Third Annual Meeting
INTOSAI Working Group on Financial Modernization and Regulatory Reform May 11—12, 2016, U.S. Government Accountability Office, Washington, D.C.
Minutes and Proceedings
The third in-person meeting of the INTOSAI Working Group on Financial Modernization and Regulatory Reform (the working group) took place on May 11—12, 2016, in Washington, D.C., United States, at the headquarters of the U.S. Government Accountability Office (GAO). The meeting was opened at 9:30 a.m. on May 11 and continued through the morning of May 12, adjourning at 12:30 p.m.
Attendees of the meeting, as well as the full set of meeting materials, are included separately.
Introduction and Welcoming Remarks
Orice Williams Brown, Managing Director of GAO’s Financial Markets and Community Investment team, convened the meeting. Gene L. Dodaro, Comptroller General of the United States and Chair of the working group, provided welcoming remarks via video. Mr. Dodaro welcomed the attendees to GAO, and noted that he was pleased that over half of the 25 working group members were participating in the meeting. He noted that over the last year the working group has worked hard to advance its strategic goals: The working group focused on collecting in-depth information on members’ financial sector audit work, furthering relationships with organizations such as the International Monetary Fund (IMF) and Basel Committee on Banking Supervision, developing a website, and continuing to monitor international financial reform developments. Mr. Dodaro expressed appreciation for the subgroup leaders who have worked to facilitate the work of their subgroups: China (subgroup 1), Canada (subgroup 2), and GAO (subgroup 3).
Discussion: Presentations by Supreme Auditing Institutions (SAIs) about Recent Work
May 11, 2016, 10:00 a.m. – 11:30 a.m.
Presenters: China
South Korea United Kingdom United States Chile
China
Mr. Wang updated the working group on China’s financial system audit. He explained that China has issued a series of significant policy measures to improve the government auditing system and guarantee that audit institutions independently perform their oversight authority in accordance with the law. The objectives of the China National Audit Office (CNAO) have expanded to include accelerating the implementation of national policy decisions and measures, promoting the safe and efficient use of public funds, maintaining national economic security, furthering reform, and combating corruption and criminal activities.
He added that the mechanisms for ensuring that auditors perform their duties properly have become sounder. For example, China has clarified the scope of government auditing to include all public funds and emphasized that auditees must cooperative with auditors.
China’s audits of financial systems have three important features:
1. Implementation of national decisions and policies;
2. Focus on the whole market instead of separate institutions; and
3. Combat financial crimes and improve financial systems and mechanisms.
Mr. Wang added that as an important force to safeguard economic security, government auditing should play a positive role in stabilizing economic fluctuations.
South Korea
Mr. Kim presented the results of the Bureau of Audit and Inspection (BAI) audit of Korea’s financial regulatory reforms. The audit objectives were to assess the regulatory reform and implementation process and ensure they are consistent with government policy, and to identify potential risks or negative impacts on financial markets or consumers of current or recently implemented financial reforms. He noted that while the size of the Korean financial sector remained high (5.6% of gross domestic product), the employment growth rate in this sector has declined since 2013.
Mr. Kim described the number and types of recent regulatory reforms. He explained that Korea announced a financial regulatory reform package in July of 2014. The reforms included those intended to improve the ability of the financial sector to support the real economy, to simplify financing for consumers, and to improve supervision and inspection processes, among others. The Korean financial regulator subsequently released a policy framework for the reforms, which consisted of 3 missions, 6 goals, and 18 tasks. For example, the 3 missions were to promote autonomy and responsibility, strengthen support for the real economy, and strengthen financial competitiveness. The BAI audited the approximately 1,000 new financial regulations and found that 141 of them were not managed efficiently. The BAI also found evidence of regulatory arbitrage between the banking and insurance sectors, and found that some financial supervisory authorities were imposing excessive burdens on private financial companies and were exercising their authority arbitrarily. The BAI published these findings and made 454 recommendations.
United Kingdom
Mr. Perkins discussed the recent changes to the audit authority of the United Kingdom National Audit Office (UKNAO) and its most recent financial audit. The authority of the UKNAO recently expanded with the passing of the Financial Services Banking Act of 2016. UKNAO now has authority to examine the economy, efficiency, and effectiveness of the Bank of England.
Previously, the UKNAO did not audit any operations of the Bank of England and could only examine the Prudential Regulatory Authority—created after the financial crisis as an independent unit within the Bank of England. The new authority nevertheless has some limits. For example, UKNAO cannot examine the merits of policy decisions of several committees, including the Bank of England committee responsible for setting monetary policy, and it can only review policy decisions about resolution of failed financial institutions after these powers have been used. UKNAO will likely still review Bank of England’s intervention decisions, though the details about such reviews are unclear. The UKNAO has a limited financial audit role. The office now may conduct financial audits of the private companies that carry out activities related to quantitative easing transactions, and the Bank of England must consult with UKNAO before appointing its independent financial auditors and on the scope, timing, and direction of those audits.
Mr. Perkins discussed another development related to UKNAO’s work: the abolition of the UK government’s Money Advice Service in spring 2016. The UKNAO reported on the Money Advice Service in 2013 and found that it was not meeting consumer needs.
Mr. Perkins also presented the results of the recent audit on mis-selling of payment protection insurance. The audit assessed, among other things, how relevant financial regulators work to prevent mis-selling and how authorities respond to complaints from consumers when mis-selling occurs. For example, millions of consumers have lodged complaints over the past several years about a product called payment protection insurance. UKNAO found that a backlog of complaint cases persists and some consumers have waited years for compensation. UKNAO’s audit also noted that claims management companies, which process the fines on behalf of the banks, are engaging in high fee-related services to transfer payments due to consumers. UKNAO issued a number of recommendations to financial regulatory authorities as a result of this work. The next steps are for the UKNAO to continue reducing regulation, report on consumer protection, and to review how regulators can protect consumers.
Questions on UKNAO Presentation:
• Mr. Kern of the European Court of Auditors (ECA) asked if mis-selling was a European problem. Mr. Perkins noted that there are particular UK banking market incentives that lead banks to try and find alternative ways to make money. Basic banking services are free. The market is intensely competitive and interest rates are down. Payment protection instruments started off as a high income stream for banks.
• Mr. Alfonso of Italian Court of Auditors responded with an Italian perspective on mis- selling. Auditing institutions should be happy that regulations have now made it to where taxpayer money is not being used to assist financial institutions. However, lack of confidence in banking has caused withdrawals with associated consequences. Mr. Alonso recommended that auditing institutions should be concerned, and that restrictions on banks should not be harsher than in those in the USA or other countries, stating that they had bailed out their institutions. Mr. Perkins responded that the UK had bailed out banks. The questions of how countries can or should impose capital requirements are still very much an issue. Higher capital requirements in the UK remain a challenge. The chief economist at Bank of England recommended an additional capital buffer on English banks. Mr. Kern recommended that these requirements would need to be implemented across the world, and noted that the bank of England has a presence on the Financial Stability Board (FSB).
