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At the Seminar on Banking Soundness and Monetary Policy in a World of Global
Capital Markets, Sponsored by the International Monetary Fund, Washington, D.C.
January 28, 1997

International Competition: Should We Harmonize Our National Regulatory
Good afternoon. It is a pleasure to be here today to discuss a topic that has become more
important in a world of global financial markets--the matter of coordinating and harmonizing
our national regulatory systems. On the conference agenda, the topic was phrased as a
question, that is, whether we should harmonize our systems. In a sense, the question is
somewhat moot--the globalization of the markets and the breadth of international
conglomerate financial institutions is forcing us in that direction. But I would quickly add
that one definition of "harmony" is "a pleasing combination of elements." We can sing
compatible and pleasant-sounding notes, without singing the same note. It is in that sense
that I believe harmonization of our regulatory systems will develop.
In my comments this afternoon, I will mention some of the efforts underway in which the
United States is working with other countries to develop more consistent supervisory and
regulatory systems, particularly for large financial conglomerates. That experience may
provide others with ideas about how they might pursue similar efforts, either on a bilateral or
multilateral basis. Perhaps more importantly, though, I will also offer my views on where our
interests are likely to be most similar and why and how regulators around the world are
likely to continue working toward compatible or "harmonized" systems. Let me begin with
those thoughts.
The Importance of Compatible Regulatory Regimes
One cannot have dealt with U.S. and world financial markets during the past few decades
without being thoroughly impressed with the rapid pace of change and the manner in which
technology and financial innovation have affected market practice. The improvements in
communications and transportation and, importantly, the gains from technology and the
miniaturization of the goods we produce have fueled a growing volume of international
trade. Our financial institutions, in turn, have sought constantly to find more effective and
efficient ways to facilitate and finance these activities, and at the same time manage the
related risks. As a result, we have seen dramatic growth in financial derivatives, strong
support within the industry for new clearinghouses and netting procedures to reduce
counterparty credit risk, a growing need to clarify our laws and regulations regarding
financial contracts, and financial markets that are far more closely linked today than they
were even a decade ago.
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In the area of bank regulation and supervision, substantial progress has been made in
developing capital standards that help to ensure the financial strength of internationally

active banks and that promote greater competition. Simply put, firms in need of international
financial services will utilize domestic or foreign financial institutions to the extent their
prices are competitive and their financial stability can be assured. As a result, regulators are
recognizing the need to harmonize laws and regulations in order to promote economic
growth and to deal with important and oftentimes increasingly complex matters that are of
common interest to us all.
We are recognizing also the need to enhance financial systems--including supervision and
regulation--in the emerging market economies, primarily for the sake of those economies,
themselves, but also because of their increasing importance in international financial
markets. Indeed, G-7 leaders at their summit meeting in Lyon last summer identified this
goal as an important element in efforts to promote international financial stability.
That we need some level of conformity seems, I'm sure, quite clear. Otherwise, the
inconsistency and incompatibility of rules and regulations across countries may make it
difficult, if not impossible, for some firms to engage in global business activities. Such
barriers are detrimental to the efficiency of international trade and finance, generally.
The difficulty, of course, is the precise nature and level of conformity that is necessary to
maintain an efficient and equitable world financial system. Here I submit that it may be less
important that we standardize particular banking laws and regulations, than it is for us to
pursue similar goals, as we independently develop our domestic regulation and supervisory
structures. Specifically, if we apply market-based incentives in our regulatory structures,
that, alone, should keep our rules sufficiently similar and compatible.
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We must also recognize that technology and financial innovation are permitting banks today
to become ever-more adept at avoiding regulatory barriers and other restrictions that
artificially constrain their activities. Moreover, to the extent they are effective, such
restrictions can work against local institutions, businesses, or consumers by making banks
less competitive internationally or by withholding from their customers the benefits that
competition can bring. Regulatory regimes are likely to be more effective in the long run for
financial institutions and for domestic economic growth if they are market-compatible.
Areas of Common Interests
In our roles as central bankers, bank supervisors, and regulators, what are the areas of
greatest common interest to us for which we should develop compatible rules and
regulations? To keep it simple, let me suggest two. First, to maintain a healthy, responsive,
and financially strong banking and financial system will facilitate the growing needs of our
domestic economies. Second, to build and maintain an adequate legal and regulatory
structure will permit our institutions to compete safely on an equal and nondiscriminatory
basis, both domestically and abroad. These thoughts may not sound original; they're not.
They are essentially the two reasons the Basle Committee on Supervision exists, and they
underpin most other international efforts to coordinate banking issues.
When I consider the past successes in coordinating international bank supervisory or
regulatory policies, I think first of the Bank for International Settlements and the work of the
supervisors' committee. After all, the BIS has been the principal forum for developing
international supervisory standards for banks in industrialized countries and, by their
voluntary adoption, for banks and bank supervisors in other countries throughout the world.

