Risk Management Presentation Monday February 18 2013

Page |1
International Association of Risk and Compliance Professionals (IARCP) 1200 G Street NW Suite 800 Washington, DC 20005 -6705 USA Tel: 202-449-9750 www.risk-compliance-association.com
Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's agenda, and what is next
Dear M ember, I will be the chairperson for the plenary sessions during the upcoming Strategic Risk & Compliance 2013 conference (from M arcus Evans) in H yatt Regency Dubai, 20-21 M ay 2013
I look forward to meeting some of you and learn what you do and which are the challenges and opportunities in your region.
I also love to visit Dubai one more time. There is a 10% discount for members: http:/ / tinyurl.com/ M arcusEvansDubai _____________________________________________________________ I always read the papers that monitor the impact of Basel iii carefully. But, dont be surprised, we still have Basel iii monitoring with Basel i figures! The Basel Committee on Banking Supervision is monitoring the impact of Basel I I I : A global regulatory framework for more resilient banks and banking systems and Basel I I I : I nternational framework for liquidity risk measurement, standards and monitoring on a sample of banks. What is interesting The monitoring exercise is targeted at both banks under the Basel I I / I I I frameworks and at those still subject to Basel I .
_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com
Page |2
H owever, as outlined in the remainder of these instructions some parts of the questionnaire are only relevant for banks subject to Basel I I or to banks applying a particular approach. I f Basel I figures are used, they should be calculated based on the national implementation, referred to as Basel I in this document. I n some countries supervisors may have implemented additional rules beyond the 1988 Accord or may have made modifications to the Accord in their national implementation, and these should be considered in the calculation of Basel I capital requirements for the purposes of this exercise. To make a long story short: we still have regulatory arbitrage (and regulatory shopping). I have just heard (again) that we live in the financial times well, we are almost there.
Read more at Number 1 below. Also

I n the N ational Banking Era, the law provided that in the event the Comptroller found that a N ational bank was deficient in its reserve, the bank could be required to cease making loans and stop paying dividends until the amount of the reserve was restored.
What is the National Banking Era?

From 1863 to 1913 Read more at N umber 2 below, an excellent paper from M ark A. Carlson, Federal Reserve Board, Washington D.C. Welcome to the Top 10 list.
Page |3
Basel iii monitoring, still with Basel i figures
Basel I I I monitoring Questionnaire and instructions

The Basel Committee on Banking Supervision is monitoring the impact of Basel I I I : A global regulatory framework for more resilient banks and banking systems and Basel I I I : I nternational framework for liquidity risk measurement, standards and monitoring on a sample of banks.
Finance and Economics Discussion Series, Divisions of Research & Statistics and M onetary Affairs, Federal Reserve Board, Washington, D.C.
Lessons from the H istorical Use of Reserve Requirements in the United States to Promote Bank Liquidity
M ark A. Carlson
Anti-M oney Laundering: Stronger rules to respond to new threats

The European Commission has adopted two proposals to reinforce the EU's existing rules on anti-money laundering and fund transfers.
Page |4
N ew DARPA program seeks performers for transient electronics demonstration

The sophisticated electronics used by warfighters in everything from radios, remote sensors and even phones can now be made at such a low cost that they are pervasive throughout the battlefield.
Steaming on in uncharted waters in storm-tossed seas five years of steering a central bank in a small, open island state and keeping the economy on an even keel
Letter by M r Rundheersing Bheenick, Governor of the Bank of M auritius, to stakeholders, Bank of M auritius, Port Louis
Regulatory Priorities for 2013

Key Areas of Focus: -Bermuda will not Apply Solvency I I -type Regime to Captives -BM A to Balance I nternational Cooperation with Independent Approach to Regulation -Faciliating Quality N ew Business for Bermuda while retaining effective oversight
Page |5
EU Cybersecurity plan to protect open internet and online freedom and opportunity
The European Commission, together with the H igh Representative of the Union for Foreign Affairs and Security Policy, has published a cybersecurity strategy alongside a Commission proposed directive on network and information security (N I S).
Bank for I nternational Settlements
I nternational financial markets and bank funding in the euro area: dynamics and participants
Jaime Caruana, General M anager Adrian Van Rixtel, Senior Economist
Countercyclical loans for the management of exogenous shocks in small vulnerable economies (SVEs) and non traditional sources of development finance
Opening remarks by M r Jwala Rambarran, Governor of the Central Bank of Trinidad and Tobago, at the Joint Commonwealth Secretariat and United N ations Development Program
Page |6
workshop on Countercyclical loans for the management of exogenous shocks in small vulnerable economies (SVEs) and non-traditional sources of development finance, Port of Spain
EM I R Rules - Statement by Commissioner M ichel Barnier on the technical standards to implement the new rules on derivatives
I take note of the fact that the European Parliament has decided not to object to our proposed technical standards to implement our new rules on derivatives. The Council had earlier confirmed that it does not object to these proposed standards.
This means that the standards can now enter into force 20 days after their publication in the Official Journal of the EU, most likely around mid-M arch.
Page |7
Basel iii monitoring, still with Basel i figures
Basel I I I monitoring Questionnaire and instructions

The Basel Committee on Banking Supervision is monitoring the impact of Basel I I I : A global regulatory framework for more resilient banks and banking systems and Basel I I I : I nternational framework for liquidity risk measurement, standards and monitoring on a sample of banks. The exercise will be repeated semi-annually with end-December and end-June reporting dates.
Scope of the exercise

Participation in the monitoring exercise is voluntary. The Committee expects both large internationally active banks and smaller institutions to participate in the study, as all of them will be materially affected by some or all of the revisions of the various standards. Where applicable and unless noted otherwise, data should be reported for consolidated groups. The monitoring exercise is targeted at both banks under the Basel I I / I I I frameworks and at those still subject to Basel I . H owever, as outlined in the remainder of these instructions some parts of the questionnaire are only relevant for banks subject to Basel I I or to banks applying a particular approach. I f Basel I figures are used, they should be calculated based on the national implementation, referred to as Basel I in this document.
Page |8
I n some countries supervisors may have implemented additional rules beyond the 1988 Accord or may have made modifications to the Accord in their national implementation, and these should be considered in the calculation of Basel I capital requirements for the purposes of this exercise. I f a bank has implemented Basel I I at a particular reporting date, it should calculate capital requirements based on the national implementation of the Basel I I framework, referred to as Basel I I in this document. Unless stated otherwise, the changes to the risk weighted asset calculation of the Basel I I framework introduced in 2009 which are collectively referred to as Basel 2.5 (Revisions to the Basel I I market risk framework (the Revisions) and Enhancements to the Basel I I framework (the Enhancements)) and through the Basel I I I framework should only be reflected if they are part of the applicable regulatory framework at the reporting date.
When providing data on Basel I I I , banks should also take into account the frequently asked questions on capital, counterparty risk and liquidity published by the Committee.
This data collection exercise should be completed on a best-efforts basis. I deally, banks should include all their assets in this exercise. H owever, due to data limitations, inclusion of some assets (for example the portfolio of a minor subsidiary) may turn out to be an unsurpassable hurdle. I n these cases, banks should consult their relevant national supervisor to determine how to proceed.
Page |9
Finance and Economics Discussion Series, Divisions of Research & Statistics and M onetary Affairs, Federal Reserve Board, Washington, D.C.
Lessons from the H istorical Use of Reserve Requirements in the United States to Promote Bank Liquidity
M ark A. Carlson N OTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary materials circulated to stimulate discussion and critical comment.
The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors.
References in publications to the Finance and Economics Discussion Series (other than acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers. *** Shortly after the Panic of 1837, states began instituting reserve requirements which mandated that banks had to hold liquid assets representing at least some minimum fraction of their liabilities. When Congress passed the N ational Bank Acts in the 1860s, banks receiving N ational Bank charters also faced a minimum reserve requirement. These rules were part of an effort to promote liquidity and soundness by ensuring that each individual bank had a pool of liquid assets that it could draw on during times of stress. Despite these efforts, as well as some efforts from within the banking sector to provide liquidity support, the banking system remained
P a g e | 10
vulnerable to banking panics and suspensions of convertibility in which banks temporarily stopped or restricted withdrawals of funds (Calomiris and Gorton 1991, Sprague 1910, Wicker 2000). These panics were quite disruptive to economic activity and demonstrated that the reserve requirements were not sufficient to ensure that the financial system remained liquid during periods of stress (Grossman 1993, James, Weiman, and M cAndrews 2012). In part to address these concerns, Congress established the Federal Reserve to create an elastic currency that could add liquidity to the banking system and serve as a lender of last resort. This paper reviews the historical experience of the United States with reserve requirements to provide insights for policymakers today regarding efforts to promote individual bank liquidity and the relation of those efforts with a lender of last resort.
(Some proposals, such as the, liquidity coverage ratio proposed by the Basel Committee on Banking Supervision, are quite similar to these historical reserve requirements.)
The insights discussed here draw importantly on the active discussions among academics, policymakers, and bankers during the 1800s and early 1900s about the value of reserve requirements. Other lessons are based on contemporary discussions and some data analysis regarding the dynamics within the banking system during panics and the impact of reserve requirements. While this paper reviews the historical experience of the United States with reserve requirements starting in the 1830s, there is a bit more emphasis on material from the N ational Banking Era (1863-1913). The empirical parts of the paper also draw on data from this period. The focus on the N ational Banking Era reflects the fact that it was
P a g e | 11
in this period that use of reserve requirements was most prominent and that the experiences during this period ultimately resulted in the creation of the Federal Reserve and a shift away from the use of reserve requirements to regulate liquidity. One key lesson that can be drawn from historical experience is that central banks are important during panics for multiple reasons.
One description of a panic is a situation where extraordinary demand for liquid assets exceeds the available supply of those liquid assets (as evidenced by the suspensions of convertibility that occurred during panics and by the spikes in short-term interest rates).
A central bank can help ease a panic by rapidly expanding the supply of liquid assets. Relatedly, banks often depend on other banks for liquidity. During a panic, the ability of other banks to furnish that liquidity support is likely to become impaired. Without access to this usual source of liquidity, and in the absence of a lender of last resort, banks may face increased incentives to hoard liquidity during stress events. This dynamic may exacerbate the severity of the stress episode. Thus, during a crisis, the liquidity of an individual bank is intricately connected to central bank liquidity policy and optimal liquidity regulation should consider these jointly. There are other pertinent lessons as well. The liquidity reserves mandated by reserve requirements are generally intended to be used when liquidity demand spikes. N evertheless, banks are often reluctant to draw down their stores of liquid assets during panics.
P a g e | 12
H istorical experience suggests that if the rules regarding the instances when the reserve should be used are unclear, the lack of clarity may exacerbate banks reluctance. On a related note, the regulations and penalties associated with monitoring and enforcing the reserve requirement during normal times that were in place during the late 1800s and early 1900s do not appear to have been particularly effective which indicates the importance of considering these aspects of liquidity requirements as well. Additionally, historical experience suggests that when certain assets are designated as stores of liquidity, institutions will seek to accumulate those assets during a crisis to demonstrate their strength; Uunless the pool of liquid assets can be expanded at those times, there is some risk that the functioning of the market for those assets expected to provide liquidity can deteriorate. This paper is organized as follows. Section 2 describes the introduction of reserve requirements, reviews the arguments for and against such requirements during the 19th and early 20th centuries, and provides some stylized facts on reserves held by banks. Section 3 reviews mechanisms within the system designed to address the stresses associated with banking panics and presents some evidence on how holdings of reserves changed shortly after a panic. Section 4 briefly recounts events from the Panic of 1907 and discusses some reasons why the reserve requirements alone were not sufficient to stop banking panics. This section also reports on the subsequent debate about the need for a central bank to provide liquidity support to the banking system.
P a g e | 13
Section 5 describes reserve requirements in the presence of a central bank and the decline in the use of reserve requirements as a tool for regulating liquidity following the establishment of the Federal Reserve. A general review of the lessons from the historical experience and concluding thoughts are provided in Section 6.
Section 2. Reserve requirements prior to the Federal Reserve

This section briefly reviews the history of the laws regarding reserve requirements. I t also describes some of the reasons given by policymakers for having reserve requirements, the differences in requirements across states, and the enforcement of the reserve requirements. Additionally, this section provides some basic empirical information on the levels of reserves held by individual national banks.
Section 2.1 I ntroduction of reserve requirements

The first reserve requirements were introduced in the United States shortly following the Panic of 1837 by the states of Virginia, Georgia, and N ew York (Rodkey 1934). These requirements were generally intended to ensure that banks had ready access to resources that would enable them to meet their liability obligations.
The adoption of reserve requirements by other states occurred slowly; only 10 states had such laws by 1860.
Although after the Panic of 1857 there were a number of journal articles and pamphlets advocating in favor of reserve requirements. When reserve requirements were first enacted the main bank liability was bank notes, which were privately issued currency that the bank promised
P a g e | 14
to redeem for specie (gold or silver coin), and state laws referred to those liabilities as the base for determining the appropriate reserve. As the liability base of banks shifted toward deposits, the reference point for the reserve requirements shifted as well. I n 1842, Louisiana passed a law requiring banks to maintain a reserve in specie equal to one-third of its liabilities to the public, which included both notes and deposits (White 1893). By 1895, 21 states had reserve requirements for commercial banks; at this time, all such laws included deposits in liability base (Comptroller 1895). For states that enacted reserve requirements, the laws regarding the ratio of reserves that had to be held relative to the liability base ranged from between 10 percent and 33 percent. State laws also differed with respect to what could be included in the reserve. Some states allowed deposits in other banks to count as part of the reserve. This feature likely owed to the fact that many banks in smaller communities maintained balances at banks in larger cities to clear payments. As many bank notes, and later checks, were redeemed at these clearing banks, interbank deposits played an important part in a banks liquidity profile (James 1978, White 1983). Other states required that that the entire reserve be carried as specie in the banks vault. A few states allowed short-term loans to count as part of the reserve.
P a g e | 15
There were some further debates about the type of deposits should be included in the base for the reserve. Some policymakers argued that banks ought to maintain a greater reserve against more volatile deposits. As a result, some states only required a reserve against demand deposits (Comptroller 1895, Welldon 1910). A handful of states mandated reserves against both demand and time deposits, but specified that the amount of liquid resources that needed to be held against each dollar of time deposits was smaller than that required for demand deposits. N evertheless, a majority of states required the reserve to be calculated against all deposits. When the U.S. Congress passed the N ational Banking Acts in the early 1860s and provided for N ational Bank charters, the legislation included reserve requirements for N ational Banks.
These reserve requirements were tiered depending on the location of the banks.
For much of the N ational Banking Era, banks located outside major cities referred to as country bankswere required to hold reserves equal to 15 percent of deposits, three-fifths of which could be held as deposits in banks of reserve cities while the rest was required to be held as vault cash. Banks in reserve cities generally larger cities were required to hold reserves equal to 25 percent of deposits, half of which could be carried as balances in central reserve cities. Banks in central reserve cities at first just N ew York but later also Chicago and St. Louis held significant amounts of interbank deposits. These banks were required to maintain a reserve equal to 25 percent of deposits which needed to be held in gold or in Treasury notes.
P a g e | 16
One reason that banks in reserve and central reserve cities were expected to hold a higher portion of their assets as reserves was that they held more interbank deposits; these deposits were seen as more volatile and, in particular, more likely to be withdrawn during banking panics (Federal Reserve 1927).
Section 2.2 The purpose of the reserve

As noted above, reserve requirements were a prudential requirement meant to ensure that banks maintained the resources to meet their obligations.
This goal is quite broad and has aspects of both solvency and liquidity. I ndeed proponents of reserve requirements often blended the two or spoke of the benefits both in terms of the safety of the banks and the promptness with which banks could meet withdrawals, though there was perhaps a bit more frequent mention of the liquidity benefits. An example of arguments framing the reserve as a tool for supplying liquidity comes from the 1873 report of the Comptroller of the Currency (Comptroller) the chief regulator of the N ational Banks who noted that the question is not whether a reserve shall be held which shall insure the payment, merely, of the note, for that is unnecessary, but what amount of reserve shall be held by the banks to insure the prompt payment of all their liabilities? (p.19) Among the arguments pointing to solvency benefits, Tucker (1858) suggested that bank failures, such as during the Panic of 1857, were the result of imprudence as banks overextended themselves and did not maintain a reserve of at least one-third of their liabilities. M ost advocates tended to blend these extremes. H ooper (1860) provided one of the most interesting blends.
P a g e | 17
H e maintained that a bank could reduce its riskiness by adjusting either its capital or its reserve and that for a given level of capital, a bank could extend more loans if it held greater reserve. H aving a strong reserve meant that the bank would be able to avoid being forced to access emergency funds from other banks or rapidly call in their loans (or presumably be forced to sell assets in firesales) and thus be stronger overall. While much of the discussion focused on the microprudential benefits to the individual banks of requiring a minimum level of reserves, some commentators did suggest that there were systemic benefits of ensuring banks retained sufficient liquid resources on hand. Opdyke (1858) argued that excessive credit growth led to a boom and bust cycle and that a reserve requirement could be useful in restraining credit growth. M ore concrete systemic benefits were described by H ooper (1860) and Coe (1873) who suggested that there were collective action reasons to mandate minimum reserves, especially for banks in the main money center of N ew York City. H ooper noted that the reserve of banks in N ew York was a common good benefitting all the banks in the city as well as the rest of the country and that the management of those banks might not internalize the social benefit they provided. As a consequence, he argued that the law needed to require them to hold a larger reserve than the banks would otherwise have chosen. I t is out of the question for the banks of the city of N ew York to hold that relation of the entire confidence through the country, so long as the action of each bank, in regard to the amount of its reserve of specie, is dependent upon the peculiar views or character of its board of managers. The law must secure the uniform ability of the banks to meet their engagements by making it imperative upon each one of them to hold the
P a g e | 18
requisite amount of specie as a condition of their power to discount (p.44). Coe noted that banks in N ew York City were linked both through their general dependence on the call loan market for liquidity (described in detail below) and that interior banks tended to react to troubles at one bank as a signal of troubles at all the banks.
Thus, during a panic the strong banks needed to support the weak to contain liquidity drains and prevent problems from cascading.
This linkage, Coe argued, was a reason that all banks needed to hold a strong reserve and was a motivation for the N ew York Clearinghouse to establish a reserve requirement in 1857.
Section 2.3 Enforcing the reserve requirement