• Mr. Liu of CNAO expressed that there is a stronger need to teach consumers to assess risk. Regulatory agencies now identify clearly what one should do before one sells, and what should be fully disclosed to consumers before one sells. Mr. Perkins concurred that consumers should be educated to be less susceptible to mis-selling. However, this has proved to be very difficult. The UK has some resources and requirements for consumers and has stated that there needs to be certain information presented to consumers so they know what they are buying. Consumers do not pay attention to small print though.
United States
M’Baye Diagne from GAO discussed the framework for monitoring financial sector indicators and regulatory effectiveness. GAO has established indicators from quarterly call report data and other supplementary sources. Mr. Diagne has observed the following:
• The financial condition and performance of the banking industry has improved throughout 2015.
• Asset quality has improved, capital ratios have increased, and earnings and profitability have improved, though modestly. Only three banks have failed this year so far. GAO monitors asset markets since asset markets can impact bank balance sheets.
• Tier 1 common equity has increased for systemically important financial institutions. Return on equity has trended down due to the increase in equity and relatively flat earnings.
GAO monitors the broader economy to assess operating environment. Mr. Diagne discussed the broader economy and global trends:
• The Federal Reserve decided to leave the federal funds reserve rate unchanged. Household spending was moderated, housing market is bright.
• In 2016, there has been some drop in U.S. profitability due to a drop in energy related loans. Problems in oil and the growth of the energy industry could compromise emerging market economies and exert greater restraint on the demand for U.S. exports.
• Inflation is still below the Federal Reserve’s 2% target.
• Negative interest rates in Europe and Japan could slow global growth further and have a negative impact on U.S. core bank earnings.
GAO also monitors emerging and heightened risks, including the following:
• Credit and concentration risks and interest rate risks.
• The concentration of small and medium size banks. Smaller retail banks had a fairly large concentration in commercial real estate lending.
• Interest rate risk. The low interest rate en
vironment continues to weigh on margins, for example, the extension of terms on auto loans.
• Leverage lending. Lending standards have been relaxed and volumes of leveraged lending have been increasing in 2013 and 2014.
• Lending to nonbank financial institutions. Nonbank financial institutions have received more loan volume recently, which has concentration risk for lending institutions.
• Financial Technology. The rapid increase in financial technology investment is a heightened risk. As banks embrace financial innovation, regulators are just now evaluating the appropriate regulatory response.
Regulators are evaluating how to address these emerging and heightened risks. GAO can use the monitoring efforts to identify opportunities to test regulatory responses and can leverage econometric modeling to help identify changes in regulatory behavior. Additionally, GAO has the authority to initiate work and then approach and audit a regulator to see how they are addressing an issue. GAO is coordinating with the inspector generals of banking regulators to avoid duplicating efforts.
Regulators have already responded that they will increase their examination of banks’ oil and gas lending due to the change in collateral requirements resulting from the decrease in prices. GAO expects to see a decrease in oil and gas lending going forward.
GAO has started an econometric modelling program to establish indicators of change in regulatory behavior. For example, GAO has access to CAMELS ratings and call report data. By comparing the public rating of a bank and what the predicted rating would be based on available data could indicate of the nature of private information reviewed in the actual bank examination.
GAO is interested in learning if other SAIs have similar monitoring efforts underway. None of the SAI representatives stated that they were monitoring financial sector indicators.
Discussion:
Mr. Kern concurred that some of the findings presented are also found in Europe. However, European banks struggle more with profitability and the energy sector.
Mr. Alfonso from the Italian Court of Auditors commented on shared risks. He noted that with the increase in financial technology, banks could lay off 150,000 employees without it affecting their work, which would have an impact not only on employment but on the property market.
Chile
Ms. Farías presented the working group’s website. The website has access to several resources, including:
• Audit reports from SAIs
• The working group’s work plans
• Annual meeting materials and presentations
• Member list with contact information
• External publications
The website also includes a member section, which requires assigned log-ins. Ms. Farías provided usernames and passwords for each member to use when accessing the member section.
Subgroup Breakout Sessions: May 11, 2016, 11:45 a.m. – 12:45 p.m.
Breakout Session for Subgroup 1
Representatives of the China National Audit Office (CNAO) chaired this subgroup breakout session on sharing information about SAIs’ authorities and experiences with audits related to financial markets issues. The session was attended by representatives from the SAIs of Austria, Mexico, European Court of Auditors, Sweden, United Kingdom, and United States.
Conclusions and Next Steps
• The financial crisis had a significant impact on SAIs:
o ECA has new audit authorities.
o Mexico had financial reforms that have impacted their audit work.
o Increased government activity in the financial sector has caused UK to increase audit expertise.
o Sweden is now conducting consumer-focused audits.
• Access to information varies significantly across SAIs:
o Austria and ECA have had difficulty in accessing information from significant institutions.
o The U.S. and UK have stronger audit authority and most private sector entities will comply with audit requests.
o China has the strongest authority with private entities.
• UK and ECA have difficulty finding and retaining experienced staff for more complex audits.
• Every SAI is responsible for maintaining the document library on our new website.
• Remaining questions:
o How will new information to the website be communicated to SAIs?
o How will the old document library be uploaded to the new website?
Status Report
Mr. Liu of CNAO led the discussion of recent developments in SAIs’ financial system audits. The core mission of the group is knowledge sharing. He explained that representatives from the China, UK, and ECA SAIs would share their experiences on financial system audits and would appreciate comments from others.
Ms. Schloegl of the Austrian Court of Audit discussed access issues. Austria has had difficulty with information gathering from significant institutions. Recently they were able to obtain the European Central Bank’s supervisory manual and she believes that this success resulted from their new procedures and their new auditing infrastructure. They do not have any findings yet under the new system because it is still new. Mr. Perkins and Mr. Kern expressed interest in the manual, but Ms. Schloegl explained that they did not have the authority to share it because they signed a confidentiality agreement with the bank. Additionally, when they publish their audit, they will need to remove any confidential information from the report, including specifics of the manual. This report is at the internal review stage.
Mr. Goebel explained that GAO’s audit authority is very broad. GAO has mandates to access financial information. Some of that access was granted as a result of the financial crises. For instance, with the Dodd-Frank Act, congressional staff built in language with the help of GAO officials to ensure the agency has appropriate access authority once the law was implemented. Regarding access to financial data, GAO does have authority to obtain anything financial regulators receive, including private sector information. GAO makes sure to safeguard sensitive data and sometimes do not take possession of sensitive information to safeguard it.
GAO may sometimes request information directly from the private sector and usually has good cooperation. When initiating an audit, they send official letters to the agencies and may also send a similar letter to private sector firms. GAO does not have subpoena authority, but the congressional requesters do. In rare occasions GAO solicits the requesters’ help to get information from uncooperative agencies.
Most of GAO’s work is U.S.-specific and not in the international financial sphere, but they have done at least one report that compared the US’s reform efforts with other institutions’ reform efforts. Mr. Goebel stated that GAO will ensure the most relevant of those reports are available on the working group’s website and will share the methodologies and criteria used.
