge in the trading book, monitor the changes concerning home and host responsibilities, and might revise its tools for cross-border cooperation accordingly.

• Supervisory disclosure: CEBS developed in 2007 its guidelines on supervisory disclosure, specifically aimed at the Capital requirements Directive. The supervisory framework is now in operation. A number of topics have been identified to further improve the use of this framework. In addition, the scope of the current framework could be enlarged. In 2009 a study will be undertaken to amend the guidelines, which could take effect in 2010-2011.

• Financial conglomerates: In 2009, the IWCFC will focus its work on the Financial Conglomerates Directive, especially geared towards a study on the implementation of said directive in the different member states and possibly on the development of proposals for regulatory changes, dependent upon the outcome of this exercise.

• Mediation: CEBS has introduced the mediation mechanism among its members in its Charter. Until now, CEBS did not use this mechanism. For 2009, a case study will be undertaken to learn how this mechanism could be utilised in practise.

• Delegation: The three levels 3 Committees will work in 2009 to deal with any possible follow-up work to their 2008 work on delegation of decisions/responsibilities. Further they will also assist the Commission in the continued work with regard to the options for voluntary delegation of supervisory competences.

Priority 3 activities

11. A number of activities have been earmarked as priority 3 activities. These activities will only be undertaken in 2009, when CEBS will have sufficient resources available. Given the current situation in the financial markets, it is uncertain whether that will be the case. Topics that have a low priority include:
• The development of a range of practises paper under Pillar 2 on interest rate risk in the banking book
• Possible follow-up work on diversification under Pillar 2
• Work on business, strategic and reputational risk, on internal governance and on economic capital models
• The establishment of a CEBS network on the treatment amongst member states on hybrid capital instruments
• Some topics in the intermediate 3L3 work programme, like the guidance on internal governance, the periodic report on non-cooperative jurisdictions and the development of 3L3 fit & proper requirements
• Updating the guidelines on validation (GL10)
• Updating the Pillar 3 implementation study undertaken in 2007

Detailed template on the work programme 2009

12. A more detailed template on the deliverables that are foreseen for 2009 is provided in appendix. For every deliverable, it shows their priority, deadline and origin of the request.

Monitoring of progress and bottlenecks

13. As of 2009, the main committee will be informed on a quarterly basis about the progress of the work programme. Possible bottlenecks will then be identified and changes in priorities as proposed by the Bureau will be agreed upon.