The debate about how to ensure that banks met the reserve requirement started soon after the requirements were introduced. Tucker (1839) advocated enforcing the requirement using a moderate penalty proportional to any deficiency of the reserve. He maintained that the penalty should be high enough to dissuade banks from running below the reserve in good times but not so high that banks were unwilling to use the reserve during a crisis. Opdyke (1858) argued for requiring a minimum reserve somewhat below what was desired as he maintained that banks would hold a buffer stock above the requirement and that the buffer could then be used: A legal minimum of 20 per cent will, it is believed, give a practical minimum of not less than 25 to 30 per cent, for no prudent bank will voluntarily occupy a position on the verge of legal death (p.15-16). I n the N ational Banking Era, the law provided that in the event the Comptroller found that a N ational bank was deficient in its reserve, the
P a g e | 19
bank could be required to cease making loans and stop paying dividends until the amount of the reserve was restored. The Comptroller (1893) stated that in the event that the bank had loaned out too great a portion of its funds or depositors had withdrawn a significant amount of funds, the only safe and prudent course for the bank to pursue is to cease paying out money in any direction except to depositors until either through the collection of demand or maturing loans on the one hand, or the receipt of deposits on the other, the required portion has been restored (p.18). I f the reserve was not restored within 30 days, the Comptroller could, with the concurrence of the Secretary of the Treasury, appoint a receiver for the bank. I t was well noted that both the finding by the Comptroller that the bank was deficient and the decision to seek a receiver were discretionary on the part of the Comptroller.
M oreover, the Comptroller stated that he only had the opportunity to learn about the banks balance sheet from one of the biannual bank examinations or the report of condition filed five times a year (1893).
The actual ability to monitor was slightly more complicated. In their examination reports, examiners were asked to look through the banks books and calculate and comment on the adequacy of banks reserve for the past 30 days (or more if deemed appropriate). Thus the examination reports allowed the Comptroller more just than a single days observation. Carter Glass (1913) asserted that this particular penalty regime was reportedly not very successful. I n the debates related to Federal Reserve Act, he maintained that the penalties for holding inadequate reserves for an extended period were so severe that they had the never been applied and that in some cases banks
P a g e | 20
had been allowed by regulators to have deficient reserves for periods of several years. Looking at examination reports for a sample of banks indicates that the examiners took note of the condition of the banks reserves and used this information, along with other aspects of the banks condition, to make recommendations about whether the bank should be allowed to pay dividends or make other changes to its capital account. This indicates that the condition of the reserve did matter to the examiners. There were no suggestions in this sample of examination reports that a bank ought not make new loans due to a deficit reserve. I nformation from Welldon (1910) suggests that, as of 1909, many states had similar, though perhaps slightly less severe, penalties for banks falling short of their reserve.
Out of the 39 states that had reserve requirements at that time, Welldon mentions a penalty for failing to meet that reserve for 25 states.
I n every case, that penalty involved a prohibition on extending new loans. I n 15 cases, there was also a prohibition on issuing dividends. For only one state, Arizona, does Welldon mention an explicit provision that failure to restore the reserve could result in a bank being declared insolvent. For one other state, Welldon notes that it had removed a previous provision allowing a bank to be declared insolvent if the bank failed to restore the reserve.
Section 2.3 Use of interbank deposits in the reserve

Whether or not to allow interbank deposits to count as part of the reserve was a subject of considerable debate.
P a g e | 21
The N ational Bank Act allowed country and reserve city banks to count interbank deposits for up to two-fifths and one-half of their reserve respectively. M ost states allowed interbank deposits to count as well; only 3 out of the 21 states that had reserve requirements in 1895 required that all reserves be held at the bank.
I nterbank deposits were allowed partly as recognition of the way banks operated.
As noted earlier, smaller banks had historically maintained deposits at correspondent banks in larger cities to clear payments or facilitate the redemption of their bank notes. As liability holders would seek to redeem the notes in the larger cities, it made some sense to include part of the balance held there to meet those obligations as part of the banks liquidity reserve.
H owever, during a panic these interbank deposits were generally not an effective source of liquidity.
N oyes (1894) notes that when demand during a panic was for physical currency, reserves held elsewhere were not particularly useful. M ore fundamentally, it was also noted that allowing interbank deposits to count as reserves created a pyramid structure. A bank could deposit cash in another bank and count that deposit in its reserve while the second bank counted the cash in its reserve. The second bank could then deposit the cash in a third bank and compound the process. A withdrawal of reserves by the bottom of the pyramid during a panic could thus result in a rapid depletion of reserves within the banking system (Bankers M agazine 1907, July).
P a g e | 22
The Comptroller noted in 1900 that reserves held in other banks had been ineffective in protecting depositors during the panics of 1873 and 1893 and encouraged Congress to increase the portion of the reserve that banks had to carry as money in their vaults (see pages 25-27).
Section 2.4 Some empirical observations on reserve holdings

Looking at the status of reserves for a sample of 208 banks in both reserve cities (82 banks) and larger country towns (126 banks) using data from the September 1892 Call Report provides some further information about the level of bank reserves. M ost banks appear to have held reserve in excess of the required reserve; the average reserve ratio was around 29 percent and quite similar for both country banks and those in reserve cities. (These ratios are similar to those found by the Comptroller in 1887.) M oreover, the ratio of reserves to deposits exceeded the legal requirement (15 percent for country banks 25 percent for reserve city banks) by 10 or more percentage points for three-fifths of country banks and almost one-fourth of reserve city banks. Banks may have preferred to hold reserve ratios in excess of what was required simply because they preferred being more liquid, as is suggested by the Bankers M agazine (1908, N ovember), or because they viewed the required reserve ratio as a minimum they did not want to breach and desired to maintain a buffer.
Reserves held in the bank (as opposed to with reserve agents) accounted for about half the total reserve.
Relative to deposits, reserves at the bank averaged about 14 percent for both groups; also well above the legal requirements of 6 percent for country banks and 12.5 percent for reserve city banks. The finding that about half the reserve was held in cash matches similar findings by the Comptroller a decade or so later (Comptroller 1907).
P a g e | 23
While many banks appear to have preferred to hold reserve well in excess of what was legally required, some banks had deficiencies in their reserve ratios. Of the banks in the sample, 10 percent of the country banks had a deficient reserve and 25 percent of reserve city banks did. That banks had deficient reserves suggests that they did not see the reserve ratio as something that had to be met at all times (perhaps especially as they had 30 days to restore it upon notice by the Comptroller). N evertheless, most of these banks did not sink too far below the legal limit many of them being within 3 percentage points of the limit perhaps indicating the rule did have some influence on their behavior.
Section 3. Reserve requirements and liquidity during panics

I t was understood that banking panics were stressful periods in which the liquidity of the banking system would be tested. I n the absence of a central bank, there were two primary mechanisms for provide liquidity during the panics: using the reserve and issuance of Clearinghouse loan certificates. This section considers these two mechanisms.
Section 3.1 Usability of the reserve during a panic

There are two aspects of the debate about the usability of the bank reserve. One is whether the law allowed banks to use their reserve, and the other is whether banks would use their reserve to support other institutions.
P a g e | 24
The concern that legally required reserves held by banks would not be helpful if the banks had to maintain these reserve at all times and could not use them was stated clearly early on. I n 1848, Kettell argued that This keeping of 15 per cent. of specie on hand has been tried in N ew York, in Alabama, and elsewhere, and its gross absurdity always made manifest. Of what use is it that a bank has the gold and silver, if the law forbids it to part with it? The debate about whether banks could legally use their reserves continued during the N ational Banking Era. I n his annual report for 1894, the Secretary of the Treasury argued against the reserve requirement for N ational Banks as then written saying that, as the law was silent on when the N ational banks could use their reserves, the law created a situation in which they were unusable: Among these are the requirements that a fixed reserve, which cannot be lawfully diminished, shall be held on account of deposits. The consequence of this last requirement is that when a bank stands most in need of all its resources it cannot use them without violating the law (reprinted in Rodkey 1934). Proponents of reserve requirements responded that the reserve was established with the intent that it be used during stress periods. As noted above, the decision to find a bank deficient in its reserve was discretionary on the part of the Comptroller. This discretion allowed the Comptroller to effectively waive the requirement during a panic and allow banks time to rebuild their reserves subsequently (Comptroller 1893). Others viewed the vagueness of the law regarding the use of the reserve to be a notable impediment to banks willingness to use the reserve.
P a g e | 25
The Bankers M agazine (1907, August) argued that the vagueness of the law regarding when the reserve could be drawn meant that many bankers felt that the reserve could not be used during a crisis. The President of the American Bankers Association expressed similar sentiments in 1908 (see Bankers M agazine 1908, N ovember). Providing certainty about when the reserve could be used was seen as inherently difficult. Coe (1873) argued that it is very challenging to prescribe rules regarding the circumstances or timing in which the reserve should be allowed to be used or rebuilt. Concerns that the rules were preventing banks from running down their reserve were sufficiently great that in at least one instance, Congress introduced legislation in which one goal to make the reserve more clearly usable.
I n 1897, Representative Walker, Chair of the H ouse Committee on Banking and Currency, argued that the currency legislation forbids, under severe penalties, the banks under any circumstances to use their reserves for the very purpose for which the banks are required to keep such reserves and proposed legislation to allow the banks to use their reserves in any legitimate way for the purpose for which they are required to keep a reserve (Committee on Banking and Currency, 1897 p. 28).
This claim was strenuously denied by the Comptroller (Eckels 1897, pp. 320 and 324). The reserve and its potential use also created tension between banks subject to the reserve requirements and those not subject to them. The Bankers M agazine (1894, April) indicated that there was some expectation that the N ational Banks would use their reserves to provide liquidity and support to state and trust companies not subject to the
P a g e | 26
reserve requirements, even if this support was only provided by the N ational Banks to protect themselves. The article indicated that this expectation was the source of some tension among bankers and resulted in some lack of cooperation during the panic. One might also speculate that some state banks or trust companies may have held lower reserves than they would have if they had not expected the N ational Banks to provide support. H ooper (1860) suggested that confidence about the reserve also likely affected banks willingness to use it. I n particular, he argued that banks in N ew Orleans were required by law to maintain a higher reserve than those in Boston and that the populace of N ew Orleans, knowing the strength of the reserve, had greater confidence in their banks and thus the N ew Orleans banks were more able to use their reserve times of financial trouble.
Section 3.2 Evidence on Use of the Reserve During a Panic

Evidence on use of the reserve during panics situations provides a mixed picture of whether banks were willing to use their reserve. As their reserves were depleted during banking panics, banks in the central reserve city of N ew York would suspend or curtail shipments of currency to other parts of the country.
Sprague (1913) argued that the N ew York banks tended to do so well before they had exhausted their reserve.
In 1907, the Wall Street Journal noted that reserves were around 21 percent of deposits around the time of suspension, below the legal requirement but still fairly high. I t was noted in the Journal that use of the reserve during the panic was appropriate:
P a g e | 27
[T]here is a deficit of the bank reserve of $38,838,825. I t should be remembered, however, that a reserve is for use. There is no wisdom in locking up immense sums of money in bank vaults unless they can be employed in times of emergency although the deficit is very large, yet there is still left in the banks a reserve amounting to over 21 percent of deposits (Wall Street Journal, N ov. 4, 1907).
Detailed information on bank balance sheets and reserves are available at a time shortly after the panic from the October 3, 1893 call report.
Comparing reserves in 1893 for banks in the same cities as in 1892 suggests that reserve rates declined slightly for country banks and increased a bit for reserve city banks. There also appears to be a shift toward holding the reserves in cash at the bank rather than as deposits with reserve agents. Shifts in the size of the total reserve ratio appear to due largely to shifts in which banks are reporting. When the sample is restricted to banks reporting in both 1892 and 1893, for the median bank the total reserve ratios is higher in 1893 by less than one percentage point higher. By contrast, the shift toward cash is evident even when looking at the same banks. Again looking at the median bank for banks reporting in both 1892 and 1893, the ratio of cash to liabilities subject to the reserve requirement rose by over 5 percentage points, while the ratio of deposits at reserve agents to liabilities subject to reserve requirements decreased by over 5 percentage points. This shift was observable at both county and reserve city banks. M oreover, the number (and share) of banks reporting a reserve ratio below the legal requirement decreased relative to what was observed in
P a g e | 28
1892. Overall, these figures give the impression that banks not under such pressure tended not use their reserves to support the general liquidity of the financial system. Given the pyramiding of reserves that occurred through interbank deposits, the shift toward use of cash in reserves likely had a detrimental impact on overall system liquidity. Looking at how the reserves in 1894 compare to those in 1892 provides some information about longer-term changes to reserve holdings following a panic. Reserve ratios at country banks continued to average 29 percent, but the average reserve ratio for reserve city banks increased to 33 percent. Considering only banks that reported in both years, reserve ratios increased 1 percentage point for banks in country towns and 2 percentage points for banks in reserve cities. (The changes are strongly statistically significant for reserve city banks and moderately so for country banks.) These changes took place entirely from increases in cash holdings at the banks as ratios of reserves held with agents relative to deposits were little changed. These changes suggest that some of the increased preference for cash evident in 1893 persisted for some time.
Section 3.3 Private sector mechanisms for promoting liquidity during banking panics
Commercial banks did have some mechanisms for responding to panics and trying to expand the supply of liquid assets.
P a g e | 29
Banks in N ew York, and other large cities, formed clearinghouses to facilitate the settlement of payments between members. The clearinghouses also provided a way to supply liquidity to their members during a panic. I n particular, the clearinghouses established procedures to allow banks to deposit securities with the clearinghouse and receive clearinghouse loan certificates that could be used to make payments to other members of the clearinghouse. Using clearinghouse notes allowed specie or other forms of cash to be used to satisfy the heightened demand from others for liquid assets (Comptroller 1873 and 1890, N ash 1908). The clearinghouse notes worked for interbank and sometimes local transactions, but not well for interregional payments. Clearinghouse notes were issued extensively in the Panic of 1907. I n N ew York these notes continued to be large denomination notes, but in many smaller cities small denomination notes were issued and circulated with other currency in the general public market. Banks appear to have been fairly willing to use these loan certificates when the need arose. Tallman and M oen (2012) report that the majority of the loan certificates issued by the N ew York Clearinghouse Association during the Panic of 1907 went to the six largest banks. N evertheless, there appears to have been some concern about the possibility of a negative reaction to the issuance of clearinghouse certificates. Coincident with the issuance of clearinghouse loan certificates, the N ew York Clearinghouse Association halted its normal practice of issuing a weekly statement that provided information on the balance sheet of each
P a g e | 30
individual bank and instead reported only aggregate figures for all clearinghouse members. This shift was reportedly done in part to protect members receiving the loan certificates and whose reserves might otherwise appear to be depleted (Bankers M agazine 1907, N ovember). M edia reaction to the issuance of loan certificates was also mixed. Shortly after the issuance of the loan certificates in 1907, the Wall Street Journal noted: Although the issue of these certificates is a confession of weakness nevertheless it is also an assurance of strength, and the situation at the end of the week is all the better for the action taken by the Clearing H ouse Association (Oct. 28, 1907, p.1).
Section 3.4 Discussion

The two mechanisms did provide some additional liquidity during a banking panic. N evertheless, as evidenced by the widespread suspension of convertibility during the major banking panics that occurred between 1865 and 1910, these mechanisms were clearly insufficient to provide the necessary liquidity during times of stress. The reserve does not appear to have been used to the degree that proponents might have hoped, perhaps because the degree of regulator discretion and rules for its use and restoration were unclear. Clearinghouse certificates also helped, but, as they could not facilitate distance transactions, also proved insufficient.
Section 4. The Panic of 1907

This section very briefly describes the events of the Panic of 1907, which
P a g e | 31
provides a useful illustration of the dynamics of bank liquidity during a crisis. The section also discusses the lessons of the crisis and the resulting impetus for a central bank.
Section 4.1 Brief history of the Panic of 1907

Two pieces of background information are useful for understanding the panic.
First, in the years prior to the panic, there had been considerable growth in the size of the trust companies of N ew York City. These institutions took deposits and were similar to banks but the state laws allowed them to operate with smaller reserve requirements and without some other restrictions faced by banks. I ndeed, these institutions established themselves as trust companies partly to avoid capital and reserve requirements. Trust companies were not members of the N ew York Clearinghouse Association, but relied on members of the association as clearing agents for payment processing. A second piece of background information is that, at both banks and trust companies, a significant portion of liquid assets consisted of call loans. Both banks and trusts depended on the call loan market as a secondary source of reserves, and most of the funding for the call loan market came from the banks and trusts. (Call loans were short-term loans to stock brokers to finance stock purchases and were collateralized by the purchased stocks. These loans could be called by the bank when funds were needed and it was assumed the stock brokers would be easily able to sell the stock to repay the loan.)
P a g e | 32
The Panic of 1907 started when an attempt to corner the copper market collapsed. A number of banks were implicated, but runs on these institutions were quelled following a statement of support from the Clearinghouse Association. Shortly thereafter, a N ational Bank announced that it would no longer provide clearing services for the Knickerbocker Trust company. When it became clear that the Clearinghouse Association would not support the trust companies, a number of trusts experienced runs. The call loan market quickly came under immense pressure and borrowers in that market that were unable to find alternative funding and faced the prospect of selling their stocks in a firesale and possibly defaulting. Consequently, banks were not able to tap the call loan market as a secondary source of liquidity as they might normally do and the functioning of that market deteriorated significantly. Although the banks had held reserves in excess of what was required by law prior to the crisis, such reserves were not sufficient to prevent the N ew York banks from being forced to restrict payments to outoftown banks. Since they held large quantities of interbank deposits, these restrictions affected bank liquidity throughout the country. The interbank market for reserves on a national level and at the city level for many regional financial centers broke down as many banks feared deposit withdrawals and hoarded cash and maintained reserves well in excess of what was required (Yates 1908). The panic ended when J.P. M organ and a consortium of bankers agreed to serve as a de facto lender of last resort to the financial sector.
P a g e | 33
Section 4.2 I mpetus from the Panic of 1907 for establishing a central bank
There were several lessons that policymakers took from the Panic of 1907 that prompted them to work toward establishing a central bank. One lesson was that when the instrument used as a reserve and primary source of supply liquidity in this case the supply of gold and Treasury noteswas fairly inelastic in the short run, demand for that instrument would exceed the available supply during a panic. The subsequent scramble for liquidity would cause short-term funding markets to freeze. (Gold could, and did, flow into the US from abroad in response to rising interest rates. These inflows boosted liquidity, but did take some time to arrive in quantities sufficient to meet demand.) As a result, many policy makers concluded that an elastic currency that could increase in quantity was required (Vanderlip 1908). The notion that an elastic currency was needed was not new; as early as 1868, the Comptroller argued in favor of providing some elasticity to the currency for use during times of stress. I n particular, the Comptroller argued that The treasury of the United States could hold in reserve a certain amount of legal tender notes in excess of the amount of money in regular circulation, to be advanced to banking institutions at a specified rate of interest upon the deposit of United States bonds as collateral security, a source of relief would be established which would effectually prevent a monetary pressure from being carried to any ruinous extent (1868, p.27). Similar arguments in favor of making available additional currency backed by bonds to add elasticity to the currency and relieve seasonal and
P a g e | 34
other financial pressures were made by the Comptroller in his Annual Report in 1899 (pp. 1 1-17) and 1902 (pp. 61-63). Various bankers also argued for an elastic currency (See for instance Pugsley (1902) and H amilton (1906). White (1983) describes various other initiatives.)
N evertheless, following the Panic of 1907, legislative action seemed considerably more likely.
Some proposals provided for an emergency currency that could be issued by a central authority only during a crisis; as a temporary palliative such a currency was included in the Aldrich-Vreeland Act of 1908. Under this Act the Secretary of the Treasury could, during a crisis, authorize the issuance of currency backed by any securities held by banks instead of the usual requirement that the currency be backed by U.S. government bonds. Ultimately, policymakers chose instead to create the Federal Reserve as a permanent solution where the discount window could be used to turn bank assets into central bank reserves and would thus provide an elastic currency that could be used to respond to changing stringencies in money markets more flexibly and continuously than could the issuance of emergency currency. A closely related argument made by advocates of a central bank was that only central bank notes or reserves are certain to be liquid during a financial crisis (Sprague 191 1). Other assets were argued to be liquid only to the extent that they could be converted into central bank reserves: I n countries where these notes of the central banks are generally accepted in settlement of debts by business men and banks, the banking reserves of the stock banks may safely consist of the central bank currency, or of a balance kept with the central bank, convertible into such currency.
P a g e | 35
These form the first line of banking reserves. The second line consists of those assets which, with certainty and promptness, may be converted into credit balances with the central bank (Warburg 1916, p. 9). Central bank reserves also have the advantage of being able to be expanded by the central bank during a stress episode. M oulton (1918) notes that the expansion of liquidity is essential during a crisis as banks are expected to be the source of liquidity for their non-financial customers during a crisis and if banks are required to bolster their own liquidity to support their reserve by demanding repayment of, or even refusing to renew, loans during a crisis then financial strains can be significantly exacerbated. (M oulton also cautions that, at least at that time, securities holdings were unlikely to be effective as a secondary reserve during a crisis as banks could only sell their securities to other banks. I f all banks were seeking to sell their securities holdings at the same time, those securities would be not function as a source of liquidity. This implies that to function as a source of liquidity during a crisis, a security must have ready purchasers from outside the banking system.) Another lesson was that behavioral dynamics could be affected by the absence or presence of a central bank. During a panic, individual banks would pull their funds out of the banks in the reserve cities and bolster their liquid resources (Bankers M agazine 1908, N ovember); several observers, such as the Comptroller (1907) and H errick (1908), reported that declines in interbank deposits contributed at least as much to the panic as the actions of individual depositors. Banks were argued to have acted out of self preservation because there was no guarantee that their regular source of liquidity, the
P a g e | 36
reserve city banks, would be able to furnish liquidity should the crisis intensity (Roberts 1908, Sprague 1913). I ndeed, the banks in N ew York had suspended payments to out-oftown banks during several prior banking panics. As a central bank would be able to provide a guaranteed liquidity backstop, individual banks would not need to hoard liquidity at the first sign of stress because they would know that the backstop would still be available in a crisis; Warburg (1914) goes a bit further and argues that to prevent hoarding the backstop and ability to turn supply cash must have absolute credibility which only a central bank could provide. I t was expected that the existence of the central bank would prompt a change in behavior during a panic and would stop minor stresses from escalating into full blown crises (Warburg 1916). A third lesson was that the liquidity requirements that tried to strike a balance between ensuring that the liquidity of the banking system was maintained yet not hampering banks in providing credit were likely to be overwhelmed during a panic. Even critics of central banks sought ways to allow private market participants to expand the supply of liquid assets during a panic. One other aspect of the panic that was not lost on policymakers was that institutions outside the normal banking system, in this case the Trust companies, could precipitate a run on the banking system.
The realization that these outside institutions could threaten the stability of the system may have prompted some large influential Clearinghouse Association members to support a central bank (see White 1983, M oen and Tallman 1999).
P a g e | 37
Section 5. Reserve requirements after the founding of the Federal Reserve