Bilateral discussions can also serve useful functions either where particular issues are of
concern or as a basis for subsequent broader dissemination.
Nearly a decade ago, such bilateral and--through the BIS--multilateral efforts produced the
risk-based capital standard, known as the Basle Accord. Since then, we have produced
numerous other policy statements dealing with sound risk management practices for banks.
These statements related first to derivatives activities and most recently involve the
management of interest rate risk. Dr. Padoa-Schioppa, chairman of the supervisors'
committee, has probably already discussed these initiatives with you.
One of the Committee's most recent accomplishments, however, is the development of new
capital standards for market risk in trading activities. That standard is notable because it
reflects a new approach for constructing international banking standards. In particular, the
internal models approach contained within that standard builds on leading industry practices
and helps supervisors to promote risk management in banks.
Promoting sound risk management is a goal we should all pursue more aggressively in
considering new banking policies and regulations. It is also the type of approach I had in
mind when I said earlier that our laws and regulations should be compatible with underlying
economics and market demands. To the extent we can continue building on "best" or sound
banking practices in designing our rules and regulations, we will be working toward a
common end. As we work together identifying those practices and deciding how to apply
them as supervisory or regulatory standards, we will also be strengthening relations among
ourselves that can prove invaluable in times of market stress.
Not to over-use the example of the market risk standard, but it illustrates another useful
point, as well. Reliance on a bank's own risk measurement and modeling process in
determining regulatory capital standards also acknowledges that no single or specific
technique is best for everyone. Each institution should tailor its risk measurement and
management process to its own needs. While adhering to basic principles, each institution
must determine for itself the proper incentives and techniques for managing its affairs. No
two banks or banking markets are identical in their operations, structure, or historical
development. Permitting a range of compatible responses to similar situations encourages
experimentation, innovation, and growth. Accommodating a certain level of flexibility is
necessary for banks, and it is necessary for regulators, too.
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Indeed, flexibility may be even more important for non-G-10 countries than it is for those of
us with large, developed financial systems because of the greater range of capital market and
economic infrastructures among developing countries. Materially different situations
typically require different solutions. Accommodating differences, though, does not reduce
the need for minimum regulatory or supervisory standards based upon well-known principles
of sound banking. It is up to supervisors and, if necessary, legislators to craft regulations and
laws consistent with internationally recognized standards, but accommodative to local
customs and economic needs.
In developing sufficiently flexible, market-compatible regulations, I believe we should rely
as much as prudently possible on market discipline and on banks' internal incentives to
perform well. This approach requires that the public have information about the risk
exposures of banks and about their procedures for managing those risks. As regulators, we

can encourage this process by requiring or prodding banks to disclose information to the
markets that is both relevant and comparable among institutions.
Whether such disclosures are imposed by official regulations or evolve through more subtle
efforts, supervisors can help guide the process by considering carefully the kinds of
information the private sector needs and that banks use--or should use--to manage risk. Even
in the United States, where surveys show disclosure is relatively good, supervisors make
available to the public data collected on Call Reports.
In countries where disclosure practices are minimal at best, bank regulators may be able to
perform a particularly important role by publicly disclosing some, if not much, of the
information banks report to them. By fueling market information in this way, regulators may
stimulate greater investor interest in banks and the growth of local capital markets. Improved
disclosure practices by banks may, in turn, also spill over to other industries. One thing we
know for sure is that investors dislike uncertainty. By shedding light on a bank's condition
and future prospects, some of that uncertainty should disappear.
While it is important that key prudential standards be sufficiently robust and consistent
among countries, certain variations in the details and applications of these standards can be
useful. As with private markets, some level of competition among regulators can stimulate
improvements and change. I will grant that the United States may take regulatory
competition to an extreme, but it also demonstrates, I believe, the advantages that derive
from accommodating different views and permitting financial institutions alternative ways to
do business. In my view, and considering the political difficulties we have faced in trying to
change U.S. banking laws, our current regulatory structure, offering some choice in charter
that is administered by multiple regulators, has provided financial institutions with more
freedom and expanded powers than they would likely have received with a single regulator.
Supervisors must be careful, however, as they try new or different techniques, that they not
impair their oversight efforts or relax them beyond prudent bounds. In such global markets
as we have today, weak or ineffective supervision in either large or small countries can have
far reaching consequences. Those concerns were at the heart of early work of the Basle
Committee and its efforts to identify the respective roles and responsibilities of home and
host authorities for internationally active banks. It is important for supervisors to be able to
rely on their counterparts in other countries to administer agreed-upon standards of financial
institution safety and soundness.
Whether we conduct our own on-site examinations, rely on external auditors, or use
combinations of other supervisory techniques, we need to assure ourselves that all banking
offices are adequately managed and supervised. I would note here that among G-10
countries a more consistent approach may begin to emerge. We in the United States are
making greater use of the findings of a bank's internal and external auditors to guide or
supplement our on-site examinations, while some of our counterparts abroad are recognizing
more the benefits of on-site exams.
Financial Conglomerates
Some of the greatest challenges to bank supervisors may arise when organizations link
banking activities with other financial or nonfinancial businesses. Such financial
conglomerates, which often combine banking, insurance, and securities activities, are not
currently allowed to provide a full array of financial services in the United States, but they
may do so abroad.