SCENARIO STRESS TESTING OF GLOBAL FINANCE

New banking regulations (Basel II and especially the economics of it) introduced in the last 5 or so years, has been trying to change the risk culture and economics awareness of banks. Banks are inveterate herd animals. It is not unrealistic to describe what we Basel II risk experts (and IFRS7 accountants) are trying to do with the surreal analogy of trying to teach cows how to swim like dolphins!
The main purpose of Basel II, which is a comprehensive set of banking regulations (several thousands of pages worth that have the power of law) to be applied to all of the world's internationally active banks has been to try and make these banks not only comply with basic solvency standards, but to force them to become astutely sensitive to economics, with the twin capabilities of understanding their own business economics fully as well as how those respond to and reflect the economies in which they operate. Understanding the economic context of traditional banking should be relatively intuitive and straightforward, but of course it is not, not when banks have to make realistic forecasts of economic and credit cycles, and also be able to calculate the effects of extreme economic shocks of the kind we are currently experiencing, what some describe as a 1 in 80 year set of interconnected events. To then also apply economic analysis and forecasting to FX, money markets, bonds, equities and commodities markets, their derivatives and their underlying 'cash' markets, both on-exchange and off-exchange (over-the-counter) is even more fraught with unique and intellectually difficult challenges. I know that the authors of the Basel II regulations have been shocked at how these fortresses of rocket scientists with supposedly unlimited research and computing resources, able to pick and choose among the world's cleverest Ph.Ds, have proven themselves wholly inadequate, not only in the economic modeling of Basel II Pillar II, but even unable to safely complete the accounting requirements of Pillar I. This is what, for example, destroyed Fortis Bank and others.
These challenges are not something banks can choose to do or not. In the EU it is a matter of law that they must do them and indeed make the tasks and the content second nature to how from here on in professional bankers understand banking. Unfortunately nearly all banks have found the challenges too great and have responded in error-prone or simply inept ways, for example using only mathematics and monte-carlo analysis, rarely integrated models and even more rarely with fully worked out macro-economics models. To understand is not to excuse. But, I do understand how difficult it is for banks to do anything very new without resorting to how and what they have done in the past. There are many reasons for failure in Basel II, and we can expect the solutions to have to go through several generations of system solutions before complete solutions are found. It probably needed a massive systemic failure such as the current crisis to really galvanise bank managements and staff to allocate resources to the correct priorities?
In almost every case I know of (and that's many) the economists that many banks have available to them were left out of the reckoning undertaken by finance and risk teams. Bankers have a severe cultural mistrust of economists and it shows in their economic stress-testing solutions. Third party suppliers of solutions have proved themselves to be little better, as usual pandering to the ignorance of their clients, even in such vitally important matters. The auditing firms too have deemed this area to be beyond their legal requirements to address. Consequently, the most important parts of Basel II financial regulations have ended up being either ignored or traduced.
As we have seen, as anyone can see, banks, insurance companies and other financial institutions, even hedge funds and ratings agencies some of whom prided themselves on their economics, have not been up to the job, or at least not in time to be ready to anticipate the present set of crises, the 'credit crunch' and subsequent economic recessions. Financial regulators, government treasury departments (finance ministries) and central banks have been better prepared, but not that much better! In recognition of the general problem, Tim Geithner, the US Treasury Secretary, as part of the next set of the Obama administration's bank bailout measures and fiscal policies to kick-start flagging zero or negative growth economies, and as part of the G20 proposals to create a new financial world order, has decided to carry out a gigantic 'stress test' of US banking. Other countries including the European Union and each of its member states are expected to do the same! However they do this must form a template or reference benchmark for the banks, to show them the way to know what the issues are and to then make similar test calculations using macro-economic models for their own banks. Each bank must construct an 'economic capital model' and 'holistically' calculate what is the worst that can happen to their capital reserves, credit risk losses, market risk losses, asset write-downs and wholesale funding problems (liquidity risk and liabilities). In fact while they must try and forecast for the next months and years, this is of course no longer a theoretical exercise for some indeterminate time in the future. The work that has to be done by everyone is to forecast in effect what is happening right now and where this will go? Back in October 2007 when Northern Rock experienced the first UK 'bank run' in a century (it was nationalised in February 2008) the Financial Services Authority (FSA) admitted that it had failed in its duty to check the bank's stress-testing. As the BBC reported, "The FSA is responsible for supervising financial institutions such as banks and it was asked why it was only doing a full review of Northern Rock's finances every three years. Conservative MP Michael Fallon said: "You are dealing with a bank whose lending has quadrupled from £25bn to £100bn - it was taking one in five mortgages - and you were not doing a full assessment for three years." Mr Sants (FSA CEO) replied: "I think there are lessons to be learned here with regard to our supervisory practice and I do think we need to look at our engagement with this company." The last FSA full review of Northern Rock was in February 2006 although FSA officials had visited the company in July to question their "stress testing". This is a process where banks and regulators examine what would happen to a bank's finances in a range of crisis scenarios. Mr Sants agreed that there were problems with the stress testing which were not picked up earlier."We were uncomfortable with their scenarios but regrettably it was late in the day," he said. In the year since then, despite the all too obvious importance of economics to banks now as most economies are near to or actually in recession, it is not hard to conclude that little progress has been made. This is my professional experience from looking at many banks. And certainly, there had been little or no evidence of the FSA or other major national regulators producing the templates and guidelines to any sufficient level of detail for banks to now knmow what to do and how to do it!
Andrew Haldane, deputy director at the Bank of England for financial stability has yesterday published a paper that defines the culture problem. This has been widely reported under the heading, "Bonus and job fears led to soft stress tests at banks". As reported by Reuters, The Daily Telegraph and others, "THE people in charge of managing risk at the City’s biggest institutions were given no incentive to carry out the stress testing that might have prevented the financial crisis, the Bank of England’s new financial stability director has said. Bankers were instead more worried about losing their jobs, according to Andrew Haldane, the Bank’s executive director for financial stability.In comments which will spark questions about why the authorities did not encourage institutions to do more disaster-testing, Mr Haldane said he and the Financial Services Authority learnt some years ago that banks’ risk officers were simply not setting themselves tough enough stress tests. The only realistic ones are where a bank's capital is wiped out at least once. In fact in the present crises banks' reserve capital is being wiped out twice over. Most banks find it difficult to bring themselves to face up to stress tests that involve losing more than a quarter or maybe a half of their capital! They have problems facing reality! Certainly none of the risk experts would ever have dared to present their boards with a scenario of losing 90% of their share capital or quadrupling of funding costs or total drying up of wholesale finance or 50+% falls in securitised asset prices. The modellers would have been told to get real or get out! Haldane said that he and the FSA discovered some time before the crisis from a seminar of risk officers charged with assessing the threats facing their banks, that they were only testing for very modest stress in the financial system. Asked why, according to Mr Haldane, one executive said: “There was absolutely no incentive for individuals or teams to run severe stress tests and show these to management.“First, because if there was such a severe shock, they would very likely lose their bonus and possibly their jobs. Second, because in that event the authorities would have to step in anyway to save a bank and others suffering a similar plight.” As we have seen in many cases on both sides of the Atlantic in the credit crunch, many boards of directors, execs as also non-execs, seem to think that ignorance of the true state of their financial affairs is some kind of reasonable defence. It is not, and never should be! The warning comes only days after the HBOS whistleblower Paul Moore alleged that he was fired from the bank after warning of the risks associated with its lending policies. The House of Commons Treasury Select Committee is now going to investigate this and the many cases like it in detail. Mr Haldane, lead author of the Bank’s Financial Stability Report, said that before the crisis “stress-testing was not being meaningfully used to manage risk... it was being used to manage regulation.“Stress-testing was not so much regulatory arbitrage as regulatory camouflage.” He said that the banker who confessed the dilemma had been “spot on”. “When the big one came, his bonus went and the government duly rode to the rescue,” he said. Mr Haldane’s remarks, in a paper written for a conference on stress testing, underline a dangerous fault — those who are supposed to guard against possible crashes are not encouraged to raise the prospect of those risks with the board.
To read haldane's paper see: http://www.bankofengland.co.uk/publications/speeches/2009/speech374.pdf