With the establishment of the Federal Reserve, required reserves were reduced as it was expected that the liquidity backstop from the central bank provided individual commercial banks with a ready means of meeting extraordinary liquidity demands.
As noted by Rodkey (1934):

With the advent of the Federal Reserve System in 1914, we entered upon an era of central banking... The central bank is thus placed in position to make advances, either directly or indirectly, to the individual member banks as the replenishment of their reserves becomes necessary... I t is clear that the presence of a central bank, prepared to make advances on eligible assets, places the individual bank in a less vulnerable position with respect to demands of its depositors. I t tends to lessen the need for primary reserves. The Federal Reserve Act recognized this fact by reducing materially the percentage of required reserves (p.64). Westerfield (1921) noted that the reduction in reserves was appropriate for several reasons including that the reserve because they were concentrated (as opposed to dispersed across banks throughout the system), because the reserves were located in a central bank which feels its responsibility and because their availability is now unquestioned. Lunt (1922), who provided instructions to insurers on how to assess the quality of a bank from its balance sheet, noted that prior to the founding of the Federal Reserve the statement of cash and cash items was regarded as extremely important, and banks that habitually carried larger reserves than those required by law were thought to be exceptionally safe (p.217).
P a g e | 38
H owever, with the Federal Reserve, the point seems far less important now, since any bank that has a proper loan account can replenish its reserve at will by the simple process of rediscounting . While reserve requirements continued to be viewed as a tool to promote bank liquidity for some time, there was a gradual shift away from this view.
I ndeed, by the late 1930s, reserve requirements were no longer seen as playing an important role in providing liquidity.
The committee [Federal Reserve System Committee on Bank Reserves] takes the position that it is no longer the case that the primary function of legal reserve requirements is to assure or preserve the liquidity of the individual member bank. The maintenance of liquidity is necessarily the responsibility of bank management and is achieved by the individual bank when an adequate proportion of its portfolio consists of assets that can be readily converted into cash. Since the establishment of the Federal Reserve System, the liquidity of an individual bank is more adequately safeguarded by the presence of the Federal Reserve banks, which were organized for the purpose, among others, of increasing the liquidity of member banks by providing for the rediscount of their eligible paper, than by the possession of legal reserves (Federal Reserve 1938). I t is useful to note that during this period, the Federal Reserve was important as a lender to the banking system. Burgess (1936) notes that in a typical month during the mid -1920s about one-third of member banks obtained at least one loan or advance from their Reserve Bank. As a regular lender to the system, it would be fairly easy for the Federal Reserve to provide additional liquidity to individual banks.
P a g e | 39
The discount window was seen by Federal Reserve staff as the primary source of emergency liquidity for the banking system, especially after the range of eligible collateral was significantly expanded in 1932.29 As they shifted away from being seen as promoting individual bank liquidity, reserve requirements were increasingly seen as a tool to manage credit growth and facilitate the use of monetary policy.
This development occurred as the Federal Reserve began to use open market operations to adjust available reserves in the banking system as its primary monetary policy tool; it was seen as impractical to have reserves both serve as a source of liquidity and be manipulated for monetary policy purposes.
The two main functions of legal requirements for member bank reserves under our present banking structure are, first, to operate in the direction of sound credit conditions by exerting an influence on changes in the volume of bank credit, and secondly, to provide the Federal Reserve banks with sufficient resources to enable them to pursue an effective banking and credit policy (Federal Reserve 1938).
Section 6. Lessons and concluding remarks

From the late 1830s until 1913, regulatory efforts aimed at promoting bank liquidity consisted primarily of reserve requirements that mandated that individual institutions hold liquid assets. H owever, these reserves were not sufficient to provide liquidity and prevent banks from suspending deposit withdrawals during banking panics. To provide for an elastic currency that could be expanded to meet the extraordinary liquidity demands experienced during a crisis, the Federal Reserve was established. Several lessons from the historical reserve requirement experience are apparent.
P a g e | 40
One of the most important lessons is that individual bank liquidity is intricately connected to central bank liquidity policy. For instance, in the absence of a lender-of-last-resort backstop, banks have more incentive to hoard liquidity which could exacerbate stress episodes. Second, the historical debates point out that a known and understood regulatory response to shortfalls in the reserve is an important factor for whether the reserve will be used in times of stress (and for how binding the reserve requirement will be during ordinary times). Third, historical experience indicates that when certain assets are designated as stores of liquidity, institutions will seek to accumulate those during a crisis. Unless the pool of designated assets is large or can be expanded at those times, there is some risk that the functioning of the market for those assets can deteriorate. Further, if non-regulated institutions also use the designated asse ts as a source of liquidity, then problems at those institutions can spill over and affect the liquidity of the banking sector. Policymakers today are considering various liquidity requirements for banks. For instance, under the Basel I I I requirements, banks will be subject to a liquidity coverage ratio (LCR). Under this requirement, banks will be required to maintain a stock of high quality and liquid assets as a buffer that is sufficient to cover potential net cumulative cash outflows at all times during a 30-day period. To a large degree, the LCR is similar to a reserve requirement in that it effectively requires liquid assets to be held against certain classes of liabilities (and lines of credit).
P a g e | 41
The historical experience with reserve requirements offers valuable lessons for policymakers as they implement the LCR and other liquidity regulations.
P a g e | 42
Anti-M oney Laundering: Stronger rules to respond to new threats

The European Commission has adopted two proposals to reinforce the EU's existing rules on anti-money laundering and fund transfers. The threats associated with money laundering and terrorist financing are constantly evolving, which requires regular updates of the rules. I nternal M arket and Services Commissioner M ichel Barnier said: "The Union is at the forefront of international efforts to combat the laundering of the proceeds of crime. Flows of dirty money can damage the stability and reputation of the financial sector, while terrorism shakes the very foundations of our society. I n addition to the criminal law approach, a preventive effort via the financial system can help to stop money-laundering. Our aim is to propose clear rules that reinforce the vigilance by banks, lawyers, accountants and all other professional concerned." H ome affairs Commissioner Cecilia M almstrm said: "Dirty money has no place in our economy, whether it comes from drug deals, the illegal guns trade or trafficking in human beings. We must make sure that organised crime cannot launder its funds through the banking system or the gambling sector. To protect the legal economy, especially in times of crisis, there must be no legal loopholes for organised crime or terrorists to slip through. Our banks should never function as laundromats for mafia money, or enable the funding of terrorism."
P a g e | 43
Today's package, which complements other actions taken or planned by the Commission in respect of fight against crime, corruption and tax evasion, includes: A directive on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing
A regulation on information accompanying transfers of funds to secure "due traceability" of these transfers
Both proposals fully take into account the latest Recommendations1 of the Financial Action Task Force (FATF) (see M EM O/ 12/ 246), the world anti-money laundering body, and go further in a number of fields to promote the highest standards for anti-money laundering and counter terrorism financing.
M ore specifically, both proposals provide for a more targeted and focussed risk-based approach. I n particular, the new Directive: improves clarity and consistency of the rules across the M ember States by providing a clear mechanism for identification of beneficial owners.
I n addition, companies will be required to maintain records as to the identity of those who stand behind the company in reality . by improving clarity and transparency of the rules on customer due diligence in order to have in place adequate controls and procedures, which ensure a better knowledge of customers and a better understanding of the nature of their business.
I n particular, it is important to make sure that simplified procedures are not wrongly perceived as full exemptions from customer due diligence.
P a g e | 44
and by expanding the provisions dealing with politically exposed persons, (i.e. people who may represent higher risk by virtue of the political positions they hold) to now also include domestic (those residing in EU M ember States) (in addition to 'foreign') politically exposed persons and those in international organisations.
This includes among others head of states, membe rs of government, members of parliaments, judges of supreme courts.

extends its scope to address new threats and vulnerabilities
by ensuring for instance a coverage of the gambling sector (the former directive covered only casinos) and by including an explicit reference to tax crimes.

promotes high standards for anti-money laundering
by going beyond the FATF requirements in bringing within its scope all persons dealing in goods or providing services for cash p a y m e n t o f 7 , 5 0 0 o r m o r e , as there have been indications from certain stakeholders that th e c u r r e n t 15 , 0 0 0 th r e s h o l d w a s n o t sufficient. Such persons will now be covered by the provisions of the Directive including the need to carry out customer due diligence, maintain records, have internal controls and file suspicious transaction reports. That said, the directive provides for minimum harmonisation and M ember States may decide to go below this threshold. strengthens the cooperation between the different national Financial I ntelligence Units (FI Us) whose tasks are to receive, analyse and disseminate to competent authorities reports about suspicions of money laundering or terrorist financing.
P a g e | 45
The two proposals foresee a reinforcement of the sanctioning powers of the competent authorities by introducing for instance a set of minimum principle-based rules to strengthen administrative sanctions and a requirement for them to coordinate actions when dealing with cross-border cases.
Background:
Further to the publication of a revised set of international standards in February 2012 (I P/ 12/ 357), the Commission decided to rapidly update the EU legislative framework to incorporate the necessary changes. I n parallel, the Commission also undertook a review of the Third Anti-M oney Laundering Directive that showed the need to update the existing legislative framework in order to address all identified shortcomings. The proposed update of the legal rules will have to be adopted by the European Parliament and the Council of M inisters under the ordinary legislative procedure.
Frequently asked questions: Anti-M oney Laundering 1. What are money laundering and terrorist financing? 1. What is money laundering?
M oney laundering is the conversion of the proceeds of criminal activity into apparently clean funds, usually via the financial system. This is done by disguising the sources of the money, changing its form, or moving the funds to a place where they are less likely to attract attention. "Criminal activity" includes fraud, corruption, drug dealing and other serious crimes.
2. What is terrorist financing?

Terrorist financing is the provision or collection of funds, by any means, directly or indirectly, with the intention or in the knowledge that they would be used in order to carry out terrorist offences.
P a g e | 46
2.What is the EU already doing to fight money-laundering and terrorist financing? 1.What is the current legal framework and to whom it applies?
The current EU legislation, the so-called Third Anti-M oney Laundering Directive (hereinafter, the 3rd AM LD), has been in force since 2005. I t provides a European framework built around the international Financial Action Task Force (FATF) standards (see I P/ 04/ 832). The Directive applies to banks and the whole of the financial sector as well as to lawyers, notaries, accountants, real estate agents, casinos and company service providers. I ts scope also encompasses all dealers in goods (such as dealers in precious metals and stones), when payments are made in cash in excess of 15 000. Those subject to the Directive need to: - identify and verify the identity of their customers and of the beneficial owners of their customers (for example, by ascertaining the identity of the natural person who ultimately owns or controls a company), and to monitor the transactions of and the business relationship with the customers; - report suspicions of money laundering or terrorist financing to the public authorities - usually, the financial intelligence unit; and - take supporting measures, such as ensuring the proper training of personnel and the establishment of appropriate internal preventive policies and procedures.
The Directive introduces additional requirements and safeguards (such as the requirement to conduct enhanced customer due diligence) for situations of higher risk (e.g. trading with correspondent banks situated outside the EU).
Since the existing Directive is based on the international standards, it will need to be reviewed in order to reflect the new FATF standards issued in February 2012. (see question 3.3.).
P a g e | 47
2.2. What are the other elements of the anti-money laundering framework?
The 3rd AM LD is part of a broader set of legislative measures aimed at the prevention of money laundering and terrorist financing, including: Directive 2006/7 0 containing a number of implementing measures with respect to Politically Exposed Persons (e.g. high-ranking officials from third countries), simplified customer due diligence procedures and limited exemptions.
Regulation 1781/2006, which ensures traceability of transfers of funds by requiring information on the payer to accompany transfers of funds for the purposes of the prevention, investigation and detection of money laundering and terrorist financing.
Regulation 1889/ 2005 on controls of cash, which requires persons entering or leaving the EU to declare cash sums they are carrying if the value amounts to 10 000 or more.
EU Council Decision 2000/ 642 concerning arrangements for cooperation between financial intelligence units of the Member States in respect of exchanging information,
A number of EU legal instruments imposing sanctions and restrictive measures on governments of third countries, or non-state entities and individuals.
2.3 H ow do M ember States cooperate in this field?

The 3rd AM LD requires M ember States to provide appropriate assistance in order to facilitate coordination of AM L matters. I n practice, M ember States take an active part in the EU Financial I ntelligence Unit platform. M ember States participate in regular meetings of the Committee for the Prevention of M oney Laundering and Terrorist Financing (CPM LT F) and the Anti-M oney Laundering Committee.
P a g e | 48
The EU Financial I ntelligence Units Platform is an informal group set up in 2006 by the European Commission, which gathers financial intelligence units (FI Us) from the M ember States. I ts main purpose is to facilitate cooperation among the national FI Us, whose tasks are to receive, analyse and disseminate to competent authorities reports about suspicions of money laundering or terrorist financing. The European Commission participates in the Platform and provides support.
3.What is being done at global level to strengthen the fight against money laundering? 1. Who is responsible for the international standards?
The FATF is the global standard-setter for measures to combat money laundering, terrorist financing, and (most recently) the financing of the proliferation of weapons of mass destruction (chemical, biological and nuclear). I t is an intergovernmental body with 36 members, and with the participation of over 180 countries through a global network of FATF-style regional bodies. The European Commission is one of the founding members of the FATF and plays an active role in the working groups and plenary meetings which are held three times a year. I n addition, 15 EU M ember States are FATF members in their own right.
2. Why a revision of the international standards?

The original FATF standards on anti-money laundering were amended in the aftermath of the 9/ 1 1 attacks to include measures to counter terrorist financing.
The Recommendations were fully revised in June 2003 to reflect an increased awareness of money laundering and terrorist financing issues; this was incorporated into the 3rd AM LD.
P a g e | 49
The latest revision of recommendations, adopted on 16 February 2012, marks a continuation of this process with an increased focus on the effectiveness of regimes to counter money laundering and terrorist financing.
4. Our action 4.1 What are the main elements of the Commission's proposals?
The Commission's proposals update and improve the EU s existing 3rd AM LD and the Funds Transfers Regulation respectively with the aim of further strengthening the EU s defences against money laundering and terrorist financing and ensuring the soundness, integrity and stability of the financial system.
They reflect the latest FAT F Recommendations (see question 4.3.), and go further in a number of fields. M ore specifically, both proposals provide for a more targeted and focussed risk-based approach. The new Directive clarifies and reinforces the rules on customer due diligence and introduces new provisions to deal with politically exposed persons. I t goes beyond the FATF requirements by bringing within its scope all persons dealing in goods or providing services for cash payment of 7,500 or more, as there have been indications from certain stakeholders that the current 15,000 threshold leaves open a vulnerability that criminals have been able to exploit. The Directive also ensures a more comprehensive coverage of the gambling sector (in the light of concerns that the wide sector is vulnerable to money laundering) and includes an explicit reference to tax crimes. The proposals foresee a reinforcement of the sanctioning powers of the competent authorities by introducing a set of minimum principle-based rules to strengthen administrative sanctions and a requirement for them to coordinate actions when dealing with cross-border cases.
P a g e | 50
4.2. H ow did the European Commission decide to update the EU rules?

Further to the publication of a revised set of international standards on 16 February 2012, the Commission committed itself to rapidly updating the EU legislative framework to incorporate the necessary changes. Already in anticipation and in parallel with the adoption of these new standards, the Commission launched its own review in 2010.
This process has included the publication of an application study conducted by external consultants, and targeted consultations with private stakeholders, civil society organisations and M ember States2. Further evidence has been provided by the European Supervisory Authorities' Anti-M oney Laundering Committee.
Why a revision of the Third Anti-M oney Laundering Directive?

The Commission prepared an application report (I P/ 12/ 357) which made a broad examination of the Directive and concluded that, generally, the legal framework appeared to work well and no fundamental shortcomings have been identified which would require far -reaching changes. The Directive was revised in order to update it in line with the revised FATF Recommendations, and in particular to enhance the risk-based approach to AM L compliance and supervision.
What about the other elements of the framework?

Regulation 1781/2 006 on information accompanying the transfers of funds has also been updated in light of the revised international standards. The results of an external study carried out on behalf of the Commission on the application of Regulation have been incorporated into the Commission's impact assessment. The Commission has also incorporated the implementing measures in Directive 2006/ 70 into the new Anti-M oney Laundering Directive, as well as introducing strengthened cooperation arrangements between FI Us, currently dealt with in EU Council Decision 2000/6 42.
P a g e | 51
4.3 H ow the directive complies with FATF revised international standards?