Mr. Perkins stated the UKNAO is reasonably effective in accessing information. Firms have found that if they don’t respond to their requests, they appear uncooperative, which they do not want. Issues affecting the UKANO include the Information Act, which they are recommending that the U.K Treasury amend to grant them access to information. The UKNAO also has a new role in auditing the Bank of England. Mr. Smith added that the UKNAO is developing an understanding of the banking sector as a consequence of the crisis interventions by the UK government. There has been a lot of innovative financial policy which has brought the government into complex financial transactions to transfer risk from private to public sector.
Additionally, the U.K. government holds stakes in many financial institutions, including student loan companies, green infrastructure lending, and some other firms. The UKNAO is concerned that they do not have the financial sector expertise in house. Currently, they are outsourcing these auditing activities to a private firm. It is difficult to retain staff with these skills in house and staff tend to move on after 3 or 4 years.
Mr. Kern of ECA commented that they have similar problems with trying to increase their competencies in financial audits. ECA has a new financial and banking team and has pulled some people in house from other departments and trained them. Additionally, they have brought in experts to assist them with financial sector audits.
Mr. Liu of the CNAO stated that they can audit for the private sector’s benefit. For example, in some special instances they can audit a private firm.
Mr. Danielsson of the Swedish National Audit Office discussed their recent work. The Swedish SAI has undertaken an audit on its Financial Supervisory Authority and how the supervisor deals with consumer protection, which they have not reviewed in previous audits. The audit will explore how they have regulated consumer protection and how they have supervised covered bonds. They have also been looking at how this regulator, the debt office, and the central bank have been able to cooperate, especially in terms of financial stability and consumer issues.
They do not know if they will have significant findings from the audit. They will issue the report in the summer of 2016. He also noted that Sweden had a major banking crisis in the 90s and had handled the crisis successfully, which in turn made the banking sector less vulnerable during the 2008 crisis, although it was affected. The Swedish banking sector today has a lot of reserves.
Mr. Cortés of the Mexican SAI discussed its recent financial sector audits. After Mexico’s financial reform in 2014, the Mexican SAI conducted performance and non-financial audits of regulators, supervisors, and government-owned banks. At that time there were not many complaints against these institutions. Currently, they are preparing new audits in line with the new legal framework of the financial system. One main problem is the financial system is highly concentrated: there are 46 banks but credit is concentrated in 7. They do not have other problems in the banking sector at this time.
Mr. Tomé of ECA provided an overview of ECA’s recent work. ECA has evolved from focusing on traditional audits to taking on more performance audits. Since the financial crisis, ECA has moved from an institution focused on the regulators to one that looks at broader issues. So far its work has centered on processes, not the outcomes of policies. ECA has developed some work that goes beyond the financial sector with systemic implications. They are working on audits of institutions in Greece and Italy. Additionally, ECA continues to learn how to negotiate access rights.
Breakout Session for Subgroups 2 and 3
Subgroup 2 and Subgroup 3 met in a combined breakout session. The representative from Canada led the discussion of Subgroup 2 issues by telephone, and representatives from the
U.S. led subgroup 3. Representatives of the SAIs of Brazil, Canada, Chile, Estonia, Finland, Indonesia, Italy, and South Korea also attended.
Status report, Subgroup 2:
Mr. Domingue from the Office of the General Audit of Canada provided an update on the recent successful outreach efforts of Subgroup 2. Mr. Domingue noted that the working group already has a good relationship with the IMF, which was established 3 years ago. In November 2015, Subgroup 2 members met with the newly appointed Deputy Director of the Monetary and Capital Markets Department at the IMF and provided an overview of the working group and its activities. The Deputy Director agreed that there were opportunities for the working group and IMF to coordinate and was supportive of the relationship the IMF and the working group had already established. The Deputy Director agreed that working group members could meet directly with individual IMF staff for technical assistance reasons, while more formal requests for information related to SAI audit work should be communicated through standard IMF protocols for each country.
In April 2016, Subgroup 2 established a relationship with the FSB under which the two organizations agreed to share information informally about their activities. Both FSB and the working group representatives agreed that the overlap between FSB’s mission and the working group’s goals was clear. The FSB officials noted that FSB is small and there is no permanent staff that conducts research. Rather, the FSB’s work is carried out by staff of FSB members, which are central banks and other financial regulators.
Mr. Domingue noted that the relationships with the Basel Committee on Banking Supervision, IMF, and FSB help advance the working group’s goals. Subgroup 2 would like to continue using the Governing Board Report as an outreach tool.
Mr. Domingue asked if the members would be interested in sharing their reports and other work on a more regular basis with international bodies:
• Mr. Männikkö, National Audit Office of Finland, commented that the working group potentially could see weak signals or trends at a more granular level than FSB or IMF, whose reports are more high-level. For example, one of Finland’s biggest banks left to be based in Stockholm because, he believes, the laws and regulations are not as strict in Sweden as they are in Finland, which is a Eurozone country. Ms. Gelb agreed that more granular information at the country level could be helpful for the international bodies as they develop their reports.
• Mr. Lee, National Audit Office of Estonia, suggested that the working group could develop a database of our work for external organizations, like IMF and FSB, to access. Mr. Domingue noted that the drawback is that the working group would not have a way of knowing whether the IMF and FSB are reading the information. Mr. Domingue suggested that it is not enough to send outside organizations our reports or information; we need to engage them more so they see there is value in having a relationship with the working group. SAIs should also engage these organizations separately.
• Mr. Dutra, Brazilian Federal Court of Accounts, stated that IMF issued a financial stability report (FSAP) on Brazil. Default rates and growth of the size of public banks were highlighted as risks. IMF found that there should be a better relationship between the federal government and banks. He added that SAIs can help IMF and FSB identify risks. For example, although IMF said Brazil’s regulatory structure was good, the Brazilian auditors knew that in reality the government would never bail out banks if they were to fail.
Status report, Subgroup 3:
Ms. Gelb provided an overview of the work plan and discussed the outline for the Governing Board Report. Subgroup 3 will work on the report over the summer with the goal of finalizing in the fall. The report will be presented in December 2016 at INCOSAI. She noted the potential for this report to be a widely read tool. She reminded the members that they have received the draft outline for comment. Like previous reports, this year’s report will have sections that summarize the working group’s accomplishments and relevant topics, such as financial stability.
The members discussed possible contributions they could make to the Governing Board Report:
• Mr. Domingue agreed to review the Bank of Canada financial stability review for this year’s Governing Board Report.
• In addition, Mr. Domingue noted that it would be good if the working group could identify whether the federal regulators in each country responsible for implementing reforms had assessed their effectiveness. The Governing Board Report could potentially discuss this
at the end of the report. For example, this section could provide an opportunity to assess if the financial reforms have gone too far. He thought the report could be more forward- looking and could address whether all the reforms and requirements that are in place now are really necessary? Are they doing everything they were intended to do? What are the costs and benefits?