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The existence of such firms--and the fact that some of them are headquartered in this
country--have required regulators and supervisors in the United States to work with
counterparts abroad to discuss oversight arrangements and develop ways to deal with
matters in times of crises. This very issue is one of our current challenges. I have to say that
this is not a particularly quick or easy process and is further complicated by the diverse
regulatory structures, both here and abroad, involving banking, securities, and sometimes
insurance regulators.
These discussions often raise difficult issues, since they tend to break new ground in
supervision. For example, what approach should be taken regarding nonbank--or even
nonfinancial--activities of companies that own banks? In the context of these conglomerates,
what does or should "consolidated supervision" mean? Within the context of consolidated
supervision, how can the traditional safety-and-soundness approach used by bank
supervisors be reconciled with the disclosure/self-regulatory approach used by many
securities regulators? Moreover, do the diverse operating structures of conglomerates imply
an extension of the safety net that virtually all governments currently extend to banks? One
thing is clear: as we address the challenges of promoting a more consistent bank supervisory
and regulatory process worldwide, we cannot always take official descriptions of regulatory
and oversight regimes at face value. We need to dig deeper to understand how laws are
interpreted and how individual banking agencies monitor and enforce safe banking.
Different countries necessarily have different banking and financial systems that face unique
combinations of exposures and business risks. Even within the United States, for example,
we have a relatively uniform supervisory approach for all banks and a risk-based capital
standard that applies to them all. In practice, however, the activities of our banks, their
capital levels, and their operating practices are quite diverse, and our oversight efforts take
those differences into account. Small banks, themselves, recognize the greater risks they
face from their lack of size and diversity, and have consistently maintained higher capital
ratios than do money center banks. But they also have less formal procedures and internal
controls, simply because their staffing and operations are so much smaller. The point is that
even a uniform set of rules within a given country can and should be implemented
differently as conditions demand.
It seems clear that as financial markets become more and more integrated, bank regulators
around the world will be seeing more of each other than they have in the past. Even in
countries that have no internationally active domestic banks, authorities need to ensure that
the banks operating in their markets are sound and subject to adequate supervision, whether
by home or host authorities. Banks operating imprudently and without proper supervision
are the ones most likely to mismeasure their risks, misprice their products, and disrupt the
markets. Detecting and deterring such institutions does not require us to have uniform
regulatory or supervisory systems, but it does require a certain level of cooperation and
coordination and a material level of consistency in our regulatory regimes. Our experience in
the United States suggests that achieving an appropriate convergence takes time, not only to
develop but to maintain. Progress we have seen through the European Union and the BIS go
far in coordinating, or harmonizing, banking laws, regulations, and operating standards, but
that's just a start. As managers of large financial institutions develop more sophisticated and
more comprehensive risk management systems, they are paying less attention every day to
the peculiar legal structure of their organizations. As regulators, we need to understand how

banking organizations manage and control risks and the full implications of their practices
for the financial safety of depository institutions. By doing so, we can do much to protect
our own interests while still recognizing and accommodating the business needs of banks.
In developing our laws and regulations we need to work together, for sure. But perhaps more
importantly, we need to understand the market forces and incentives that banks face. If we
keep those factors in mind in developing our individual rules, we may go far in developing
regulatory systems that are both compatible among countries and less intrusive to the
institutions we oversee.
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1997 Speeches
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Last update: January 29, 1997 9:10 AM