Key Changes introduced in EU legislation : Consolidating the risk-based approach: The new standards put more focus on the risk-based approach. This means that countries need to clearly understand the money laundering and terrorist financing risks which affect them, and adapt their Anti M oney laundering/ Counter Financing of Terrorism (AM L/ CFT) system to the nature of these risks with enhanced measures where the risks are higher and the option of simplified measures where the risks are lower. Thus, countries will be able to target their resources more effectively and apply preventative measures that correspond to the risks of particular sectors or activities. A well-implemented risk-based approach means that the AM L/ CFT system will be more effective and less costly. I mproving Transparency measures: There is a lack of transparency at the moment around the ownership of companies, making them potentially vulnerable to misuse by criminals and terrorists. The new Recommendations have strengthened transparency requirements. Reliable information available about the ownership and control of companies, trusts, and other legal persons or legal arrangements is required as well as more rigorous requirements on the information which must accompany electronic funds transfers. M easures to improve transparency, implemented on a global basis, will make it harder for criminals and terrorists to conceal their activities. Towards more effective I nternational Cooperation: With the increasing globalisation of money laundering and terrorist financing threats, the FATF has also enhanced the scope of international cooperation between government agencies, and between financial groups (e.g. simplified extradition mechanisms).
P a g e | 52
The revised Recommendations will allow more effective exchanges of information, tracing, freezing, confiscation and repatriation of illegal assets. I dentification of clear Operational Standards: the FATF Recommendations concerned with law enforcement and FI Us have been expanded significantly. The revisions clarify the role and functions of the operational agencies responsible for combating money laundering and terrorist financing; and set out the range of investigative techniques and powers which should be available to them. N ew threats & new priorities to be covered: The FATF has also addressed new and aggravated threats and responded to the priorities set out by the international community, e.g. through the G20, in particular:
Corruption & Politically Exposed Persons - The FATF Recommendations tighten the requirements on "politically exposed persons"; i.e. people who may represent a higher risk of corruption by virtue of the positions they hold.
The requirement to apply enhanced due diligence to foreign politically exposed persons has been expanded with the new Recommendations also applying to domestic politically exposed persons and international organisations, and to the family and close associates of all politically exposed persons reflecting the methods used by corrupt officials and kleptocrats to launder the proceeds of corruption.
Tax Crimes - The list of predicate offences for money laundering has been expanded to include tax crimes which are brought within the scope of the powers and authorities use d to combat money laundering.
This will contribute to better coordination between AM L and Tax authorities, and remove potential obstacles to international cooperation regarding tax crimes.
P a g e | 53
Terrorist Financing The financing of terrorism remains a serious concern for the international community, and a major focus of the FATF.
The Recommendations reflect both the fact that terrorist financing is a long-standing concern, and the close connections between anti-money laundering measures and measures to counter the financing of terrorism.
5. N ext steps
The two proposals will have to be adopted by the European Parliament and the Council of M inisters under the ordinary legislative procedure. The Commission is planning to organise a public hearing on 15 M arch 2013 which will be a forum where the main changes in the international framework as well as the new Directive will be debated among various groups of stakeholders.
P a g e | 54
N ew DARPA program seeks performers for transient electronics demonstration

The sophisticated electronics used by warfighters in everything from radios, remote sensors and even phones can now be made at such a low cost that they are pervasive throughout the battlefield. These electronics have become necessary for operations, but it is almost impossible to track and recover every device. At the end of operations, these electronics are often found scattered across the battlefield and might be captured by the enemy and repurposed or studied to compromise DoD s strategic technological advantage. What if these electronics simply disappeared when no longer needed? DARPA announces the Vanishing Programmable Resources (VAPR) program with the aim of revolutionizing the state of the art in transient electronics or electronics capable of dissolving into the environment around them. Transient electronics developed under VAPR should maintain the current functionality and ruggedness of conventional electronics, but, when triggered, be able to degrade partially or completely into their surroundings. Once triggered to dissolve, these electronics would be useless to any enemy who might come across them.
The commercial off-the-shelf, or COTS, electronics made for everyday purchases are durable and last nearly forever, said Alicia Jackson, DARPA program manager.
DARPA is looking for a way to make electronics that last precisely as long as they are needed.
P a g e | 55
The breakdown of such devices could be triggered by a signal sent from command or any number of possible environmental co nditions, such as temperature. DARPA has posted a special announcement for a Proposers Day to be held in advance of a full solicitation in the form of a broad agency announcement.
Performers are sought to conduct basic research into materials, devices , manufacturing and integration processes, and design methodology that will enable a revolutionary shift in transient electronics capabilities.
The program seeks to culminate in a technology demonstration that builds a circuit representative of an environmental or biomedical sensor that is able to communicate with a remote user. DARPA has previously demonstrated that transient electronics might be used to fight infections at surgical sites, said Jackson.
N ow, we want to develop a revolutionary new class of electronics for a variety of systems whose transience does not require submersion in water.
This is a tall order, and we imagine a multidisciplinary approach. Teams will likely need industry experts who understand circuits, integration, and, design. Performers from the material science community will be sought to develop novel substrates. There's lots of room for innovation by clever people with diverse expertise.
P a g e | 56
Steaming on in uncharted waters in storm-tossed seas five years of steering a central bank in a small, open island state and keeping the economy on an even keel
Letter by M r Rundheersing Bheenick, Governor of the Bank of M auritius, to stakeholders, Bank of M auritius, Port Louis On 28 December 2007, from my vantage point as newly-installed Governor, I issued my first Letter to Stakeholders to plug what I felt was a gap in our communication. I saw it as a vehicle to review developments in the economic and financial landscape and to give interested stakeholders a flavour of the Banks actions during the past year. I t was the year of the Banks 40th Anniversary celebrations. Less auspiciously, it was also the year when the first tremors of an impending global financial crisis began to be felt in specialized corners of the financial market dealing with esoteric sub-prime mortgages originating in the US. 2. Five years on, the Letter to Stakeholders is well-embedded in the calendar of publications of the Bank, with its release much-awaited, not least by the local financial press. Five additional years in the life of the institution, five years at its helm as Governor, and five years of unending crisis, to boot surely all this requires us to pause awhile, look back over those tumultuous, challenging yet ultimately rewarding, years and take stock of the progress achieved.
P a g e | 57
But, first, a brief assessment of 2012 and the perspective for 2013 may provide some context. 3.The Global Economy 2012 has proved far more turbulent, uncertain and painful than most economists had predicted. The European Union, hailed until recently as the nec plus ultra of regional cooperation, came on the brink of implosion, with the rest of the world holding its breath in anticipation of the expected global crash likely to follow in the wake of the widely-predicted Grexit which would bring the eurozone to an ignominious end. Across the Atlantic, the US economy was hardly in better shape, barely managing in the nick of time to surmount its fiscal cliff before the predicted financial catastrophe. Fortunately, emerging market economies, though wounded, managed to pull the world economy round.
I n such exceptional circumstances, central banking in advanced economies had to be reshaped to accommodate unconventional policy measures, which would have been clearly beyond the pale for central bankers a decade earlier.
4.So here we are, at the start of 2013, facing the same questions as in preceding years: when shall we finally see an end to the global economic crisis and a sustained rebound in growth and job creation? As we start the N ew Year, there are tentative signs that the global economy is finally picking up, with growth momentum building modestly and financial conditions becoming more supportive. But the transition is likely to be slow and fragile. Even as we see some global growth, the legacy of subpar performance over the recent years is expected to play a major role in influencing investment and macroeconomic performance in general in 2013 and beyond.
P a g e | 58
Doubts persist over the sustainability of the timid recovery once the flood of central bank money, propping up economic activity in the advan ced countries, begins to be withdrawn as it clearly must if we are not to see an unprecedented debasement of major reserve currencies, hand in hand with runaway inflation. 5.The M auritian Economy - For M auritius, the odds of surviving intact in the face of the global turmoil over the past five years were very thin at best. We have a small open economy, heavily dependent on exports to the European Union, and we have been unable to rely significantly on regional or domestic demand to pick up the slack from depressed conditions in our traditional markets. N evertheless, we avoided recession and have come out rather well. Key factors here were the support from the fiscal stimulus at the beginning of the crisis and an appropriately accommodative, but muchmaligned, monetary and exchange rate policy that have together allowed the domestic economy to continue recording positive growth rates even as some major trading partner economies were contracting. The added adaptive advantage arising from our smallness proved to be a real asset in these troubled times. I n addition, our closely-regulated banking system was not drawn into the seemingly very lucrative, but high-risk, operations that proved fatal to banks in many advanced economies and we have had no banking failures or bailouts. 6 . I t is evident, however, that our economy is still operating below its potential. The crisis has shown up the shortcomings of the inertia in much of our trade for both goods and services, where we have seemed locked into previously successful, but fragile, strategies that have left us at the mercy of external market and policy failure.
P a g e | 59
While the lesson has been learnt, many sectors have been caught wrong-footed and are now scrambling to diversify products and markets. 7. M y own personal experience at the Bank - The uncertainty and instability prevailing in the global economic and financial environment have kept me on my toes. I t was a path full of challenges that confronted me, a path strewn with obstacles where I sometimes stumbled and where I found myself, like many fellow-governors elsewhere, regularly attacked, sometimes ridiculed, and even scorned. But I always emerged, often bruised, but more determined than ever, motivated by the unchanging desire to rise to the constantly-changing challenge, raise the profile of the Bank, and transform it into a modern and innovative institution that fulfils its mission confidently and efficiently for the sustainable development of the M auritian economy. We had our share of achievements, small victories and successes obtained with great satisfaction. 8.The decisions and actions that I took at the Bank over the last five years have been directed towards maintaining financial and macroeconomic stability this, as the global financial crisis revealed, is the most important function of a central bank. This overriding consideration has guided all my decisions and actions. H owever, given the highly uncertain and unstable global environment, flexibility and promptness in action turned out to be key elements in our decision-making. I saw the need to bring some key reforms to the organisational structure of the Bank. For operational efficiency, the Bank was restructured into a more flexible institution.
P a g e | 60
N ew divisions were created to monitor areas that I had foreseen would be critical in the years to come, among which the Financial Stability Unit to monitor and assess the risks to financial stability and associated macro-prudential policy. Our strategies have borne fruit and the Banks contribution to financial and macroeconomic stability has been recognised locally and internationally. 9.Let me sketch the broad outlines of the Banks policies and actions during the past five years, which flow from this overriding consideration. 10.M onetary Policy - At the very start of my tenure as Governor, I set out to remedy what was, to my mind, a major flaw in our approach to monetary policy decision-making. Although it had been three years since the new Bank of M auritiusAct had been enacted, with explicit provision for the creation of a M onetary Policy Committee (M PC), the interest-rate decision process had remained unchanged. One of my first moves as Governor was to establish this Committee, which was officially launched in April 2007. Soon after the first meeting, I proposed that amendments be brought to the law to enhance the independence of the M PC. 1 1 . I t was also a decisive stride towards improving governance at the Bank. I wanted more transparency and accountability at the level of the M PC and instigated a major review after it had been in operation for four years. The review resulted in two major changes, firstly in the composition of the M PC and, secondly, in the publication of the minutes of the meeting, including the voting patterns of individual members.
P a g e | 61
12. The establishment of the M PC with its enhanced transparency and accountability made monetary policy gain increasing credibility in the eyes of the public. We complemented our action by developing clear lines of communication with economic agents and adopted an open-door policy to respond to the concerns of the various economic stakeholders including real sector operators, academia, opinion leaders, and consumer associations. I held regular public consultations through press conferences and public addresses. Today, inflation expectations are well-anchored and it has become much easier to interpret and understand monetary policy decisions. The Bank has been successful in disinflating the economy and has brought down the inflation rate to less than 4 per cent in 2012 from 10.9 per cent in April 2007.
13.Exchange Rate Policy - M any of you will recall that the value of the rupee was in free fall in the years preceding my nomination as Governor of the Bank of M auritius in 2007, paving the way for a one-way bet against the currency and fuelling unsustainable over-borrowing in rupees.
I t was clear to me that this would plague the economy with speculative transactions and constrain our move to the next stage of development. Exchange rate stability was the necessary condition that we had to satisfy if we were to stand any chance to succeed in realising the vision of our political leadership to build M auritius into a vibrant international financial centre of repute. 14.M y stance was to favour a stable currency, given our euro-biased exports and dollar-biased imports and the high exchange-rate volatility witnessed in the international forex market during the global financial crisis.
P a g e | 62
A stable currency would remove foreign exchange risk, thus providing some element of certainty in doing business for both importers and exporters. To pursue this stable exchange rate policy, the Bank continued with its methods of adjustment and fine-tuning but never shied away from doing what we assessed was right under the varying circumstances faced by the economy. M ore recently, the Bank has attuned its policy to mitigate further appreciation pressures on the exchange rate value of the rupee to avert the adverse potential impact of the worsening euro debt crisis on key sectors of the economy. I firmly believe that the real test of our management of exchange rate policy has emerged in the medium-term perspective over the five years for a short-run view can be very misleading, even if it makes good headlines in the media.
15. M odernisation of the Financial M arket infrastructure - When I took over as Governor in 2007, I discovered that the growing financial sector, in particular the offshore segment, and increasing cross-border transactions posed new and complex challenges to the existing payment system infrastructure.
I realised that the financial market infrastructure needed a major overhaul to meet these demands. So the first decision that I took in this area was to replace the existing real-time gross settlement system the M auritius Automated Clearing and Settlement System (M ACSS) with another application that was built on a more resilient architecture and supported multi-currency transactions. The extended capability of the system has no doubt been a major contributing factor behind the appointment by COM ESA member-states of the Bank of M auritius as the settlement bank for its Regional Payment and Settlement System, whose operations we now host.
P a g e | 63
We pursued our modernisation process with the implementation of the Cheque Truncation System, which provides for the bulk clearing of low-value electronic transactions. I set out, during my tenure, to extend the coverage of the Mauritius Credit I nformation Bureau (M CI B) to all types of credit institutions operating in the economy.
The M CI B has over the years emerged as an essential risk management tool for banks in their lending activities.
16.Over the past years, the card-based payment method has assumed growing importance in the economy and it is expected to make further inroads on cash and cheque-based settlement. The systemic importance of card transactions may pose a threat to the stability of the financial system if left unattended. I n line with our mandate to ensure the stability and soundness of the financial system, I saw the need to revisit our erstwhile hands-off approach to this sector and move to regulate it properly. The Bank will thus set up and operate a N ational Payment Switch (N PS) by the end of the year. The N PS is a national, multifaceted switching platform for various payment channels and it will settle the net positions of banks on the M ACSS while reducing the cost of transactions and routing costs via the reduction of interconnection charges and merchant fees, in particular on domestic transactions. The N PS will therefore address the inefficiencies of the current setup and provide a level playing field to all banks and operators. 1 7 . I also devoted a lot of attention to deepening financial markets, the other leg of the modernisation of the financial market infrastructure.
P a g e | 64
Small size and lack of depth have always hampered the development of the domestic money and foreign-exchange markets. I have introduced a number of measures to bring down the surplus of liquidity and enhance both the price-discovery process and the transmission mechanism in the money market. I am particularly pleased to note the progress achieved on this front by end-2012. I t is even more encouraging to note that private initiatives have been coming forward to build on the current momentum. The current context in which M auritius is viewed positively by international credit rating agencies, the low interest rate and inflation environment, and the prudent fiscal path and public debt levels provide increased traction to speed up the countrys transformation into the long-awaited sophisticated international financial centre that would generate income and jobs for generations to come. 18. Reserves M anagement Reserves are strategic for a country to survive trade shocks and economic crises as they act as the first line of defence. I t was clear to me that a more efficient management of these reserves would provide rich dividends to the country. Over the five years since 2008 I have found managing foreign exchange reserves an increasingly challenging task. M onetary policy worldwide turned significantly accommodative and a number of major central banks implemented quantitative easing, resulting in progressively lower yields on our reserves. I instigated a review of the Banks investment strategy given the low profitability of operations. I n an attempt to increase returns while containing risks, we reduced our exposure with foreign commercial banks (which were being de-rated),
P a g e | 65
reviewed the investment horizon, invested in cash and near-cash instruments, and increased our holdings in high-yielding currencies even as we moved to include new currencies in our portfolio. I n N ovember 2009, the Bank purchased two metric tons of gold from the I M F, to diversify our portfolio further and mitigate the impact of currency volatility.
Subsequently, I also increased our share of investment in fixed-income instruments.