• Mr. Männikkö agreed that reporting on effects of changes in the environment could be valuable. For example in the past, troubled banks would have been taken over by other banks, but in Finland the government is taking them over. The Finnish government is now guaranteeing off-balance-sheet items because of Basel standards. This exposes Finnish taxpayers to financial risks.
Discussion
The Subgroup 3 members also discussed relevant observations from their countries:
• Mr. Dutra explained that the Brazilian Federal Court of Accounts is conducting a performance audit comparing the supervision of the two biggest public banks and two biggest private banks. They have not identified any differences.
• Mr. Lee, National Audit Office of Estonia, stated that his office is working on a testing framework to evaluate sustainability goals in light of the recent UN global sustainability goals. This framework will help them understand financial policy risks.
• Mr. Lee also agreed with the suggestion to assess the effectiveness of new regulations and how the regulations could affect the overall market. He noted that the Estonia regulators have not done any work on this.
• Mr. Susetyo stated that the Audit Board of the Republic of Indonesia is working on gaining greater authority to audit financial institutions.
• Ms. Farías, Office of the Comptroller General of Chile, was interested in learning about the different type of audits. Currently, the Chilean SAI does not conduct performance audits but rather only conducts compliance audits.
• Mr. Männikkö commented that the National Office of Finland does not have authority to audit the European Central Bank. However, the office does have access to information and for the first time is exploring the type of access they can achieve. The European Central Bank’s response so far has been limited. The office is also participating in a parallel audit with 4 or 5 other European Union (EU) members that will be published in 2017 on the European Central Bank.
• Mr. Alfonso shared that most of the conversations in the Bank of Italy and the Italian Court of Auditors have been around bank union regulations. He believes that new rules should be adopted with flexibility.
Lunchtime Presentation: May 11, 2016, 12:45 p.m. – 2:00 p.m.
Presentation by the European Court of Auditors (ECA) on Financial and Economic Governance Audits and Audits of the European Banking Union
Presenters: Baudilio Tomé Muguruza, Member of the European Court of Auditors, Dean of the Chamber IV
Helmut Kern, Principal Auditor, Head of Single Resolution Mechanism Audit, Financial and Economic Government Project Team
Background:
The goal of this session was to provide an overview of ECA’s perspective on working with the national audit offices of the EU Banking Union. Additionally, the speaker will review the results of the survey on accountability and public audit arrangements related to banking supervision, conducted by the Supreme Audit Institution of the European Union’s Banking Union Task Force.
Relationship between ECA and the National Audit Offices of the EU Banking Union
Mr. Tomé provided an overview of the relationship between ECA and the National Audit Offices of the EU Banking Union. Until 2011 to 2012, ECA had primarily focused its work on financial audits and compliance audits of EU members and publishing annual reports giving their opinion of the European Commission accounts.
After the financial crisis, ECA took on new challenges, such as new supervisory authorities (including monitoring the financial system) and the establishment of the EU Banking Union. Auditing the EU Banking Union was a new field for ECA. ECA created a single supervisory mechanism, which it has reported on recently. ECA also published a report on the procedure in place for EU states that do not meet their deficit targets and conducted audits on assistance to Greece. ECA is also auditing insurance supervision and the new banking union.
Mr. Tomé highlighted a report published in December 2015 about ECA’s audit on the European Commission’s financial assistance programs provided to countries under financial duress. ECA found weaknesses in several of the commission’s processes, including forecasting, documentation, quality review, and monitoring. It also found that countries in similar statuses or facing similar conditions were not treated consistently by the commission. The European Commission, IMF, and ECB worked together, but the cooperation was informal only. At the beginning, the European Commission learned a lot from the IMF. Ultimately, ECA learned this cooperation is necessary and should be subject to protocol.
Despite the weaknesses ECA reported, the programs met their objectives in terms of the countries returning to market. It is important that the EC itself should perform an evaluation of the programs’ economic and social impact and influence on the competitiveness of the countries.
ECA Survey on Accountability and Public Audit Arrangements
Next, Mr. Kern discussed the survey on accountability and public audit arrangements related to banking supervision. He explained that the EU Banking Union consists of 3 pillars: The single supervisory mechanism (SSM), the single resolution mechanism, and the deposit guarantee scheme. ECA is currently conducting a review of the single supervisory mechanism. The audit
of the SSM is challenging because ECA is required to assess the operational efficiency of the mechanism, but there is no definition of operational efficiency and there are conflicting points of view between ECA and the ECB on the audit’s scope.
ECA also conducted an external audit to identify audit benchmarks from the US and Canada, which have stronger audit mandates than the ECA. They also surveyed European Supreme Audit Institutions and found a lack of harmonization across Europe, as some SAIs have full audit mandates and others do not. ECA is also preparing to audit the Single Resolution Mechanism (SRM), although the scope and structure of the audit will depend on whether or not the SRM fund is used.
Discussion
Mr. Alfonso commented that the complex EU regulatory machinery risks killing the system it is designed to monitor. The duty of the working group is to highlight the problems and the risks that arise from new complicated regulations. The working group could possibly talk about this in the future and compare the results.
Mr. Perkins asked how ECA deals with differing economic views. Mr. Tomé responded that they are not able to solve some problems where there are political issues. ECA tries to center its review on processes and procedures, not political decision-making. It can also audit how decisions were prepared, including what information was used. For instance, ECA has audited how debt is collected as part of an audit on deficit procedures. Also, ECA has reviewed all the forecasting tools to find consistencies inside the models. Mr. Tomé said that ECA will likely continue to evolve over the years.
Panel Discussion: May 11, 2016, 2:30 p.m. – 3:30 p.m.
Expert Panel Presentations on Propagation of Economic and Policy Shocks and the Impact on Financial Regulatory Systems
Moderator: Lawrance L. Evans Jr., Director, FMCI, GAO
Presenters: David Dollar, Senior Fellow, Foreign Policy, Global Economy and Development, John L. Thornton China Center, Brookings Institution
Joseph Gagnon, Senior Fellow, Peterson Institute for International Economics
Charles Taylor, Executive Fellow, Office of Financial Research
Background
The panelists provided an overview of emerging risks, including effects of economic and policy shocks on global financial markets. Specifically, panelists addressed (a) tools for monitoring risks, (b) risk trends, and (c) potential spillover effects.
Joseph Gagnon
Mr. Gagnon discussed three risks affecting global financial markets: the decline of real interest rates, borrowing in a different currency, and the return of trade imbalances.
• Decline of real interest rates: Mr. Gagnon stated that the most general risk is the decline of real interest rates, meaning the nominal rate minus rate of inflation. Such rates have been falling for 30 years, and this trend has continued through the latest recession, resulting in record low rates. Some countries have moved to negative rates, which is unprecedented. There are differing views on the reasons for declining interest rates, but it is likely a combination of demographics, the convergence of economies, saving habits, technology, emerging markets switching from borrowing to saving habits, and some financial regulations which encourage safer investments. It is possible that over the next 10 to 20 years rates could rise, but it is also possible that rates will remain low. However, this is not clear. Too many people are expecting higher rates of returns than will be likely, especially for pension funds and life insurance. He believes these expectations are too optimistic.
