Bankers, Regulators and Governments: the Difficult Consensus

Writing from Vienna, June 11, 2010

As the Washington-based Institute of International Finance (IIF) gathers for its semi-annual event, it has the unique ability to attract decision makers involved in reshaping the banking industry.

In the middle of the Eurozone debt crisis, the debates were as hot as the early summer weather in Vienna and the performance of the famous Lipizzaner stallions of the Spanish Riding school reminded the participants of the difficult equilibrium between horse and rider is not unlike the current balancing act of finding financial stability.

What is even more remarkable, is the consensus that the IIF manages to build amongst its members, as expressed through substantive publications on "Systemic Risks and Systematically Important Firms," "Reform in the Financial Services Industry" and "A Global Approach to Resolving Failing Financial Firms" where tough resolutions are proposed, and for many of the banking members, starting to be implemented.

Yet despite this progress, the mood here is somber and probably overly pessimistic. It took the IIF (and Deutsche Bank) Chairman, Josef Ackermann, to remind the attendants that there was no question of the Euro disappearing, and that the Eurozone would stay the course. European Central Bank President Jean-Claude Trichet added that "Central Banks have changed, because the financial world against them has changed."

The changes in the regulatory landscape are part of a unique dialogue between the IIF and the Basel Committee of the Bank for International Settlements, chaired by the Dutch Central Bank President, Arnout Wellink. It does not mean that the new banking standards currently prepared by the BIS and the Financial Stability Board will please the bankers. Just like the new U.S. financial regulation, he was insisting on liquidity buffers, a better capturing of trading risks and the creation of a "global liquidity framework." Basel III is still hotly debated, but seems now certain that it will happen and will include serious provisions.

With all this action is everything under control? Are we making sure that what provoked the last crisis will not happen again? Despite all of this new regulation, banks seem reluctant to sever their links from the most speculative activities and leave the hedge funds to finance themselves in the public markets rather than through their balance sheets.

The recent crisis was a failure of risk management -- a diagnosis widely shared among the members of the IIF. But we are also starting the next crisis: the public finance crisis in Europe, the United States and Japan. As we saw during the Greek crisis, the banks are the largest holders of Government Bonds. It makes them the biggest lender of their regulators. A public finance crisis is also a bank crisis. The interconnectedness of the financial markets leave no real escape: only diversification allows for risk mitigation. There is afterall a close correlation between the quality of banks and the quality of its risk managers.

But all this discussion is happening within the financial bubble that doesn't involve consumers and other companies. In this context, the risk management of banks encompasses a set of variables that make this job closer to an art than a science.

As I leave for the closing dinner where the speaker is Greek Prime Minister George Papandreou who managed the impossible for his country, I was thinking of a quote from Mark Twain: "it is not the dangers we are afraid of that are worrying it is those we are not afraid of because we are not anticipating them."