I am happy to report that the diversification strategy, coupled with enhanced operational efficiency, translated into higher net profits for the Bank: Rs395 million in FY 201 1/ 12, from Rs258 million in FY 2010/ 201 1, and just Rs72.4 million in FY 2009/2 010. And we managed to do this at a time when many central banks and fund managers were actually making losses.
I n June 2012, we launched the Operation Reserves Reconstitution to maintain a more comfortable import cover and to combat unwarranted appreciation of the rupee.
The Banks gross external reserves at end-December 2012 amounted to USD3.0 billion (Rs93.0 billion), having risen from USD1.3 billion (Rs44.7 billion) at end-December 2006. 19. Regulation and Supervision At the time of my appointment as Governor, the Prime M inister, as the nominating authority, shared with me his vision of a sophisticated financial system that would contribute to make M auritius a recognised international financial centre. This vision included a banking sector that could aspire to become a regional leader in the field. I proceeded to flesh out this vision.
P a g e | 66
I imagined a vibrant, competitive, transparent, robust and profitable banking sector further extending its footprints in the region and beyond, but always well-regulated and enhancing the reputation of its home jurisdiction. 20.M y assessment of the regulatory and supervisory framework in place at the time revealed that the framework was adequate although there were some areas that required strengthening to enhance the performance of the banking sector and the financial system. Some of these areas were highlighted in the report of the I MF/ World Bank Financial Sector Assessment Programme team that was concluding its field visit to the country just as I was stepping into the shoes of Governor. N ew rules had in the meantime also been released by international standard-setting bodies e.g. those of the Basel Committee on Banking Supervision and the I nternational Accounting Standards Board.
Armed with these, we took measures to build confidence in the integrity of the banking system and encourage banks to improve their performance.
We instilled more competition in the sector by opening up to new players as part of our efforts to reduce intermediation margins and provide a fairer deal to bank customers. And we continued to strengthen our regulatory and supervisory framework to align it with emerging international best practice resulting from the global regulatory reforms triggered by the crisis. 2 1 . I t may appropriate here to comment en passant on the largest fraud to have ever been unearthed in the domestic banking sector, the M CB/ N PF case, a financial scandal of the bank-within-a-bank type that came to light in 2003. I t has been an eye-opener for the Bank, prodding us to step up the surveillance and supervision of financial institutions under our purview.
P a g e | 67
This case still awaits resolution ten years later and the perpetrators are yet to be held accountable as the various associated cases laboriously wend their way through the legal process in domestic and British courts. This stands out in sharp contrast to the rapidity with which prosecutors and regulators in major money centres have reached settlement with several universal banks for a range of crisis-related misdemeanors and malpractices, with record fines. The glaring absence of an efficient banking resolution mechanism may be a brake on our attempt to transform our jurisdiction into an international money centre. 22.Another source of concern is the dominating presence of a couple of large complex financial institutions in our banking sector and their systemic importance the so-called Domestic Systemically I mportant Banks. To mitigate the systemic risks that such institutions could pose to the system, I have urged those banks to reduce the complexity of their structures by separating their banking from non-banking activities. This will enable us to clarify the regulatory perimeter and assist in efficient resolution, should the need arise, without having recourse to taxpayers money. I n the same vein, we have encouraged branches of foreign banks operating in M auritius to convert into locally-incorporated subsidiaries that would give us more effective control and greater ability to act independently in conditions of stress. We have met with some success on this front, and the process of conversion of the branch of a major foreign bank into a local subsidiary is at an advanced stage. 23.We raised some hackles when we moved to adopt what many considered an overly intrusive approach regarding governance at the level of bank boards.
P a g e | 68
A major lesson learnt from the global financial crisis was the failure of board oversight. What happens in bank boardrooms is of vital importance for the smooth functioning of, not just of the bank concerned, but also the economy as a whole. We have brought major changes to our Guideline on Corporate Governance to prescribe rotation at board level and limit the tenure of board members to six years. Domestic realities and capacity constraints dictated a flexible approach to smooth the transition to the new regime. 24. Today, our banking sector is very vibrant, well-regulated, robust, profitable and increasingly transparent. There are new financial product offerings including I slamic banking and forex futures. I t attracts growing interest from investors three new banks have set up shop in six years. Some of our banks have set up subsidiaries in the region, with more now figuring in the Top 100 African banks. M auritius is one of the rare countries in Africa to be Basel-I I -compliant and we are now ready to move towards Basel I I I . There are however a few signs that are less comforting and that need to be addressed. The sustained increase in credit growth in some specific sectors could be an early indicator of incipient asset bubbles. Also, the rise in non-performing loans noted during the year does not augur well.
P a g e | 69
25. Developmental role of the Bank I n the aftermath of the global financial downturn, central banks assumed, in truth, a more central role as they stepped in swiftly to shore up their economies and restore confidence in the financial system. The Bank of M auritius did not shirk its responsibility and jumped into the fray with a number of unconventional measures to support the economic and social development of the island as the effects of the crisis began to reach our shores. These included (i)The provision in December 2008 of a Special Foreign Currency Line of Credit of USD125 million for trade financing (ii)The extension of a preferential line of credit to small sugar-cane planters faced with a sharp reduction in their revenue, and (iii)Our full support to the Small and M edium Enterprises Financing Scheme a limited form of directed lending which was initiated by the M inistry of Finance to ensure that SM E s had adequate access to bank credit. M ore importantly, the Bank introduced a Special Facility in Foreign Currency for an amount of 600 million to help highly-indebted economic operators, in the export-manufacturing and tourism sectors, suffering from the compression of margins in depressed market conditions, the weakness of export currencies, and the mismatch between their earnings in foreign currency and their debt in rupees. The Bank made a pre-emptive move to forestall any knock-on effects on the balance sheets of lending banks, which could have posed very serious risks to financial stability in view of some inherent characteristics of the local credit landscape relating to the interconnected nature of much lending across borrowers, sectors, and banks which presented clear contagion risks.
P a g e | 70
26. Financial inclusion Good supervision cannot be dissociated from the need to ensure that the best interests of consumers of financial services are protected. As far back as 2007, two flagrant areas where the consumer was not getting a fair deal came to my attention: the high interest rates on loans and opaque fees and commissions.
One of my first actions was to request all banks to publish their principal interest rates, fees, charges and commissions, using a standard template to enable customers to better compare the cost of services provided.
This took effect in N ovember 2008. In the same spirit, the indicative exchange rates of individual banks are now published daily on the Banks website for public information since September 2009. I n 2012, I initiated work to impose a cap on fees and charges for services provided by financial institutions and actually imposed the maximum allowable margin for same-day trading of forex. I also established a Complaints Desk at the Bank and made it mandatory for each domestic bank to set up its own complaints desk. Furthermore, I instituted a Task Force on Unfair Terms and Conditions in Banking and Related Financial Contracts this work is ongoing. 27. A new communication culture - When I joined the Bank in 2007, I was struck by the very conservative manner in which the Bank communicated, mostly to a very limited and specialized audience. N o wonder that few of our countrymen could grasp the essential functions that a central bank performs in an economy. This lack of understanding made the work of the Bank less effective because the public could not relate to it or understand that it was in fact their own interests that the Bank was meant to promote.
P a g e | 71
So I decided to embark the Bank on a new communication drive not without some misgiving from some quarters which saw this central bank activism as a transgression. I n the past five years, I have made 80 local addresses, held more than 35 press conferences, and given innumerable press interviews and statements in both the local and international press.
28.The process of increasing our dialogue with a wider range of stakeholders of the economy brought many critical issues to light which enabled us to take several initiatives to respond to the identified needs.
I n the course of this transformation, the Bank was able to take more-informed decisions, and its visibility increased as did the publics understanding of our various actions. Our web site has been upgraded and all information pertaining to the activities of the Bank are posted in real-time.
I n parallel, we launched financial literacy programmes to increase the awareness of our citizens to enable them to make better use of available financial products and of redress mechanisms available to them.
29.Let me here highlight the significant improvement in the quality, frequency, and timeliness of central bank statistics which since February 2012 have met the stringent requirements of the I M Fs Special Data Dissemination Standards (SDDS). We are now engaged in the process to move to the even higher SDDS+ standard. 30.Regional cooperation and I nternational visibility I have long held the view that tiny M auritius cannot unlock its full development potential without accelerating its integration in the sub-Saharan Africa region. I have pursued this line during my mandate at the Bank which saw our increasing participation in various fora under the auspices of SADC,
P a g e | 72
COM ESA and the AACB to advance the regional and continental integration agenda. I n 201 1, I had the honour to co-chair, on behalf of fellow-Governors, the two separate inaugural Joint M eetings between Central Bank Governors and M inisters of Finance for both COM ESA and SADC. I also co-chaired the first meeting of the SADC Peer Review Panel in M auritius in October 201 1. I n August 2012, I acceded to the Vice-Chairmanship of the AACB and the Bank will be hosting the 37th Assembly of Governors in August 2013. I n February 2012, the Bank was invited to become a member of the newlyestablished Sub-Saharan Africa Regional Consultative Group of the Financial Stability Board. I n October 2012, we successfully launched the Regional Payment and Settlement System of COM ESA, which is hosted at the Bank. 31. Way Forward Over the past years, I have been constantly griping at the slow and long-drawn-out pace at which we are embracing change in much of the economy and in many of our institutions on which we depend to accelerate growth and development. I t is widely recognised that we need to be quicker on our feet, more open to the process of innovation, more agile in exploiting alternative markets and new products and services, and much more willing to change our policies and procedures. Global economic poles are irremediably shifting to new centres in the East and to the South. N earer to us, Africa is on the move. We must be quick to engage in the competition for the opportunities offered by the resource-rich, growing and more stable African continent.
P a g e | 73
A higher growth path requires us to pay greater attention to international competitiveness. We must become more productive, shedding unnecessary layers of bureaucracy and ensuring greater probity in procurement, in both the public and private sector. Economic history, as embodied in the relatively recent Asian success stories, leaves no doubt about the importance of more efficient production and ease of doing business. 32.Our monetary policy strategy will continue to be guided by our primary objective of price stability and the promotion of orderly and balanced economic development. Central bankers worldwide continue to accumulate evidence that low and stable inflation allows all economic agents to make better decisions on savings and investment the key conditions for sustained growth.
33.Going forward, we shall continue to ensure that monetary and exchange rate policy is formulated taking into consideration the interests of all stakeholders of the economy.
While the fundamentals of the economy seem fairly strong for now, I am particularly concerned about the persistently high current account deficit, which mirrors a worryingly low savings rate. As our main export markets in Europe grapple with fairly bleak economic prospects in the foreseeable future, it is vitally important that we do not reduce our structural reform efforts to raise the productive potential of the economy and prepare for the heightened competition which we are likely to encounter on foreign markets as the recovery takes hold. 34.The Bank remains ever vigilant to potential risks to financial stability that could hamper our progress to another plane of development. On the regulatory front, we are moving forward with the implementation of Basel I I I .
P a g e | 74
We shall introduce more stringent conditions, including higher capital requirements, as we step up our endeavours to address the risks posed by Domestic-Systemically I mportant Banks, whose failure might entail widespread consequences for the economy. I ncreasing access to financial services is a key priority for the regulator and I will take all necessary measures to ensure that consumers get a fair deal. The Bank is determined to keep a tight rein on bank charges and commissions, in the light of the report of the Task Force on Unfair Terms and Conditions in Banking and Related Financial Contracts, which I mentioned earlier. We concluded a lengthy process of consultation with both domestic banks and international regulatory bodies before finalizing draft legislation on the Deposit I nsurance Scheme which we submitted to the M inistry of Finance at the end of last year.
We will pursue our efforts to deepen our financial markets.

35. Concluding Remarks - As I look back upon my years helming the Bank, I am acutely aware of the weight of responsibility that comes with being called on to ensure financial and macroeconomic stability amid the extraordinary events of the past five years. I wish to thank the Prime M inister, Dr the H onourable N avinchandra Ramgoolam, GCSK, FRCP, for having given me this opportunity to serve the nation in this capacity. M y thanks also go to the various M inisters of Finance with whom I always maintained cordial personal although occasionally tense professional relations, my Deputy Governors, the H ead of Governors Office, and other key staff-members on whom I relied to deliver on my mandate. 36. The past five years have been tumultuous, but as I mentioned in my acceptance speech when I received the Central Banker of the Year 2012,
P a g e | 75
Africa award, I have always maintained an unwavering focus on the statutory mandate of the Bank. M y aim has also been to rejuvenate the Bank by bringing in vital improvements in line with international best practice. After 45 years, I believe the Central Bank has reached a level of maturity where it can confidently play a key role, not only in maintaining confidence in the economy, but also in accompanying the countrys progress to ever-higher levels of growth, development and welfare.
P a g e | 76
BERMUD A MON ETARY AUTH ORI TY SETS OUT REGULATORY PRI ORI TI ES FOR 2013 I N LATEST BUSI N ESS PLAN
Key Areas of Focus: -Bermuda will not Apply Solvency I I -type Regime to Captives -BM A to Balance I nternational Cooperation with Independent Approach to Regulation - Faciliating Quality N ew Business for Bermuda while retaining effective oversight H AM I LTON , BERM UDA - The Bermuda M onetary Authority published its 2013 Business Plan which sets out its regulatory priorities and goals for the year. Jeremy Cox, the Authoritys Chief Executive Officer, presented the Plan to stakeholders from the public and private sector at the Authoritys Annual M eeting held at BM A H ouse. Describing what will be another extremely busy year for the Authority, M r Cox said, We will work hard to ensure that Bermuda firms will continue to benefit from operating within a practical, risk-based regulatory and supervisory environment that fits the unique nature of Bermudas market. Several key areas of focus in the Plan were highlighted, including:
Bermuda Will N ot Apply Solvency I I -type Regime to Captives

We can definitively state that Bermuda will not apply any Solvency I I -type regime to the captive sector, M r Cox said, as he described plans to implement refined reporting requirements for captives this year. We will introduce a risk return as part of consolidated annual filing for captives that they will submit electronically, which will create efficiencies in the process for both the market and the Authority.
P a g e | 77
That is the extent of our refinements, M r. Cox said. What the risk return embodies is something that allows the regulator to get that key risk information and I think it is something the industry will be quite happy to see in place given that they were volunteering so much of this information already. I ts good for Bermuda and the market that we can make this decision based on the proven appropriateness of our regime for captives, he said. This step, as well as the changes to our framework for the commercial sector, reflects our ability to take independent decisions on regulatory change at a pace thats right for Bermuda and according to what makes sense for our diverse market, while taking into account achieving global recognition for our supervisory regimes.
Balance I nternational Cooperation with an I ndependent Approach to Regulation

M r Cox also indicated that the Authority remains committed to appropriate international engagement, while implementing fit-for-purpose regulations for Bermuda. The Authority recognises the importance of contributing to, as well as preparing for, global changes that can affect the Bermuda market. We will continue our advocacy efforts, and to have a seat at the table within global standard setting bodies.
This means we can contribute to international developments as well as determine on going relevance or impacts for Bermuda of such changes, he said.
M aintaining strong working relationships with key decision-makers is a very important aspect of reinforcing the credibility we have earned overseas, and supports acceptance of Bermudas regulatory approach globally.
P a g e | 78
This also facilitates our work on group supervision of the insurance market, and the supervisory colleges programme we have introduced and will continue through this year. What we need to be doing is having our own independent views of what needs to be done for our Bermuda market recognising that there are companies here that have a global footprint, he said.
We are strong enough, we are credible enough, we are skilled enough as a jurisdiction and as a regulator to make our own independent views on how we should be positioning the regulatory and supervisory framework here in Bermuda.
Faciliating Quality N ew Business for Bermuda While Retaining Effective Oversight

M r Cox also announced regulatory projects planned for 2013 that will support initiatives identified as new business development opportunities for Bermuda. These include a new licensing and supervisory regime for Corporate Service Providers (CSP). The Corporate Service Provider Business Act came into effect on 1st January 2013. Under the CSP regime the Authority will license and supervise professional service providers in Bermuda that act as agents for forming corporate entities, as well as providing other corporate services. This addresses an opportunity that industry identified some time ago for building new business in this area, while establishing appropriate oversight. The Authority will also be focused on the hedge fund area, participating in the on going jurisdictional effort to position Bermuda as a domicile of choice for asset managers.
P a g e | 79
Based on my own interactions with stakeholders in key markets overseas regarding hedge funds, Bermuda has the opportunity to raise its profile further and compete more aggressively in this area, he said. The Authority is also engaged as a priority with local industry participants and the Bermuda Government on developing Bermudas position regarding Europes Alternative I nvestment Fund M anagers Directive. I ts appropriate for the Authority to be part of such jurisdictional efforts to facilitate quality new business for Bermuda while ensuring we achieve regulatory objectives appropriately, in a manner that is workable for all parties.
P a g e | 80
EU Cybersecurity plan to protect open internet and online freedom and opportunity
The European Commission, together with the H igh Representative of the Union for Foreign Affairs and Security Policy, has published a cybersecurity strategy alongside a Commission proposed directive on network and information security (N IS). The cybersecurity strategy "An Open, Safe and Secure Cyberspace" represents the EU's comprehensive vision on how best to prevent and respond to cyber disruptions and attacks. This is to further European values of freedom and democracy and ensure the digital economy can safely grow. Specific actions are aimed at enhancing cyber resilience of information systems, reducing cybercrime and strengthening EU international cyber-security policy and cyber defence. The strategy articulates the EU's vision of cyber-security in terms of five priorities: Achieving cyber resilience

Drastically reducing cybercrime
Developing cyber defence policy and capabilities related to the Common Security and Defence Policy (CSDP) Developing the industrial and technological resources for cyber-security
Establishing a coherent international cyberspace policy for the European Union and promoting core EU values
The EU international cyberspace policy promotes the respect of EU core values, defines norms for responsible behaviour, advocates the
P a g e | 81
application of existing international laws in cyberspace, while assisting countries outside the EU with cyber-security capacity-building, and promoting international cooperation in cyber issues. The EU has made key advances in better protecting citizens from online crimes, including establishing a European Cybercrime Centre (I P/ 13/ 13), proposing legislation on attacks against information systems (I P/ 10/ 1239) and the launch of a Global Alliance to fight child sexual abuse online (I P/ 12/1308). The Strategy also aims at developing and funding a network of national Cybercrime Centers of Excellence to facilitate training and capacity building. The proposed N I S Directive is a key component of the overall strategy and would require all M ember States, key internet enablers and critical infrastructure operators such as e-commerce platforms and social networks and operators in energy, transport, banking and healthcare services to ensure a secure and trustworthy digital environment throughout the EU.
The proposed Directive lays down measures including:

(a) M ember State must adopt a N I S strategy and designate a national N I S competent authority with adequate financial and human resources to prevent, handle and respond to N I S risks and incidents; (b)Creating a cooperation mechanism among M ember States and the Commission to share early warnings on risks and incidents through a secure infrastructure, cooperate and organise regular peer reviews; (c)Operators of critical infrastructures in some sectors (financial services, transport, energy, health), enablers of information society services (notably: app stores e-commerce platforms, I nternet payment, cloud computing, search engines, social networks) and public administrations must adopt risk management practices and r eport major security incidents on their core services. N eelie Kroes, European Commission Vice-President for the Digital Agenda said:
"The more people rely on the internet the more people rely on it to be secure. A secure internet protects our freedoms and rights and our ability
P a g e | 82
to do business. I t's time to take coordinated action - the cost of not acting is much higher than the cost of acting."
Catherine Ashton, H igh Representative of the Union for Foreign Affairs and Security Policy/ Vice-President of the Commission said: "For cyberspace to remain open and free, the same norms, principles and values that the EU upholds offline, should also apply online. Fundamental rights, democracy and the rule of law need to be protected in cyberspace. The EU works with its international partners as well as civil society and the private sector to promote these rights globally." Cecilia M almstrm, EU Commissioner for H ome Affairs said:
"The Strategy highlights our concrete actions to drastically reduce cybercrime. Many EU countries are lacking the necessary tools to track down and fight online organised crime. All Member States should set up effective national cybercrime units that can benefit from the expertise and the support of the European Cybercrime Centre EC3."
Background
Cyber-security incidents are increasing in frequency and magnitude, becoming more complex and know no borders. These incidents can cause major damage to safety and the economy. Efforts to prevent, cooperate and be more transparent about cyber incidents must improve. Previous efforts by the European Commission and individual M ember States have been too fragmented to deal with this growing challenge.
Facts about cybersecurity today

There are an estimated 150,000 computer viruses in circulation every day and 148,000 computers compromised daily.
P a g e | 83
According to the World Economic Forum, there is an estimated 10% likelihood of a major critical information infrastructure breakdown in the coming decade, which could cause damages of $250 billion.
Cybercrime causes a good share of cyber-security incidents, Symantec estimates that cybercrime victims worldwide lose around 290 billion each year, while a M cAfee study put cybercrime profits at 750 billion a year.
The 2012 Eurobarometer poll on cyber security found that 38 % of EU internet users have changed their behaviour because of these cyber-security concerns: 18 % are less likely to buy goods online and 15 % are less likely to use online banking.
I t also shows that 74% of the respondents agreed that the risk of becoming a victim has increased, 12% have already experienced online fraud and 89% avoid disclosing personal information. According to the public consultation on N I S, 56.8% of respondents had experienced over the past year N I S incidents with a serious impact on their activities.
M eanwhile, Eurostat figures show that, by January 2012, only 26% of enterprises in the EU had a formally defined I CT security policy.
Proposed Directive on N etwork and I nformation Security frequently asked questions

I nformation systems can be affected by security incidents, such as human mistakes, natural events, technical failures or malicious attacks. These incidents are becoming bigger, more frequent, and more complex.
57% of people who responded to a Commission consultation said they had experienced Network I nformation Security (NI S) incidents over the previous year.
A lack of N I S can compromise vital services: it can stop businesses functioning, generate substantial financial losses for the EU economy and negatively affect societal welfare.
P a g e | 84
Digital information systems, in particular the internet, work across borders. A disruption in one EU country can have a knock-on effect in other M ember States or the EU as a whole - for example, cross-border movement of goods, services and people could be hampered.
Who will benefit and how?