• Borrowing in a different currency: He explained that borrowing in a currency other than the one an institution or household earns is a concentrated risk. People are tempted to borrow at a low interest rate, even if it is in a different currency. This is a huge risk because exchange rates can swing unexpectedly, even if they have been stable for a while. This risk is underestimated. Governments and banks seem to have learned this lesson, but recently households have started borrowing money in other currencies. Additionally, emerging market corporations are adapting this habit by borrowing in dollars but primarily borrowing in yen. Some of this risk involves corporate subsidiaries, for example, if a company is borrowing to fund home operations.
• Return of trade imbalances: The return of trade imbalances refers to the fact that the
U.S. trade deficit is rising and other countries’ surpluses (i.e., China) are rising, outside
of commodity exporters. This is a problem because it distorts the economy and requires additional effort to create jobs in other sectors other than the trade sectors. Additionally, it creates an unsustainable pattern because it does not allow the U.S. to pay off debt.
Currently the U.S. debt is rising faster than GDP is growing and it will at some point reach a breaking point. This raises protectionist pressures and pressure for trade wars. Trade imbalances may not be an immediate issue, but they are a noted trend.
David Dollar
Mr. Dollar discussed risks stemming from China’s transitioning economy and the government’s macroeconomic stimulus.
• Transitioning economy: Mr. Dollar stated that China is undergoing a difficult transition, which has created stress in the economy. For a while, China grew well based on exports, but that has been losing momentum. It is hard for China’s exports to grow faster than trade when they are the largest exporter in the world. Currently, trade is growing at 2%, but it will be a lagging sector, not a leading sector. China took the investment rate to above 50% of GDP, which enabled good growth for a while, but it also created excess capacity (for example, vacant apartments, excess capacity in steel and cement, and airports in cities with very little passage). It is natural for profitability to decline, and thus investment slows.
o Fortunately, Chinese consumption has been strong, and it is promising that household income continues to grow and the labor market is stable.
Consumption is primarily of services, which drives demand for the service sector.
o Mr. Dollar noted that this transition has a large effect on the rest of world, even though China is not well integrated, because of its trading. During the economic boom, China created demand from other countries. However, during this current slow-down, it is providing less demand for trade partners and there is worry that this will worsen. Certain events, such as the collapsing of the stock market bubble and the small devaluation of currency, have had big global effects. Mr.
Dollar believes that the world is reacting to the possibility of much a greater slow- down in trading, even though there is not much evidence to support this.
• Macroeconomic stimulus: The Chinese government has introduced macroeconomic stimulus to prevent the effects of slow growth. In the short run, it is stimulating some of old economic activity and stimulating investment to continue. Global sentiment seems to have calmed down over the worry of a hard landing, due to this stimulus. However, the stimulus, which is in the form of an increase in credit, is allowing certain risks to build up in the system. Overall debt is above 200% of GDP and China is taking on more credit to build GDP growth. Non-performing loans are becoming a larger concern as well. This is not a risk for a classic banking crisis. On the other hand, there are other types of distortions that could arise, for example, the banking system could operate inefficiently; risk is continuing to slowdown growth. There is some risk of devaluation in China. Their trade surplus is very large, so one would expect to see appreciation pressure, but China has so much capital outflow that it is putting on downward pressure. The government is trying to maintain a relatively stable exchange rate, but there was a period where reserves were declining substantially, although it has since stabilized. If the stimulus loses momentum, we may again see devaluation pressure because there is a lot of saving, which means minimized investment opportunities.
Charles Taylor
Mr. Taylor discussed the U.S. Office of Financial Research (OFR), monitoring of the stability of the financial system, and challenges OFR faces in conducting its work. He explained that financial systems should include functions like credit allocation, liquidity provisions, etc. and that these functions are vital to the functioning of the real economy. Financial regulators generally have several concerns: 1) that the system is fair; 2) that the system is reasonably transparent; and 3) the stability of the system. The financial system pursues efficiency well, but is by no means stable. He believes that it is necessary to minimize risks to the system responsibilities, and if they do arise, to minimize the cost. This will ensure that the financial system is stable during periods of economic downturns.
• OFR: According to Mr. Taylor, OFR was established as a result of the Dodd-Frank Act, but was almost an afterthought for drafters of legislation. The purpose of the office is to improve understanding of the stability of the financial system and provide some underpinnings for regulators and participants to be more stable. There are three pillars to the mission:
o To conduct research: For example, OFR conducts research on network structures and what makes a financial system unstable. OFR also looks at work of other disciplines and conducts more traditional financial analysis.
o To become a source of data for the regulators: In the U.S. there are different regulators for different sectors of the system, which creates challenges. For instance, OFR recently completed a pilot program with the Federal Reserve to conduct research in repurchase agreement (repo) market. OFR had good data on triparty repo but little data on bilateral repo. Bilateral repo is an area where there is strong interest, but little data. OFR is currently in the process of institutionalizing the collection of those data. OFR is also acting as a data hub, providing access to data that others do not have access to in order to synthesize information from different data sources.
o To set data standards: Currently, data collection and reporting across financial institutions are not standardized. If an institution fails, regulators and others may not know what that institution’s terms mean. For example, there is confusion over whether “end of month” means the last business day of the month or the last calendar day. Different instruments have very different data terms and structure. OFR has tried to introduce data standards, such as the legal entity identifier system. During the failure of the Lehman Brothers investment bank during the financial crisis, parties responsible for winding down Lehman kept finding thousands of legal entities that comprised Lehman. Regulators realized it was necessary to create a global legal entity identifier to better track sub-entities. A next logical step would be to make transactions more standardized, but OFR is a long way from that.
• OFR Financial Stability Monitor: Mr. Taylor explained that there are a range of indicators that OFR summarizes into 5 areas: Macro, Market, Credit, Funding/Liquidity, and Contagion (which measures the vulnerability of the financial system to sudden shocks that may spill over or spread as a result of interconnectedness). Contagion is particularly important because there is a lack of good maps of global financial system. The last crisis was so different from previous ones because of the contagion factor. Understanding how
institutions are interconnected is fundamental to understanding how fragile and robust the system is. Mr. Taylor is concerned about interest rates, asset markets, inflation uncertainty, and interconnectedness.
• Challenges: One challenge of monitoring the stability of the financial system is that it is a moving target – the system is evolving rapidly, new instruments and funds appear every day, and institutions redesign their business models, sometimes due to regulatory pressures. Another challenge is the need for data security. Privacy concerns and proprietary concerns make it difficult to assert a right to every kind of financial information organizations would like in order to better understand stability. Finally, an important challenge is that the financial system is a human system, so private incentives are not always aligned with public interest. Private incentives are more short-term focused and it is difficult to get players to think ahead. OFR’s job is to focus on potential problems that hopefully do not materialize. OFR’s research is U.S.-oriented, but there are a lot of global interconnections.