Citizens and consumers, however they define themselves, will have more trust in the technologies, services and systems they rely on day-to-day.
This increased confidence will means a more inclusive cyberspace, and a digital economy that grows even faster, supporting our economic recovery. Governments and businesses will be able to rely on digital networks and infrastructure to provide their essential services at home and across borders. Secure eCommerce platforms could bring more customers online and create new opportunities. Providers of I CT security products and services will benefit from specific security measures, combined with a more harmonised EU approach. Demand for their products and services is bound to increase, leading to innovative products and economies of scale. Activists need to be safe online in order to express themselves freely. A more secure and resilient internet means these vital voices will be heard and protected more than happens today. The EU economy will benefit as sectors that rely heavily on N I S will be supported to offer a more reliable service. H armonised N I S requirements will lead to more consistent risk management measures and response and more systematic reporting of incidents. All of these should create more equal and stable conditions for anyone trying to compete in Europes Single M arket.
P a g e | 85
When will the Directive come into effect?

Member States will have to implement the Directive within 18 months of its adoption by the Council and European Parliament.
Why do digital technologies, networks and services need protecting?

Because most Europeans rely on digital technologies, networks and services to conduct their day-to-day life, even if they dont always realise it. Each year, 200 million Europeans 40% of all citizens buy over the internet. The I CT sector alone represents almost 6% EU GDP, and Europe's I CT sector and I CT-related investments deliver around half of our productivity growth. The internet economy has generated 21% of EU GDP growth over the last 5 years. M ajor cybersecurity incidents put jobs and our chances for economic growth at risk.
What is the scale of the problem?

Cybersecurity incidents or breaches can have a major impact on individual companies and on Europe's wider economy. According to a Symantec and Ponemon I nstitute study, a data breach could cost a company anything up to US$58 million, with equally significant potential side effects like reputational damage, loss of customers and market share. A 2012 PwC survey found that 93% of large corporations and 76% of small businesses had a cybersecurity breach in the past year, with estimated losses of 15,000-30,000 even for smaller businesses. Recent large-scale problems have included: a large worldwide online retailer (Amazon) has experienced a number of outages in recent days and years paralysing their marketplace
P a g e | 86
I n January 201 1, the Commission had to suspend trading in the Emissions Trading System due to security breaches at national registries.
I n 201 1, a certification company (DigiN otar) did not report that its systems were hacked and did not revoke the digital certificates (i.e. the certificates ensuring the security of communications over the internet) that were fraudulently issued.
This resulted in a large number of invalid certificates circulating online, compromising the security of internet services and eventually affecting trust in the internet.
Why the new approach?Are existing regulatory measures or initiatives not working?
Past efforts have been on too small a scale and too fragmented, with the voluntary nature of past efforts leaving many gaps in our overall cybersecurity. For example, under existing EU rules, only telecoms companies and data controllers have to adopt security measures, and telecoms companies alone are required to report significant security incidents. The new proposed Directive works to level the playing field by applying to all owners of critical infrastructure.
What do the proposals on risk management and reporting of security incidents mean for businesses and other organisations?
The Commission proposes to extend the obligation to report significant cyber incidents to: Key I nternet companies (e.g. large cloud providers, social networks, e-commerce platforms, search engines).
Banking sector and stock exchange - M cAfee reported recently that fraudsters, using malware, and replicating the same
P a g e | 87
scheme in several countries, had attempted to steal up to 2 billion from accounts in Europe, the US and Columbia. I n 2010 the London Stock Exchange experienced a serious cyber-attack at its headquarters, which compromised its trading system. Energy (e.g. electricity and gas) - Generation, transmission and distribution of energy are highly dependent on secure network and information systems.
Transport (operators of air, rail and maritime transport and logistics). For example, aviation infrastructure relies on continuous and uninterrupted information flows and databases, which cannot fail
H ealth - Electronic medical devices are found throughout hospitals and clinics, so it is essential that only known, authorised devices are able to connect to their network.
Online or electronic patient medical records are increasingly used and it is essential to protect this personal health and financial information from cybercrime. Public administrations -eGovernment and eParticipation are increasing with citizen demand for timely and cost- effective services and with it the N I S risks for state and local administrations.
Will every incident have to be reported?

N o. Only incidents having a significant impact on the security of core services provided by market operators and public administrations will have to be reported to the competent national authority. For example, an electricity outage caused by a N I S incident and having a detrimental effect on businesses; the unavailability of an online booking engine that prevents users from booking their hotels or of a cloud service provider that inhibits users to get access to their content; the compromise of air traffic control due to an outage or a cyber attack. The competent national authority may require that the public be informed. Public announcement will not be mandatory.
P a g e | 88
Wider public interest will need to be considered in such judgements and vulnerabilities should not be disclosed until appropriate security fixes are available.
Why does the Directive target internet companies?

The proposed Directive includes internet companies because it is absurd to work to protect critical internet infrastructure without obliging such companies to take responsibility for their wider role in this ecosystem.
What about I nternet Service Providers or the network owners?

These companies are already reporting incidents under the risk management and incident reporting obligations under the EU Telecom Framework Directive. EN I SA (European N etwork and I nformation Security Agency) has recently published its report on incident reporting in 201 1. I n total, 51 incidents were reported.
- M ost of the reported incidents affected mobile telephony or mobile internet (60%).
- I ncidents affecting mobile telephony or mobile internet affected around 300.000 users. - N atural phenomena like storms, floods and heavy snow have a big impact on the power supply of providers. N atural phenomena cause long lasting incidents, around 45 hours on average. Given that M ember States now have more mature national incident reporting schemes compared to 201 1, EN I SA expects that the next annual report will contain 10 times more incidents.
Who is exempted from the reporting obligations?

H ardware manufacturers and software developers are exempted from the risk management and reporting obligations. The same applies to specific sectors or sub-sectors, for example insurance, water, food supply.
P a g e | 89
The sectors currently covered in the proposed Directive are the ones for which the importance to ensure cybersecurity is widely recognised. The public consultation on N I S also pointed to these sectors. Trust services are not covered as they are covered by the Commission's proposal for a Regulation adopted in June 2012.
Are media companies involved if they provide I T-like services?

The N I S Directive covers key internet enablers, i.e. those players whose services, delivered through the internet, empower key economic and social activities. When such activities or services are suspended for a couple of hours there may be a significant impact. The annexed table gives some examples of players that could be affected. N ews agencies and publishers, even when they provide I T and/ or online services, are not covered. They are not key internet enablers like large eCommerce or cloud platforms, booking engines or social networks. N either are Web browsers like Mozilla Firefox or websites like Wikipedia or content management systems like Wordpress.
What will you do to ensure companies don't end up dealing with 27 systems for reporting breaches?
Common reporting systems will be developed through implementing measures for the Directive. Specific templates could also be developed by EN I SA, which has already brought together national regulators to develop harmonised national measures for risk management and incident reporting as part of the EU telecoms rules. EN I SA is going through the same process for Article 4 of the ePrivacy Directive.
P a g e | 90
Doesnt security regulation limit freedom and openness?

N o. This strategy and the proposed Directive emphasise that security and freedom go hand-in-hand. Security enables citizens to reap the full opportunities that digital technologies offer. I t is in full compliance with the EU Charter of Fundamental Rights, respecting privacy, with protection for personal data, freedom to conduct a business, the right to property, the right to an effective remedy before a court and the right to be heard.
Will the EU define minimum standards or level of security?

N o, the Commission is not a standard-setting body. The proposed Directive seeks to lift the quality and assurance of cybersecurity, but does not impose any specific technical standards or mandate particular technological solutions. The wider Strategy asks EN I SA to work with standardisation bodies and all relevant stakeholders to develop technical guidelines and recommendations for the adoption of N I S benchmarks and good practices The proposed Directive does, however, impose the take-up of a minimum level of security by obliging critical infrastructure operators, key internet companies and public administrations to manage risks and report significant incidents.
I t also details a minimum set of NI S capabilities which Member States are required to put in place (e.g. a well-functioning Computer Emergency Response Team (CERT) which is adequately staffed and resourced). Member States are free to go beyond and adopt or maintain stricter security requirements.
P a g e | 91
Why was minimum harmonisation chosen for the proposed N I S Directive?

The current level of N I S in the EU varies across M ember States and industries. I t is therefore important to first establish a common minimum level, before moving to more advanced cooperation. Those M ember States and businesses that want to be frontrunners in terms of N I S by going beyond the minimum requirements are free to do so, even at this stage.
I sn't EN I SA already doing enough in the field of cybersecurity in the EU?

Effective cybersecurity cannot be outsourced to a single body. EN I SA will continue to provide its expertise and advice at EU level on the basis of its mandate in the new cooperation framework, to be established by the proposed N I S Directive.
H ow is the EU approach different to the US approach?

President Obama has long recognised cybersecurity as a top priority and recently announced that he will issue an Executive Order on cybersecurity. The executive order is likely to contain recommendations for operators of critical infrastructure such as energy and transport to join a voluntary program and follow a set of cybersecurity standards. The guidance is not thought to prescribe one type of security over another. The main difference is that under the US Executive Order companies will be encouraged, but not required to adopt some non-technical standards, to be defined by the I nstitute of Standardisation and Technology.
P a g e | 92
What proof is there that openness and reporting is better for companies than covering up?
The obligation to report incidents will give companies the incentive to ensure that appropriate security processes are in place. Being prepared is vital, given the staggering potential cost of just one data breach. Being open and reporting incidents is also a way to ensure the long-term survival of a company. For example, DigiN otar a Dutch certificate authority, failed to report a significant breach it suffered in 201 1. When the breach was unveiled, DigiN otar suffered from a catastrophic loss of reputation and subsequently went bankrupt. Being open about a problem, and what a company is doing to resolve it, can restore confidence.
P a g e | 93
M ore than half of EU citizens access the internet at least once a day (53%), although a substantial minority (29%) say that they never access the internet. N early all internet users (95%) access the internet from home, while 39% access the internet from work, 16% when they are on the move, and 1 1% at school or university. As well as accessing the internet from a desktop computer (63%) or a laptop computer or netbook (61%), 24% of internet users access the internet through a smartphone, and 6% use a tablet computer or touchscreen. Around half of internet users in the EU say they buy goods or services online (53%), use social networking sites (52%), or do online banking (48%), while 20% sell goods or services. There is considerable variation in the online activities that respondents undertake in different countries. 29% of internet users across the EU are not confident about their ability to use the internet for things like online banking or buying things online. 69% say that they are fairly or very confident. When using the internet for online banking or shopping, the two most common concerns are about someone taking or misusing personal data (mentioned by 40% of internet users in the EU) and security of online payments (38%). I nternet users have changed their behaviour in a number of ways because of security concerns. 37% say that they are less likely to give personal information on websites, while 43% do not open emails from people they dont know. 51% have installed anti-virus software. H owever, more than half (53%) of internet users in the EU have not changed any of their online passwords during the past year. M ost EU citizens say they have seen or heard something about cybercrime in the last 12 months (73%), and this is most likely to have been from television (59%).
P a g e | 94
M ost EU citizens do not feel very or at all well informed about the risks of cybercrime (59%) while 38% say they are very or fairly well informed. There is a clear link between being well informed and feeling confident online. M ore than half of those who feel confident in their ability to do online banking or buying things online say they feel well informed about cybercrime (59%). 12% of internet users across the EU have experienced online fraud, and 8% have experienced identity theft. 13% have not been able to access online services because of cyber-attacks. I n addition: M ore than a third (38%) say they have received a scam em ail, including 10% who say that this is something that has happened to them often; 15% of internet users say that they have accidentally encountered material which promotes racial hatred or religious extremism. I nternet users express high levels of concern about cyber security: 89% agree that they avoid disclosing personal information online; 74% agree that the risk of becoming a victim of cybercrime has increased in the past year; 72% agree that they are concerned that their online personal information is not kept secure by websites; 66% agree that they are concerned that information is not kept secure by public authorities. The majority of internet users in the EU (61%) are concerned about experiencing identity theft. Around half of internet users are concerned about: accidentally discovering child pornography online (51%); online fraud (49%); and scam emails (48%). I n addition, 43% are concerned about not being able to access online services because of cyber-attacks, and 41% are concerned about
P a g e | 95
accidentally encountering material which promotes racial hatred or religious extremism. I f they experienced or were the victim of cybercrime, most respondents say they would contact the police, especially if the crime was identity theft (85%) or if they accidentally encountered child pornography online (78%). There are differences between countries that run throughout the survey: Respondents in Sweden, Denmark and the N etherlands are more likely to be frequent internet users (83% accessing the internet at least once a day), to use the internet for buying things (80%, 78% and 76% respectively) or for online banking (87%, 87% and 84%). They are also more likely to be well informed about the risks of cybercrime (69%, 73% and 54% feeling either very or fairly well informed) and to have made changes to increase security. I n these countries, respondents are less likely to be concerned about being the victim of cybercrime. By contrast, in a number of countries such as Portugal and Bulgaria, levels of internet use are lower (with 58% and 47% of interviewees never using the internet) and respondents are less well informed about the risks of cybercrime (24% feeling either very or fairly well informed in both countries).
P a g e | 96
JOI N T COMM UN I CATI ON TO TH E EUROPEAN PARLI AM EN T, TH E COUN CI L, TH E EUROPEAN ECON OM I C AN D SOCI AL COM M I TTEE AN D TH E COM M I TTEE OF TH E REGI ON S Cybersecurity Strategy of the European Union: An Open, Safe and Secure Cyberspace
1 . I N TRODUCTI ON 1. Context
Over the last two decades, the I nternet and more broadly cyberspace has had a tremendous impact on all parts of society. Our daily life, fundamental rights, social interactions and economies depend on information and communication technology working seamlessly.
An open and free cyberspace has promoted political and social inclusion worldwide; it has broken down barriers between countries, communities and citizens, allowing interaction and sharing of information and ideas across the globe; it has provided a forum for freedom of expression and exercise of fundamental rights, and empowered people in their quest for democratic and more just societies - most strikingly during the Arab Spring.
For cyberspace to remain open and free, the same norms, principles and values that the EU upholds offline, should also apply online.
Fundamental rights, democracy and the rule of law need to be protected in cyberspace.
Our freedom and prosperity increasingly depend on a robust and innovative I nternet, which will continue to flourish if private sector innovation and civil society drive its growth. But freedom online requires safety and security too.
P a g e | 97
Cyberspace should be protected from incidents, malicious activities and misuse; and governments have a significant role in ensuring a free and safe cyberspace. Governments have several tasks: to safeguard access and openness, to respect and protect fundamental rights online and to maintain the reliability and interoperability of the I nternet.
H owever, the private sector owns and operates significant parts of cyberspace, and so any initiative aiming to be successful in this area has to recognise its leading role.
I nformation and communications technology has become the backbone of our economic growth and is a critical resource which all economic sectors rely on. I t now underpins the complex systems which keep our economies running in key sectors such as finance, health, energy and transport; while many business models are built on the uninterrupted availability of the I nternet and the smooth functioning of information systems. By completing the Digital Single M arket, Europe could boost its GD P by almost 500 billion a year; an average of 1000 per person. For new connected technologies to take off, including e-payments, cloud computing or machine-to-machine communication, citizens will need trust and confidence. Unfortunately, a 2012 Eurobarometer survey showed that almost a third of Europeans are not confident in their ability to use the internet for banking or purchases. An overwhelming majority also said they avoid disclosing personal information online because of security concerns. Across the EU, more than one in ten I nternet users has already become victim of online fraud.
P a g e | 98
Recent years have seen that while the digital world brings enormous benefits, it is also vulnerable. Cybersecurity incidents, be it intentional or accidental, are increasing at an alarming pace and could disrupt the supply of essential services we take for granted such as water, healthcare, electricity or mobile services. Threats can have different origins including criminal, politically motivated, terrorist or state-sponsored attacks as well as natural disasters and unintentional mistakes. The EU economy is already affected by cybercrime activities against the private sector and individuals. Cybercriminals are using ever more sophisticated methods for intruding into information systems, stealing critical data or holding companies to ransom. The increase of economic espionage and state-sponsored activities in cyberspace poses a new category of threats for EU governments and companies. I n countries outside the EU, governments may also misuse cyberspace for surveillance and control over their own citizens. The EU can counter this situation by promoting freedom online and ensuring respect of fundamental rights online. All these factors explain why governments across the world have started to develop cybersecurity strategies and to consider cyberspace as an increasingly important international issue. The time has come for the EU to step up its actions in this area. This proposal for a Cybersecurity strategy of the European Union, put forward by the Commission and the H igh Representative of the Union for Foreign Affairs and Security Policy (H igh Representative), outlines the EU's vision in this domain, clarifies roles and responsibilities and sets out
P a g e | 99
the actions required based on strong and effective protection and promotion of citizens' rights to make the EU's online environment the safest in the world.
1.2. Principles for cybersecurity

The borderless and multi-layered Internet has become one of the most powerful instruments for global progress without governmental oversight or regulation. While the private sector should continue to play a leading role in the construction and day-to-day management of the Internet, the need for requirements for transparency, accountability and security is becoming more and more prominent. This strategy clarifies the principles that should guide cybersecurity policy in the EU and internationally.
The EU's core values apply as much in the digital as in the physical world
The same laws and norms that apply in other areas of our day-to-day lives apply also in the cyber domain.
Protecting fundamental rights, freedom of expression, personal data and privacy

Cybersecurity can only be sound and effective if it is based on fundamental rights and freedoms as enshrined in the Charter of Fundamental Rights of the European Union and EU core values. Reciprocally, individuals' rights cannot be secured without safe networks and systems. Any information sharing for the purposes of cyber security, when personal data is at stake, should be compliant with EU data protection law and take full account of the individuals' rights in this field.
P a g e | 100
Access for all

Limited or no access to the I nternet and digital illiteracy constitute a disadvantage to citizens, given how much the digital world pervades activity within society. Everyone should be able to access the I nternet and to an unhindered flow of information. The I nternet's integrity and security must be guaranteed to allow safe access for all.
Democratic and efficient multi-stakeholder governance

The digital world is not controlled by a single entity. There are currently several stakeholders, of which many are commercial and non-governmental entities, involved in the day-to-day management of I nternet resources, protocols and standards and in the future development of the I nternet. The EU reaffirms the importance of all stakeholders in the current I nternet governance model and supports this multi-stakeholder governance approach.
A shared responsibility to ensure security

The growing dependency on information and communications technologies in all domains of human life has led to vulnerabilities which need to be properly defined, thoroughly analysed, remedied or reduced. All relevant actors, whether public authorities, the private sector or individual citizens, need to recognise this shared responsibility, take action to protect themselves and if necessary ensure a coordinated response to strengthen cybersecurity.
P a g e | 101
2. STRATEGI C PRI ORI TI ES AN D ACTI ON S

The EU should safeguard an online environment providing the highest possible freedom and security for the benefit of everyone. While acknowledging that it is predominantly the task of M ember States to deal with security challenges in cyberspace, this strategy proposes specific actions that can enhance the EU's overall performance. These actions are both short and long term, they include a variety of policy tools and involve different types of actors, be it the EU institutions, M ember States or industry. The EU vision presented in this strategy is articulated in five strategic priorities, which address the challenges highlighted above: - Achieving cyber resilience - Drastically reducing cybercrime - Developing cyberdefence policy and capabilities related to the Common Security and Defence Policy (CSDP) - Develop the industrial and technological resources for cybersecurity - Establish a coherent international cyberspace policy for the European Union and promote core EU values
2.1. Achieving cyber resilience