Discussion
Mr. Smith, UKNAO, asked for the panelists’ views on the concentration and scale of the risks discussed. Mr. Taylor stated that two or three experiences of recent market disruptions are not particularly damaging and have little economic impact. However, these market disruptions could be harbingers of problem of unpredictability of liquidity in some markets. Transparency is very useful because it reduces uncertainty. Mr. Gagnon added that he believed the Federal Reserve was a success story when it lent to sectors at penalty rates during the crisis. This makes him less worried about concentration of risks because it means that lending at penalty rates is an option even if it is a broad step for multiple institutions. Mr. Taylor noted that OFR is looking at the diversification of the financial system and now has datasets about portfolios of hedge funds and money market funds, among other portfolios, and can review their diversification. OFR is starting to conduct early research with the goal to monitor diversification and to see if a reduction in diversification is a harbinger of financial instability, which he would expect it to be. Mr. Dollar added that many officials in China believe that diverging monetary policies of the U.S., EU, and China have made their currency less stable. China’s currency had risen with the dollar in recent years, which Chinese leaders felt was not appropriate, so in August 2015 China tried to separate from the dollar. However, because the currency had been so stable for so long when it was linked to the dollar, it only took a 2% or 3% variance to cause worry.
Mr. Tomé, ECA, asked about the strength of the Euro 8 years after the crisis. Mr. Gagnon stated that the EU is trying to deal with the design flaws of the Euro and is making slow progress. The flaw is that the monetary union was not paired with a fiscal union. Revenues outside the center of the EU are small compared to total revenues, which is not how they should be. The EU needs an automatic trigger for fiscal transfers like that of the U.S. and Puerto Rico. Puerto Rico is receiving more than three times as much in transfers as a share of its GDP than Greece is.
Puerto Rican residents also have the Social Security system, which is a significant fiscal transfer. These transfers are much bigger than the transfers Europe is giving Greece and they are automatic because they were built into the system from the start, so the transfers do not become political. Europe did not have this and still does not, but it needs a structure like this to avoid decisions about financial stability becoming political. Greece receives certain transfers (with high interest rates) from EU countries, but it required a lot of political negotiations.
Mr. Alfonso, Italian SAI, asked whether the global financial safety net is adequate to face sudden crises that could develop. For example, are the IMF resources enough to face possible
imbalances? Mr. Gagnon responded that in some sense, the IMF is not large enough to prevent imbalances. However, the IMF is mainly suited to dealing with borrowing in a currency that the countries do not control, so the size of the IMF is not the problem. For example, the IMF may not be useful—and is not needed– or in cases like the U.S. or Japan where all the borrowing is in their currencies. Further, quantitative easing is not a big part of causing trade imbalances; rather fiscal policy and growth are the bigger players in the development of imbalances. Mr.
Taylor added that part of the safety net is the FSB and standard setters, like the Basel Committee on Banking Supervision. These organizations bring additional strength to the system by setting standards, so hopefully the financial system is less likely to be vulnerable in the event of some disturbance. The question is what happens when institutions do not reach standards and whether they should be penalized.
Mr. Kern, ECA, asked if the right tools exist to monitor financial stability and whether ratios from Basel III are the appropriate measures of financial stability. Mr. Taylor stated that this is difficult to answer definitively. Financial institutions manage liquidity differently and ratios are artifacts of regulators– they depend on which systems are in place. There was debate within the Basel Committee on Banking Supervision on whether to monitor the ratios daily, monthly, or on the first day of the month. Leverage ratios are interesting and much simpler – they have been modified in the Basel standards so they are now more sophisticated but still straightforward.
However, there is a real concern that if it is a binding ratio, it will encourage banks to take risks that do not appear on balance sheets. For example, measuring with leverage ratios may penalize banks for holding treasuries, which are very safe.
Mr. Lin, CNAO, asked for the panelists’ perspectives on currency policy and whether the dollar is too expensive. Mr. Dollar stated that he agrees with Chinese authorities’ assessment that the Chinese currency is fairly valued. It is difficult to see the currency as overvalued due to its trade situation. However, the U.S. Treasury recently released a report that shows China has been intervening to keep its currency high, so the currency is also not undervalued. Mr. Gagnon added that China will not be able to return to 10% GDP growth that it previously enjoyed because GDP is so much bigger now, and the Chinese authorities understand this. It is difficult to introduce flexibility amidst an economic slowdown because there is some risk of unruly devaluation. The capital flows are highly volatile, so there would be risks to China moving quickly to a free-floating currency.
Presentation and Discussion: May 11, 2016, 3:45 p.m. – 4:30 p.m.
Presentation on the IMF’s Financial Sector Assessment Program:
Speaker: Nigel Jenkinson, Assistant Director, Monetary and Capital Markets Department
Background
The goal of this session was to provide an overview of the IMF’s Financial Sector Assessment Program (FSAP). The presenter discussed the IMF’s methodology to design and implement the assessments, including an overview of the reviews on standards and codes that generally accompany an FSAP; the integration of the FSAP with IMF’s ongoing surveillance, such as the Article IV reviews; and the relationship between the FSAP and the Financial Stability Board’s peer reviews.
FSAP Program Objectives and Components
Mr. Jenkinson provided an overview of IMF’s FSAP program. The IMF established the FSAP program in 1999 to provide a comprehensive, in-depth assessment for a country’s financial sector. FSAPs analyze the resilience of the financial sector, the quality of the regulatory and supervisory framework, and the capacity to manage and resolve financial crises. FSAPs produce recommendations of a micro- and macro-prudential nature, tailored to country-specific circumstances. The FSAP reports provide recommendations on individual institutions and also on the financial system in terms of its interconnectedness.
There are four inter-related objectives of the FSAP program:
1. Strengthening the financial system, including identifying vulnerabilities and building robust systems,
2. Knowledge transfer,
3. Improving financial systems, and
4. Mitigating crisis and contagion.
Since the 2008 crisis, IMF has been trying to create more rigorous and comprehensive stress testing of the banking system. Staff are focusing on the system’s performance as a whole, including a micro/macro prudential focus. For example, staff review policies, cross-sectoral regulations, crisis preparedness, and cross-border regional policies designed to mitigate financial crisis.
The development of the FSAP evolved over the years in three phases:
1. Phase 1: From 2000 to 2008, IMF was gathering information experimenting with the assessment method and tools. FSAPs in this phase were voluntary.
2. Phase 2: IMF saw that the assessments were helpful and made the assessments mandatory every 5 years for the 29 systemically important countries.
3. Phase 3: This phase is ongoing. IMF is focusing on links between economies and the financial sector.
IMF has conducted 344 FSAP reviews in 170 jurisdictions and 728 full assessments of International Standards. FSAPs contain a detailed review of banking sectors, including risk assessments, financial stability policies, and financial safety nets, and are increasing focus on nonbank entities. The World Bank reviews emerging markets, including infrastructure, access, and inclusion. IMF does not conduct assessments of potential standards related to market integrity, for example, money laundering and compliance.
Key Standards
FSAPs could include Full Standards Assessments which cover key standards for a sound financial system. These key standards include financial regulation and supervision, macroeconomic policy and data transparency, and institutional and market infrastructure.