To promote cyber resilience in the EU, both public authorities and the private sector must develop capabilities and cooperate effectively. Building on the positive results achieved via the activities carried out to date further EU action can help in particular to counter cyber risks and
P a g e | 102
threats having a cross-border dimension, and contribute to a coordinated response in emergency situations. This will strongly support the good functioning of the internal market and boost the internal security of the EU. Europe will remain vulnerable without a substantial effort to enhance public and private capacities, resources and processes to prevent, detect and handle cyber security incidents. This is why the Commission has developed a policy on N etwork and I nformation Security (N I S). The European N etwork and I nformation Security Agency EN I SA was established in 2004 and a new Regulation to strengthen EN I SA and modernise its mandate is being negotiated by Council and Parliament. I n addition, the Framework Directive for electronic communications requires providers of electronic communications to appropriately manage the risks to their networks and to report significant security breaches. Also, the EU data protection legislation requires data controllers to ensure data protection requirements and safeguards, including measures related to security, and in the field of publicly available ecommunication services, data controllers have to notify incidents involving a breach of personal data to the competent national authorities. Despite progress based on voluntary commitments, there are still gaps across the EU, notably in terms of national capabilities, coordination in cases of incidents spanning across borders, and in terms of private sector involvement and preparedness: This strategy is accompanied by a proposal for legislation to notably: - establish common minimum requirements for N I S at national level which would oblige M ember States to: designate national competent authorities for N I S; set up a wellfunctioning CERT; and adopt a national N I S strategy
P a g e | 103
and a national N I S cooperation plan. Capacity building and coordination also concern the EU institutions: a Computer Emergency Response Team responsible for the security of the I T systems of the EU institutions, agencies and bodies ("CERT-EU") was permanently established in 2012 - set up coordinated prevention, detection, mitigation and response mechanisms, enabling information sharing and mutual assistance amongst the national N I S competent authorities. N ational N I S competent authorities will be asked to ensure appropriate EUwide cooperation, notably on the basis of a Union N I S cooperation plan, designed to respond to cyber incidents with cross-border dimension. This cooperation will also build upon the progress made in the context of the "European Forum for M ember States (EFM S)", which has held productive discussions and exchanges on N I S public policy and can be integrated in the cooperation mechanism once in place. - improve preparedness and engagement of the private sector. Since the large majority of network and information systems are privately owned and operated, improving engagement with the private sector to foster cybersecurity is crucial. The private sector should develop, at technical level, its own cyber resilience capacities and share best practices across sectors. The tools developed by industry to respond to incidents, identify causes and conduct forensic investigations should also benefit the public sector. H owever, private actors still lack effective incentives to provide reliable data on the existence or impact of N I S incidents, to embrace a risk management culture or to invest in security solutions.
P a g e | 104
The proposed legislation therefore aims at making sure that players in a number of key areas (namely energy, transport, banking, stock exchanges, and enablers of key I nternet services, as well as public administrations) assess the cybersecurity risks they face, ensure networks and information systems are reliable and resilient via appropriate risk management, and share the identified information with the national N I S competent authorities
The take up of a cybersecurity culture could enhance business opportunities and competitiveness in the private sector, which could make cybersecurity a selling point.
Those entities would have to report, to the national N I S competent authorities, incidents with a significant impact on the continuity of core services and supply of goods relying on network and information systems. N ational N I S competent authorities should collaborate and exchange information with other regulatory bodies, and in particular personal data protection authorities. N I S competent authorities should in turn report incidents of a suspected serious criminal nature to law enforcement authorities. The national competent authorities should also regularly publish on a dedicated website unclassified information about on-going early warnings on incidents and risks and on coordinated responses. Legal obligations should neither substitute, nor prevent, developing informal and voluntary cooperation, including between public and private sectors, to boost security levels and exchange information and best practices. I n particular, the European Public-Private Partnership for Resilience (EP3R) is a sound and valid platform at EU level and should be further developed.
P a g e | 105
The Connecting Europe Facility (CEF) would provide financial support for key infrastructure, linking up M ember States' N I S capabilities and so making it easier to cooperate across the EU. Finally, cyber incident exercises at EU level are essential to simulate cooperation among the M ember States and the private sector. The first exercise involving the M ember States was carried out in 2010 ("Cyber Europe 2010") and a second exercise, involving also the private sector, took place in October 2012 ("Cyber Europe 2012"). An EU-US table top exercise was carried out in N ovember 201 1 ("Cyber Atlantic 201 1"). Further exercises are planned for the coming years, including with international partners.
The Commission will:

- Continue its activities, carried out by the Joint Research Centre in close coordination with M ember States authorities and critical infrastructure owners and operators, on identifiying N I S vulnerabilities of European critical infrastructure and encouraging the development of resilient systems. - Launch an EU-funded pilot project early in 2013 on fighting botnets and malware, to provide a framework for coordination and cooperation between EU M ember States, private sector organisations such as I nternet Service Providers, and international partners.
The Commission asks EN I SA to:

- Assist the M ember States in developing strong national cyber resilience capabilities, notably by building expertise on
P a g e | 106
security and resilience of industrial control systems, transport and energy infrastructure - Examine in 2013 the feasibility of Computer Security I ncident Response Team(s) for I ndustrial Control Systems (I CS-CSI RTs) for the EU. - Continue supporting the M ember States and the EU institutions in carrying out regular pan-European cyber incident exercises which will also constitute the operational basis for the EU participation in international cyber incident exercises. The Commission invites the European Parliament and the Council to: - Swiftly adopt the proposal for a Directive on a common high level of N etwork and I nformation Security (N I S) across the Union, addressing national capabilities and preparedness, EU-level cooperation, take up of risk management practices and information sharing on N I S.
The Commission asks industry to:

- Take leadership in investing in a high level of cybersecurity and develop best practices and information sharing at sector level and with public authorities with the view of ensuring a strong and effective protection of assets and individuals, in particular through public-private partnerships like EP3R and Trust in Digital Life (TD L).
Raising awareness
Ensuring cybersecurity is a common responsibility. End users play a crucial role in ensuring the security of networks and information systems: they need to be made aware of the risks they face online and be empowered to take simple steps to guard against them.
P a g e | 107
Several initiatives have been developed in recent years and should be continued. I n particular, EN I SA has been involved in raising awareness through publishing reports, organising expert workshops and developing public-private partnerships. Europol, Eurojust and national data protection authorities are also active in raising awareness. I n October 2012, EN I SA, with some M ember States, piloted the "European Cybersecurity M onth". Raising awareness is one of the areas the EU-US Working Group on Cybersecurity and Cybercrime is taking forward, and is also essential in the context of the Safer I nternet Programme (focused on the safety of children online).
2.2. Drastically reducing cybercrime

The more we live in a digital world, the more opportunities for cyber criminals to exploit. Cybercrime is one of the fastest growing forms of crime, with more than one million people worldwide becoming victims each day. Cybercriminals and cybercrime networks are becoming increasingly sophisticated and we need to have the right operational tools and capabilities to tackle them. Cybercrimes are high-profit and low-risk, and criminals often exploit the anonymity of website domains. Cybercrime knows no borders - the global reach of the I nternet means that law enforcement must adopt a coordinated and collaborative crossborder approach to respond to this growing threat.
P a g e | 108
Strong and effective legislation

The EU and the M ember States need strong and effective legislation to tackle cybercrime. The Council of Europe Convention on Cybercrime, also known as the Budapest Convention, is a binding international treaty that provides an effective framework for the adoption of national legislation. The EU has already adopted legislation on cybercrime including a Directive on combating the sexual exploitation of children online and child pornography. The EU is also about to agree on a Directive on attacks against information systems, especially through the use of botnets.
P a g e | 109
Bank for I nternational Settlements
I nternational financial markets and bank funding in the euro area: dynamics and participants
Jaime Caruana, General M anager Adrian Van Rixtel, Senior Economist
1. I ntroduction
Financial markets are undergoing major and at times very rapid changes, mostly as a result of the financial crisis that began in 2007. I t is still too early to say for certain which of these changes will endure and which will disappear and to what degree when a new balance is reached. H owever, we must analyse them in order to be able to design appropriate policies. Among the many forces driving these market developments, we would like to focus on three which have their roots in the crisis. First are changes in market participants perception and management of risk. Counterparty and liquidity risk, for example, were undervalued in the years preceding the crisis but are now major concerns for financial institutions. I n addition, systemic risk, stemming from the interconnections between the financial system and the real economy, must be internalised.
P a g e | 110
Second, imbalances accumulated on public and private balance sheets over many years must be corrected. These imbalances are reflected on financial institutions balance sheets in the form of excessive leverage and excessive maturity and liquidity transformation. While deleveraging is part of the adjustment needed to restore the soundness of the banking sector, at the same time it burdens financial markets with asset sales and contractions in credit, giving rise to vicious cycles that increase systemic risk. Policies to reduce risk and provide protection against contagion are leading to a renationalisation of financial flows and to market fragmentation. Cross-border lending has contracted more rapidly than domestic lending.
I n particular, markets in the euro area have been segmented increasingly along national borders.
As they attempt to protect themselves against the effects of the crisis, some national authorities are building barriers against cross-national liquidity movements that threaten further segmentation along national lines. Third are regulatory changes. Financial markets are undergoing regulatory changes aimed at making them sounder and more stable. These changes seek to apply the lessons learned from the crisis while preventing collective behaviour from leading to a watering-down of regulations.
P a g e | 111
M uch emphasis is being placed on consistency in the adoption of the regulations in different countries and on analysing the unwanted negative effects these measures might have. These drivers and their effects on the financial system can be clearly seen in the unfolding crisis in the euro area, particularly in the strains and changes in bank financing.
At the most critical points in the crisis, risk aversion and volatility in euro area financial markets increased sharply, with severe contagion effects to international financial markets.
The recent tensions in some countries were driven by the increasing interaction between concerns about the sustainability of public finances and the fragility of financial systems in an atmosphere of low growth. Concerns about government deficits and debts in various peripheral European countries, especially when accompanied by external imbalances, spilled over to euro area banks. And financial systems fragility generated contingent liabilities in public finances, thus making the fragilities of sovereign debt become increasingly intertwined with the financial crisis, and creating difficulties for bank funding. I n addition to this vicious circle, lower economic growth and the inability to provide stimulus due to the lack of fiscal space make deleveraging even more difficult and weaken bank asset quality. Bank funding had already seen major changes in the years prior to the euro area crisis. During the past few decades, banks loosened the constraints of deposit growth and raised funds from institutional investors in global financial markets. They tapped new sources of funding, such as securitisation.
P a g e | 112
The business model of investment banks relied on wholesale funding from institutional investors, especially at short maturities (M erck et al (2012)). Financial globalisation allowed banks to tap institutional investors beyond national borders, which expanded traditional international funding to international interbank markets (CGFS (2010a), M cGuire and von Peter (2009), Fender and M cGuire (2010)). This greater reliance on funding provided through financial markets experienced unprecedented dislocations during the 200709 global financial crisis. I t set off major adjustments in banks business and funding models, which in many cases were later reinforced by the euro area financial crisis. I n both crises, some banks access to funding was limited, predominantly because of a deterioration of the quality of their assets, eg mortgage related financial instruments in the case of the global crisis and sovereign debt in the euro crisis. This article investigates how bank funding in the euro area in recent years reflected these market developments. I n fact, bank funding can be seen as the area where important issues related to the crisis and financial markets come together. I t should be emphasised that this analysis simplifies a very complex reality, with profound differences among different financial institutions and countries. First, adverse feedback effects between the weaknesses of sovereigns and banks disrupted funding markets severely. During episodes of severe sovereign strains, access to short- and longer-term wholesale funding markets became problematic even for euro area banks with the highest credit ratings, forcing them to resort to alternative funding sources and to shrink the size of their balance sheets.
P a g e | 113
Second, BI S data show that international interbank funding for euro area banks has collapsed from the high levels observed in 2008. This renationalisation applies especially to funding provided by euro area banks to other euro area banks. As a result, a banks country of origin largely determines its access to various funding instruments and their costs instead of its financial strength. These difficulties have been most pronounced for banks from peripheral countries, which have suffered the most severely from fiscal imbalances. Third, a particular class of international institutional investors, US money market mutual funds, has on balance over the past year withdrawn large sums of short-term funding from euro area banks. For these institutional investors, however, it is not so much a case of a return to home bias as a shift from euro area and UK banks to oth er foreign banks. Fourth, the crisis has led to a growing recourse to funding secured by collateral, such as covered bonds. This development adds to the already growing demand for assets with high liquidity and low credit risk, in the aftermath of the 200709 global financial crisis. M eanwhile, changes in regulation are adding to demand for such assets even as the loss of creditworthiness of sovereigns is reducing the number of suppliers. This has raised concerns about a p o te n ti a l s c a r c i ty o f s a f e assets that can be used as collateral. I n addition, the fact that a larger part of bank assets is used as collateral for covered bonds (BI S (2012)) tends to raise the riskiness of unsecured debt, leading investors all the more to demand that debt be collateralised.
P a g e | 114
Finally, the renationalisation of bank funding has intensified the dependence on ECB liquidity, which has substituted for lost access to euro area cross-border interbank and bond funding. I n what follows, we analyse some of these market trends: first we sketch the adverse feedback between sovereigns and banks. Then we concentrate on the dynamics of several main sources of funding, namely international interbank markets (mostly for loans but also for bond holdings), US money market funds, bond markets and ECB liquidity. The final section concludes.
2. Link between sovereigns and banks

Since the first quarter of 2010, sovereign debt tensions and their spillover to banks in general and their funding in particular have dominated, in various stages and to different extents, financial and economic developments in the euro area. These sovereign debt strains came before many European banks had really cleaned their balance sheets of assets that were impaired during the global financial crisis. I n the event, government finances and banks funding interacted strongly (Caruana (201 1), Caruana and Avdjiev (2012)). I n particular, sovereign risk affects bank funding through several channels (CGFS (201 1)). M any banks hold significant amounts of predominantly domestic sovereign bonds on their balance sheets, which can lead to valuation losses and credit risk concerns when sovereign yields rise sharply. M oreover, sovereign debt serves as collateral for various financial transactions, including private repos.
P a g e | 115
Sovereign tensions result in lower collateral values, owing to larger haircuts or margin requirements, which effectively reduce the ability of banks to obtain funding. I n addition, sovereign downgrades spill over to banks, worsening both their cost of and access to funding, while reducing the funding benefits they derive from implicit and explicit government guarantees.
P a g e | 116
Signs of the strong link between sovereigns and banks started to become more pronounced early in 2010. Tensions in international financial markets were driven by growing concerns about the sustainability of public finances in view of persistent government deficits and high levels of public debt in peripheral European countries in general and in Greece in particular. Specifically, this was the case when the tensions were compounded by countries extensive reliance on foreign funding and that funding had to compete with the refinancing of high public debt.
P a g e | 117
These concerns spilled over to banks and, in most euro area countries and most periods, were reflected in marked increases in bank CDS spreads in parallel to the sovereign ones (Graph 1). I n this context, interbank funding costs, not only for euro borrowing but also for that in US dollars and sterling, increased sharply (Graph 2, left-hand panel).
Again, euro area banks experienced strains in US dollar short-term funding markets (Fender and M cGuire (2010)).
I nternational spillovers of the euro area financial crisis were also visible in the frequent and often sharp declines in stock prices of US and UK banks in parallel to those of euro area banks (Graph 2, right-hand panel). Weak economic growth and loss of competitiveness pointed to lower government revenues and loan losses, and the anticipation of these feedback effects pressured banks further.
The significance of the strong interconnection between sovereigns and banks in the euro area financial crisis is shown by the overall increasing trend in the predominantly positive 90-day moving correlations between sovereign and bank CDS spreads for most countries (Graph 3).
P a g e | 118
The co-movement between these spreads increased across euro area countries after the nationalisation of Allied I rish Bank in January 2009, which subsequently contributed to a more pronounced transmission of sovereign risks to banks (M ody and Sandri (201 1)). It was particularly high for most euro area countries during crisis periods involving various peripheral countries, such as Greece, I reland and Portugal, joined later in the crisis by Spain and I taly. At the same time, correlations between sovereign and bank CDS spreads of these countries declined sharply after they received supranational support. [Greece, I reland and Portugal received support through joint EU -I M F programmes in M ay 2010/ M arch 2012, N ovember 2010 and April 201 1, respectively; the ECB re-activated its Securities M arkets Programme (SM P) for I talian and Spanish sovereign debt in August 201 1; Spain received limited official funding to support the recapitalisation of its banking sector in June 2012.]
Cross-border holdings of government debt by banks have played an important role in the development of the euro area financial crisis.
P a g e | 119
Traditionally, domestic banks in key euro area countries held a larger share of their respective governments debt than banks in the US or UK (but a smaller one when compared with Japanese banks). The introduction of the euro reduced this home bias by fostering portfolio diversification, which led to a significant increase in cross-border euro area sovereign bond holdings among euro area countries.
In fact, owing to EMU, euro area investors increased the share of their investments in debt securities issued by euro area countries more than investors from all other countries (De Santis and Grard (2009)).
Still in 2007, the share of sovereign debt held by domestic banks remained large, particularly for the peripheral countries (Greece, Ireland, I taly, Portugal and Spain). M oreover, there are indications that during more recent crisis periods the home bias of banks from peripheral countries increased again (M erler and Pisani-Ferry (2012)). H oldings by euro area monetary financial institutions (M FI s) of other euro area countries sovereign debt as a ratio of their total bond holdings have been on a declining trend since 2006 and have now returned to levels observed in 1998 (ECB (2012b)). All in all, the euro area crisis has demonstrated that sovereign debt holdings can impede banks efforts to regain the trust of their peers and market participants at large. The high degree of international integration between government debt markets and banking systems in the euro area has played an important role in the propagation of the crisis (Bolton and Jeanne (201 1)). Exposures to sovereigns in the euro areas periphery spread bank distress to countries with stronger state finances. And for many banks headquartered in the periphery countries, exposures to own governments are much higher than common equity.
P a g e | 120
They are also sizeable in the case of large national banking sectors in other euro area countries. Thus, getting sovereign finances in order is a necessary condition for a healthy banking system.
3. I nternational interbank lending

Since the onset of the financial crisis in August 2007, euro area banks have seen their access to international interbank funding reduced, in some cases substantially.
This has been mainly concentrated in intra-euro area interbank markets: international lending by euro area banks to other euro area banks has declined sharply, as funding within the euro area has again become segmented along national lines. Overall, between end-2008 and end-201 1, international interbank lending from one euro area bank to another shrank drastically, thereby reversing an equally dramatic surge between 2003 and 2008 (Graph 4). This withdrawal of international funds from intra-euro area interbank markets was not offset by an increase in funding provided by non-euro area banks. The decline in international interbank lending within the euro area was concentrated in funds provided through both loans and deposits and debt securities (Graph 5).
Debt securities contracted most in proportional terms, but international loans and deposits also fell sharply from the historic high recorded at end-June 2008.
The dynamics of the movement in international funds provided between banks in the euro area followed the development of the euro area crisis closely. For both loans and deposits and debt securities, it fell sharply during
P a g e | 121
episodes of severe market stress, such as the first half of 2010 and the second half of 201 1, while it recovered during periods of subdued tensions, most notably the first half of 201 1. The recent measures taken by the ECB, the expansion of the range of acceptable collateral and the new sovereign bond-buying programme (Outright M onetary Transactions, OM T) have reduced redenomination risk, one factor that had increasingly been contributing to market fragmentation. Sustaining the improvements achieved with regard to risk premia will require swift progress both at the country level and through institutional advances in the euro area.
P a g e | 122
4. The role of US money market funds