These assessments may result in the following products:
• Aide-Memoire: 1 or 2 missions at IMF produce an Aide Memoire prepared on-site. These are confidential.
• Technical notes or detailed assessment reports may be published.
• IMF publishes a Financial Sector Stability Assessment (FSSA) and Reports on Observance of Standards and Codes (ROSC), which are circulated to the Executive Board.
• The World Bank: Financial Sector Assessment (FSA) report is issued to the Executive Board for information only.
Overview of U.S. FSAP in 2015
Mr. Jenkinson provided an overview of the recent U.S. FSAP as an example:
• The U.S. FSAP in 2015 involved 31 staff, 10 of whom were external experts and 21 of whom were IMF staff. They held meetings with private sector institutions and experts, auditors (including GAO and the Council of Inspectors General), and financial regulatory and supervisory agencies.
• Findings:
o U.S. banks have a stronger capital position, have improved liquidity, and increased compliance with standards for globally systemic important banks. Banks are in the process of developing living wills, or resolution plans, and the
U.S. has made progress in implementing the Dodd-Frank Act.
o However, interconnectedness has increased and big banks have gotten bigger.
Risk guidance for operational, interest rate, and concentration risk needs updating. Insurance companies are taking on more risk due to low interest rates and in general the U.S. is slightly behind other countries in terms of the risk framework for insurance.
• Areas of concern include money market funds, mutual funds, tri-party repurchase agreements, housing, and securities lending. Also, the IMF found asset management
and market liquidity issues correlated with size and interconnections. Obligations to investors may not be matched by the liquidity of assets. Additionally, there are poor data on risks and no comprehensive stress testing exists.
• Systemic risks: IMF found that the Financial Stability Oversight Council (FSOC) is the key forum for systemic risk oversight. The U.S. has a complicated regulatory system, so coordination and communication among the regulators is important to identify systemic risks and address them.
• Recommendations: The U.S. should reinforce collective ownership among U.S. financial regulators to enhance data collection and sharing. Also, explicit financial stability mandates are needed for each of the financial regulators that are members of FSOC to further develop specific follow-up actions and formal crisis preparations.
• IMF presented and discussed the U.S. FSAP to the IMF Board. The published report includes 31 key recommendations out of 249 in total.
Discussion
Mr. Smith, UKNAO, asked whether authorities have to formally accept the recommendations. Mr. Jenkinson explained that authorities are not required to accept the recommendations. For example, one recommendation from the U.S. FSAP was to consider simplifying the regulatory structure, but this was not adopted by the U.S. Congress in the Dodd-Frank Act, so IMF recognizes that it is unlikely that this recommendation will be implemented.
Ms. Gelb, GAO, asked about the key challenges when conducting the FSAPs. Mr. Jenkinson noted that countries prefer positive findings over negative findings. Terms used in assessing standards, such as Basel’s “compliant,” “largely compliant,” “materially non-compliant,” and “fully non-compliant” are strong and can be problematic. IMF aims to develop positive recommendations that will be useful to the countries in addition to negative ones, especially since some countries are more receptive than others. He added that generally if the IMF finds a positive finding for the U.S, it provides encouragement for China to adopt that practice and then other countries follow suit as well.
Mr. Tomé asked about FSAPs of the EU. Mr. Jenkinson stated that IMF conducted the FSAP for Eurozone, but for the EU Banking Union specifically. IMF will likely conduct one in the future and IMF has conducted several FSAPs specific to individual EU countries.
Presentation: May 12, 2016, 9:30 a.m. – 10:15 a.m.
Presentation by the Basel Committee on Banking Supervision Standards Implementation
Presenters: Olivier Prato, Head of Basel III Implementation, Basel Committee on Banking Supervision, Bank for International Settlements
Background: The goal of this session was to provide a broad, high-level overview of the Basel Committee on Banking Supervision, which provides a forum for regular cooperation on banking supervisory matters to enhance understanding of key banking supervisory issues worldwide.
The speaker discussed the Basel Committee on Banking Supervision’s implementation monitoring and any challenges, how it assesses regulatory consistency, and the effects on the banking industry.
Introduction:
Mr. Prato’s presentation focused on four issues of the Basel Committee on Banking Supervision (BCBS):
• Implementation monitoring of the Basel III reforms
• Promoting regulatory consistency
• Monitoring the effects of the reforms on banks
• Challenges implementing the reforms
He noted that the BCBS agenda is to implement standards, though they have no legal force and no enforcement authority. The committee’s goal is to create convergence towards modern standards and to monitor implementation.
Implementation Monitoring:
Mr. Prato stated that Basel III was developed in response to the financial crisis, and it substantially changed and improved the financial landscape, particularly capital reserves and buffers. The agenda for the past year has been to:
• Finalize regulatory reforms by the end of this year including the calibration and design of the liquidity coverage ratio (LCR) and internal models to measure credit risk and capital floors,
• Monitor implementation and impact of reforms, and
• Promote strong and effective supervision including providing a forum for supervisory matters and to identify best supervisory practices.
Promoting Regulatory Consistency:
BCBS developed the Regulatory Consistency Assessment Programme (RCAP), which is intended to ensure full, timely, and consistent implementation of standards and maintain confidence in banks’ regulatory ratios. This consists of:
• Monitoring timely implementation of standards, mainly through self-reporting;
• Assessing consistency of domestic regulations, for example, looking at whether the domestic regulations are aligned with Basel; and
• Analyzing comparability of regulatory outcomes with a focus on consistency and variability.
Monitoring the Effects of the Reforms:
Mr. Prato said the committee’s work has been guided by three key principles: (1) a firm commitment to the mandate to increase supervision of banks worldwide, (2) including a wide range of stakeholders in the process, and (3) making a comprehensive and rigorous impact on the banking system and wider economy. The latest BCBS report was published in March, and data have been provided for more than 230 banks comprising more than 100 internationally active banks. Mr. Prato stated that this helps in monitoring the impact of agreed-upon reforms and helps calibrate the ongoing reforms, especially ensuring consistency and coherent calibration of different components of different standards.
Basel III has already had a far-reaching impact. For instance, Mr. Prato said they can see that capital ratios have increased substantially. Since mid-2015, they can see that all large internationally active banks already meet LCR minimums.
Challenges:
Mr. Prato said that the assessments are resource intensive. There are a number of forthcoming standards coming into force early next year and into 2019, and the committee’s plan is to include the new standards progressively and over time into assessments. Member jurisdictions and banks have up to three years to implement standards, and there are notably information technology challenges and challenges reporting to regulators. The complexity and length of domestic rulemaking and legislative processes to amend existing regulations can also take time, and Mr. Prato said BCBS will have to handle some delays and be aware of those issues by jurisdiction in implementing standards.
Discussion:
Mr. Kern expressed concern that banks in the EU cannot provide loans because of the new capital requirements. Mr. Prato disagreed and said the regulatory impact of Basel III was clear and that the increase in capital and liquidity base of banks occurred without negative impacts. There may have been some formal deleveraging on a small scale, but not among the large banks. Several SAI representatives asked about variability issues in monitoring. Mr. Prato said that a main challenge in monitoring is the variability in how banks calculate their risk-weighted assets using various models.
Presentation and Discussion: May 12, 2016, 10:15 a.m. – 11:00 a.m.
Presentation by Financial Stability Board (FSB) on an Overview of its Work and Implementation Monitoring
Presenter: Costas Stephanou, Member of the FSB Secretariat and Secretary of the FSB Standing Committee on Standards Implementation
Background: The goal of this session was to provide a broad, high-level overview of the FSB, an international body that monitors and makes recommendations about the global financial system. Additionally, the presenter discussed FSB’s implementation and monitoring activities and work agenda and priorities.
Background:
Mr. Stephanou said FSB was created by the Group of Twenty (G20) in 2009 when the G7 upgraded to the G20. FSB had a smaller predecessor, the Financial Stability Forum (FSF), created in the aftermath of the Asian financial crisis, but it was not very effective. When FSB was created it had expanded membership and a broader mandate.
FSB Overview:
• FSB now represents 24 member jurisdictions—the twenty G20 members plus the EU and 5 other jurisdictions. All the relevant decision makers sit in the same room and make decisions jointly. It is a community for the global finance system and also includes many of the global authorities such as standard-setting bodies.
• The plenary is where official decisions are made, and the steering committee is a subset of the membership that is tasked with overseeing the work program in-between plenary meetings. There are three standing committees to (1) assess vulnerabilities, (2) develop policies, and (3) monitor implementation, and the committees are supported by technical work teams.
• FSB’s goals are to assess vulnerabilities, coordinate regulatory policies, and promote implementation of reforms.
FSB’s Work Program:
Mr. Stephanou said the effect of the most recent financial crisis led to the development of a comprehensive reform agenda:
• Making financial institutions more resilient;
• Ending “Too Big To Fail;”
• Making the over-the-counter derivatives markets safer; and
• Transforming shadow banking.
These reforms cover a broad set of issues and the objective of all these reforms is to support the G20’s agenda of sound, strong economic growth. They are meant to ensure that by
reducing the frequency and severity of financial crises and making financial systems more robust, the members are able to have higher growth over the longer term.
The 2016 priorities of FSB reflect the reform agenda and the G20 presidency’s priorities:
• Implementation of reforms in a timely manner consistent with standards with no ill effects;
• Addressing new and emerging vulnerabilities, like asset management misconduct, banking, and climate change; and
• Central counterparty (CCP) resilience: Central counterparties now are the clearing entities for trades that Mr. Stephanou said were previously bilateral transactions that were not transparent, and now the CCPs have concentrated those risks, which have grown in size and importance.
Implementation Monitoring:
To monitor implementation, FSB carries out peer reviews and regular reports, usually annually, to make sure that implementation is consistent with international standards and to identify gaps.
• Peer reviews are an important means of identifying gaps and putting forward recommendations to address those gaps. By doing that, and doing it publicly, there is peer pressure on those countries to take the next step and implement reforms. Peer reviews include thematic reviews (across countries) and country reviews (jurisdiction- specific reviews focused on specific reforms).
• G20 report: FSB created a single report for G20 leaders that covers all reforms and monitoring processes. The first was published in November 2015, and the goal is to publish a second report before September this year. FSB has found that progress is steady but inconsistent; much of the Basel III reforms have been implemented, for example, but shadow banking and resolution reforms have been less consistently implemented.
FSB has asked its members to provide evidence of unintended consequences of reforms, and so far there have been none. Mr. Stephanou said there are still a few key areas to monitor more closely: (1) the effects of reforms on emerging markets; (2) an open and integrated financial system; and (3) market liquidity.
Discussion:
Several SAI representatives were concerned about the effects of reforms. Mr. Stephanou said that there has been some work on the effects, which are complex, long-term, and include lots of challenges. At this stage, they are using a variety of approaches to understand the effects. The bottom-up effects are the direct effects of each individual reform to meet its intended outcome. The top-down effects are even more difficult to examine because they are the combined effects of reforms at the macro level –global financial resilience and mediation and economic growth.
There are a host of factors affecting those variables. These are what the G20 are most interested in seeing, but those are the hardest to review. Mr. Stephanou said they will be working on the framework and method for doing this, including how other authorities are looking at this issue.
Plenary Session: May 12, 2016, 11:30 a.m. – 12:30 p.m.
The Plenary Session included reports from the chairs of the three subgroups and related discussions.
• Members universally found the speakers from IMF, Basel, and FSB to be extremely valuable and the UK noted that the working group provides members with greater access to these bodies than they would have on their own.
o Members suggested that to ensure that the relationships are mutually beneficial, SAIs could focus on developing ways to provide information to these bodies on a periodic basis about relevant work or insights. FSB specifically mentioned that this kind of information would be useful.
• The Brazilian officials suggested that the working group could provide (1) examples of criteria that can be used for performance audits of the banking system and (2) identification of risk areas. For example, Brazil’s growth in public banks is a concern for them.
• The Chinese officials suggested that next year’s meeting include more in-depth discussion of narrower topics.
• The ECA officials said repeatedly that the working group meeting was extremely valuable in providing opportunities to share experiences and in providing information from key international financial bodies on their work.
• The Estonian and Finnish officials said that although they are small countries, they are affected by global financial stability so the working group is very valuable in keeping them aware of financial conditions that may affect them.
• The Estonian official also noted that the international financial bodies’ monitoring efforts are all peer reviews—which highlights the value of SAIs in providing independent perspectives on financial reform and regulatory oversight.
• The Finnish official noted that more forward-looking analyses would be helpful.
• The Swedish official noted that the working group meeting not only served to inform members, it was also “knowledge generating;” – for example, through exchanging ideas and educating one another about performance audit approaches and topics. Officials from ECA, Austria, Mexico, Chile, and Indonesia noted that they found the meeting and the working group in general, extremely valuable in this regard.
• The effects and effectiveness of financial reforms was a topic of discussion during the subgroup 2/3 breakout session and the plenary, and FSB and Basel Committee presenters noted that in the future, their monitoring efforts would include a focus on the effects of reforms.
o Specifically, the working group members proposed that the working group could (1) find out more about the extent to which individual countries’ financial regulators have evaluated the effects (e.g., costs and benefits) of the reforms
and (2) examine whether the international financial reforms that are largely implemented are the “right” reforms.
o This topic could be added to the Governing Board report this year or in the future.
Appendix Documents: Handouts
• Presentation by UKNAO on Financial Services Mis-selling Regulation
• Presentation by South Korea’s Bureau of Audit and Inspection on its Financial Reform Audit
• Presentation by GAO on Monitoring of Financial Sector Indicators
• Presentations by ECA on Financial and Economic Audits and Banking Union Audits
• Presentation by IMF on FSAP
• Presentation by Basel on the Basel Committee on Banking Supervision Implementation Standards
• Presentation by FSB on Implementation Monitoring Activities