So-called prime US money market funds (M M Fs) are important participants in international financial markets, as they channel funds from US households and firms to non-US banks. These funds invest in short-term instruments and try to offer more attractive returns to retail and corporate investors than bank deposits do. Before the crisis, US M M Fs became one of the main funding sources of the shadow banking system, by purchasing asset-backed commercial paper (ABCP) from structured finance vehicles and other short-term debt issued by US investment banks and non-bank mortgage lenders. Competition to offer investors higher yields has long led M M Fs to hold short-term debt and certificates of deposit issued by European and other banks headquartered outside the United States. US M M Fs became the largest single supplier of dollar funding to non-US banks, providing around one trillion US dollars to European banks in mid-2008 (Baba et al (2009)).
P a g e | 123
I n the aftermath of the 200709 global financial crisis, they increased their exposures to euro area banks further, while those to US banks fell strongly (Graph 6, left-hand panel) as US banks were downgraded, and changed their funding models. Since early 2010, following the intensification of the euro area financial crisis, however, US M M Fs have sharply reduced their exposures to euro area banks in general and to peripheral countries banks in particular (Graph 6, right-hand panel). This has been driven not only by heighted assessment of underlying risk, but also by managers of M M Fs seeking to reassure uninsured investors. After the run by institutional investors on prime M M Fs in September October 2008 and amid ongoing discussion of whether the systemic threat of such runs had been removed by subsequent Securities and Exchange Commission reforms, such funds appear to have been particularly quick to reduce exposures to euro area banks.
With the intensification of the crisis in the summer of 201 1, the joint exposures of US M M Fs to the five peripheral euro area countries, which were never large, became negligible.
Strikingly, they also reduced their short-term investments in core euro area banks, which were large. This reduction was the most pronounced for French banks, driven by concerns about their exposures to peripheral sovereign debt, but also affected German, Dutch and Belgian banks (Graph 6, right-hand panel). I n the first half of 2012, euro area exposures of US M M Fs stabilised but remained at very low levels. Rather than retreating from international exposures, these funds increased their investment in debt instruments issued by Canadian, Japanese and Swiss banks, as well as Scandinavian banks (not shown in Graph 6).
P a g e | 124
5. Bond markets: preference for secured funding can lead to scarcity of Collateral
I nstitutional investors in bank bonds have reduced holdings of euro area bank bonds as well.
The euro area financial crisis has impaired access to these markets, most notably during episodes of rapidly increasing market tensions and for banks from peripheral countries. Banks from Greece, I reland and Portugal have been virtually shut out of primary bond markets, while those from I taly and Spain have enjoyed only intermittent and unreliable access to them (Graph 7).
At the same time, funding stress frequently affected core countries banks as well.
Banks from Germany, France and the N etherlands issued very modest amounts of bonds in months of severe market turmoil linked to the euro area crisis. M oreover, during these episodes, market strains spilled over to banks outside the euro area, such as UK banks (Graph 7).
P a g e | 125
Overall, gross bond issuance by euro area banks has declined with the worsening of the crisis, by 15% in 201 1 from 2010 and by 22% in the first half of 2012 from the same period one year earlier.
P a g e | 126
The crisis has led to major changes in the composition of gross bond issuance by instrument, especially for banks from peripheral countries. The euro area financial crisis has reinforced the trend towards greater recourse to secured longer-term funding, such as covered bonds (Romo Gonzlez and Van Rixtel (201 1), ECB (2012a)).
The share of covered bonds in total gross bond issuance by euro area banks has increased from 26% in the first half of 2007 to 40% and 45% in the first half of 2010 and 2012, respectively.
For many banks from peripheral countries, most notably from Spain and I taly, this instrument has become the main source of long-term wholesale funding, as their access to unsecured markets has been partially or fully closed (Graph 7).
P a g e | 127
Covered bond issuance has been spurred as well by more structural factors, such as favourable regulatory treatment, for example under Basel I I I and Solvency I I and in various bail-in proposals, and legislative initiatives in several countries. Growing issuance of covered bonds has added to the concerns about the scarcity of collateral, or more precisely of safe assets that can be used as collateral. Covered bond issuance by banks results in a balance sheet in which a substantial proportion of their assets is encumbered, ie pledged with priority to investors in covered bonds. The intensification of the crisis has led banks to overcollateralise to a larger degree, which has reduced even more the unencumbered assets available to serve as collateral for new covered bonds. Asset encumbrance also reduces access to unsecured senior debt issuance, because as the pool of encumbered assets underlying covered bonds grows, holders of unsecured bank debt have a claim on fewer assets in the event of the banks insolvency. This substantially reduces their attractiveness as investments (Oliver-Wyman (201 1), BI S (2012), ECBC (2012), ECB (2012a)). Concerns about collateral scarcity seem to be an important driver of the increasing trend of so-called retained issuance by peripheral countries banks.
As the access of many of these banks to primary bond markets has become impaired, they have started to retain larger parts of their gross bond issuance instead.
These banks mainly use this paper as collateral in ECB liquidity operations.
P a g e | 128
I n the first half of 2012, significantly larger shares of gross bond issuance by I talian, Portuguese and Spanish banks were retained (Graph 7). I n contrast, issuance by German, French and Dutch banks has remained targeted to primary public markets and thereby to outside investors. This difference in bond issuance patterns between peripheral and core countries again underscores the renationalisation of funding markets. Strained access to bond financing has led to a revival of the issuance of government guaranteed bonds. The intensification of the crisis in the second half of 201 1 propelled the re-activation or prolongation of programmes in all peripheral countries, as well as in Germany. Government guaranteed issuance had become a very important source of longerterm bank funding in 2008 and 2009 at the height of the global financial crisis, and generally has been assessed positively, although not as being without some costs (CGFS (201 1), Muller et al (201 1)). The reactivation of the programmes in I taly and Spain allowed solid positions had not reduced the value of these explicit guarantees substantially.
6. The provision of ECB liquidity

With the development of the crisis, some euro area banks have resorted to central bank funding on a massive scale. The ECB has conducted a wide range of open market operations, amounting to an unprecedented 1.1 trillion at the end of June 2012. This liquidity was absorbed predominantly by banks from countries either under joint EU-I M F programmes or experiencing severe sovereign tensions, showing the distinct segmentation of bank funding according to bank nationality.
P a g e | 129
I t was augmented by Emergency Liquidity Assistance (ELA) especially in Greece and I reland, where national central banks took on the risk of funding local banks through their lender of last resort function. All in all, the worsening euro area financial crisis has substantially increased the dependence of several national banking systems on central bank liquidity, as a result of the increasing renationalisation of market-based bank funding. This trend has been the clearest for Greece, with almost 30% of total bank assets financed by ECB liquidity, while for I reland and Portugal the proportion has reached about 10% (Graph 8, left-hand panel). The sharp deterioration of the crisis from M arch 2012 onwards that was concentrated on Spain and spilled over to I taly led to significant increases in the dependence of their banking systems on ECB liquidity as well (Graph 8, right-hand panel).
7. Policy implications
The severe funding dislocations that were observed during the most intense episodes of the euro area crisis led to unprecedented challenges for policymakers and forced them to take exceptional measures on a large scale.
P a g e | 130
Although the dynamics of the crisis are still evolving, we would like to emphasise several implications for policy. First, recent experience has again demonstrated how quickly and profoundly bank funding can dry up when there is a lack of confidence in the markets. Funding structures that seem stable in normal times can turn highly unstable during episodes of financial market stress. Financing obtained from foreign sources tends to be particularly unstable, and may be especially sensitive to shocks in recipient countries. A case in point is the sharp reduction in international interbank exposures within the euro area in recent years. This has demonstrated again the benefits of stable funding structures, which facilitate the lengthening of maturities, and of considerable diversification between domestic and foreign sources based mainly on deposits and equity and less on short-term wholesale funding.
The Basel I I I Framework promotes the latter shift.

I t ensures that banks rely on their own capacity to build liquidity buffers and raise stable funding, thereby reducing funding liquidity risk. Banks with strong capital and liquidity buffers are much better equipped to withstand disruptions in funding. Second, the strong link between sovereigns and banks has underscored the importance of fiscal prudence and, in the European case, the need for greater financial integration in the euro area. This is particularly true for those dependent for funding on foreign capital, which can suddenly leave, shifting the burden to domestic banks and investors.
P a g e | 131
I t is easier to build up fiscal buffers in good times than to restore confidence in a crisis. Financial cycles are longer and more difficult to assess than normal business cycles, and more room for manoeuvre is required to deal with them. Third, because recourse to secured funding encumbers a larger part of a banks assets, in the event the bank fails fewer assets are available to holders of the banks unsecured debt, which reduces its attractiveness to investors. Thus, heavier asset encumbrance may increase concerns of collateral scarcity and potentially may impair both the access to and cost of unsecured funding. Scarcity of collateral is worsened if formerly safe assets that could be used as collateral become seen as risky assets.
Quite apart from the usual macroeconomic reasons for appropriate fiscal policy, financial markets require sovereigns that are considered practically risk-free.
For this reason, in financial systems that tend to operate on the basis of collateral, confidence in the sustainability of public debt has an added value. I ts absence leads to difficulties and higher funding costs for the economy as a whole. Finally, the increased fragmentation of financial markets, especially in the euro area, and the reliance of peripheral banking systems in the euro area on ECB liquidity require action on several fronts. Within each country, public debt must be made more sustainable, structural reforms must facilitate growth and the financial system must be repaired.
P a g e | 132
For the euro area as a whole, institutional improvements must continue, and there must be greater financial and fiscal integration, mainly with regard to the three aspects of the banking union: common supervision, system-wide deposit insurance and a single resolution system. The recent ECB measures provide more time for these reforms to be implemented, but they are not a substitute for the reforms, so swift progress is still needed.
P a g e | 133
Countercyclical loans for the management of exogenous shocks in small vulnerable economies (SVEs) and non traditional sources of development finance
Opening remarks by M r Jwala Rambarran, Governor of the Central Bank of Trinidad and Tobago, at the Joint Commonwealth Secretariat and United N ations Development Program workshop on Countercyclical loans for the management of exogenous shocks in small vulnerable economies (SVEs) and non-traditional sources of development finance, Port of Spain Ladies and Gentlemen, I thank the Commonwealth Secretariat and the United N ations Development Program (UN DP) for the invitation to deliver opening remarks at this joint workshop on what I consider to be one of the more critical issues facing small vulnerable economies, but which ten years after the M onterrey Consensus on Financing for Development has been largely ignored by the international policy community. While developing countries have made much progress in meeting the 8 M illennium Development Goals (M DGs) to free humanity from extreme poverty, hunger, illiteracy and disease by 2015, substantial challenges still remain, especially in reaching the most vulnerable. M ultiple financial, food, energy and economic crises, which often respect no borders, further aggravate matters.
As the deadline approaches, we have the opportunity to design a post-2015 framework that builds on successes, learn from past shortcomings, and addresses the gaps in the current M DGs.
P a g e | 134
Jeffrey Sachs, Professor of Sustainable Development at Columbia University, warns us in his January 24th 2013 article entitled Writing the Future that humanity faces no greater challenge than to ensure a world of prosperity rather than a world of ruins. Professor Sachs strikes a prescient note when he states Like a novel with two possible endings, ours is a story yet to be written in this new century.
There is nothing inevitable about the spread or the collapse of prosperity.

M ore than we know (or perhaps care to admit), the future is a matter of human choice, not mere prediction. I therefore commend the Commonwealth Secretariat and the UN DP for mounting this first of three workshops here in the Caribbean, with the other two to be held in the African and Pacific regions. Perhaps this will be the first chapter on the post-2015 development story of new financing arrangements for small vulnerable Caribbean economies, whose future might be partly based on the choices you make at this workshop. I certainly look forward to the outcomes of all three workshops, and hope that the shared positions will help to influence African, Caribbean and Pacific governments in their advocacy for innovative sources of development finance to be a front-burner issue on the international economic agenda. Ladies and Gentlemen, it is no secret that small vulnerable economies in the Caribbean have grappled with external shocks of varying magnitudes and duration over the past two decades. These shocks include a compression of aid flows, dismantling of preferential trade arrangements for sugar and bananas, interventions related to anti-money laundering and combating the financing of terrorism.
P a g e | 135
M ore recently, the Caribbean has been gradually recovering from the shock of the global financial crisis, which originated in the United States and spread to Europe, the regions two closest trading and investment partners. The untold story, however, is that the combined influence of these multiple shocks has led to a dramatic and fundamental shift in the composition of external financing flows to the Caribbean. I n my respectful view, the most significant change in the regional pattern of external resource flows stemmed from the sharp compression in Official Development Assistance (ODA). Flows of ODA to many Caribbean countries began falling in the 1990s, as donors redirected their aid priorities to the newly emerging Commonwealth of I ndependent States and the Least Developed Countries. This is certainly ironic because the eighth M DG recognizes that developing countries require more generous development aid to have the best chances of reducing poverty and accelerating development within the stipulated 15 year timeframe. Faced with declining aid resources, many Caribbean governments resorted to more expensive commercial borrowing to bridge their funding gaps. This, combined with the growing inability of regional governments to generate high enough primary fiscal surpluses for debt servicing, contributed to a large public debt overhang. Gross public debt in the Caribbean climbed rapidly from 65 percent of GDP in 1998 to a peak of almost 100 percent of GDP in 2002, before falling to a still elevated 80 percent of GDP in 2012. The accumulation of public debt was even faster in the Eastern Caribbean, moving from just over 60 percent of GDP in 1998 to a high of
P a g e | 136
almost 120 percent of GDP in 2004, before falling to 95 percent of GDP in 2012. Generally, a public debt ratio of over 90 percent of GDP is considered exceptionally high. By this measure, four countries in the Caribbean are projected to hold exceptionally high public debt in 2013: Jamaica (140 percent), St. Kitts & N evis (139 percent), Grenada (109 percent), and Antigua & Barbuda (93 percent). Another six countries are projected to have heightened debt vulnerabilities, averaging in the range of 50 to 90 percent of GDP, in 2013. These are the Bahamas, Belize, Dominica, Guyana, St. Lucia and St. Vincent and the Grenadines. Ladies and Gentlemen, the magnitude of the fiscal adjustment required to stabilize and eventually reduce the Caribbeans public debt overhang is neither socially nor politically feasible. Only two small island developing states in the Caribbean Guyana and H aiti have been able to access comprehensive debt relief under the enhanced H eavily I ndebted Poor Country (H I PC) Initiative and under the M ultilateral Debt Relief I nitiative (M DRI ). Other small vulnerable Caribbean economies are considered not poor enough and/ or not severely indebted enough to benefit from similar international debt relief measures. I n the meantime, a few Caribbean small island developing states have engaged in debt restructuring operations, sometimes more than once, but debt problems persist. The sombre picture, Ladies and Gentlemen, is one of wide external current account deficits, heavy public debt and slowing capital flows which are placing undue pressure on the regions international reserves and predominantly fixed exchange rate regimes (inclusive of a
P a g e | 137
currency board arrangement in the Eastern Caribbean). Caribbean countries are unwilling to devalue their currencies to support their weaker external positions. Barbados, in particular, remains vehemently opposed to devaluation, which it considers ill-conceived and unsuccessful at correcting the low growth, high debt dilemma facing small, vulnerable Caribbean economies. An appropriate balance is yet to be struck between adjustment and financing. Since September 2008, nine small island developing states in the Caribbean have turned to the I M F for increased financial support under various lending facilities. These are Antigua and Barbuda, Belize, Dominica, Grenada, H aiti, Jamaica, St. Kitts/ N evis, St. Lucia and St.Vincent and the Grenadines. Yet, it is arguable whether the current lending facilities of the I M F, the World Bank and other international financial institutions are sufficient enough to help mitigate the impact of large, unforeseen external shocks on Caribbean and other small vulnerable economies. Over the past decade, the international community has championed several initiatives to help mobilize more resources for development or to make them more effective. Well known examples include the I nternational Finance Facility for I mmunization, debt conversions, emissions trading, a financial transactions tax and use of the I M Fs Special Drawing Rights (SDRs). The jury is still out on whether these major schemes have created additional financial flows for development. For many Caribbean countries, remittances have become an important and promising source of non-traditional external financing.
P a g e | 138
I n fact, the Caribbean is among the larger recipient of remittances in proportion to its GDP. For countries such as H aiti, Jamaica and Guyana, remittances represent a lifeline, contributing to smoothing household consumption, easing balance of payments pressures, and financing domestic investments. I n effect, the Caribbean has created its very own large, highly educated diaspora pool that represents a potential alternative source of long-term funding. The stock of the Caribbean diaspora is estimated to be around 3.5 million people or more than one-fifth of the regions population. Preliminary estimates place the annual savings of the Caribbean diaspora at over 15 percent of the regions GDP.
Despite this impressive potential market, regional governments are yet to adopt innovative financing solutions such as diaspora bonds to tap into the wealth of its diaspora.
Ladies and Gentlemen, I have noted the wide scope of this workshop agenda, which ranges from exploring the feasibility of countercyclical loan instruments from the I M F and World Bank to identifying new sources of revenues including new regional financing mechanisms for small vulnerable economies. I am also most impressed with the caliber of the presenters. I have no doubt that you have the right ingredients for stimulating and fruitful discussions over the next two days. But we must be realistic. There is no silver-bullet solution to the deep-rooted, financing challenges facing small vulnerable economies.
P a g e | 139
Stabilizing the Caribbeans debt overhang as a priority is only a start. Putting in place the policies and institutions to allow pro-poor growth and achievement of the M DGs in the Caribbean will require persistent action from governments across the region. I n this regard, I see both the Commonwealth Secretariat and UN DP continuing to play an active role.
Conclusion
I n closing, Ladies and Gentlemen, I must remind our foreign participants that even as you devote attention to the rigors of the workshop, you have come to Trinidad and Tobago during the Carnival season, a most opportune time to witness the creativity, energy and passion of our people. So do take time if only to experience Super Blues Fantastic Friday. Let me assure you all of the continued support and collaboration of the Central Bank of Trinidad and Tobago in helping to move development finance issues facing small vulnerable economies onto the international agenda. I thank you.
P a g e | 140
EM I R Rules - Statement by Commissioner M ichel Barnier on the technical standards to implement the new rules on derivatives
I take note of the fact that the European Parliament has decided not to object to our proposed technical standards to implement our new rules on derivatives. The Council had earlier confirmed that it does not object to these proposed standards. This means that the standards can now enter into force 20 days after their publication in the Official Journal of the EU, most likely around mid-M arch. This reform is essential to bring more responsibility and transparency to derivative transactions. As a result, financial institutions and non-financial companies will be subject to new transparency rules in terms of reporting and supervision, and to clearing obligations for derivative contracts. By adopting these standards the EU meets its G20 commitment in the context of the reform of financial services. The new rules will reduce the risks related to derivative transactions. N ext week I will be travelling to the USA and will meet amongst others with Gary Gensler, Chairman of the Commodity Futures Trading Commission (CFT C). I will be able to reassure our American counterparts that the EU is meeting its G20 commitment on derivatives, and that we are now in a
P a g e | 141
position to apply stringent rules in Europe that are equivalent to the ones in the USA. With my visit I hope to make progress towards a system whereby the EU and the USA recognise the application of their respective rules on both sides of the Atlantic as equivalent.
Background
I n September 2009, at the G20 Pittsburgh Summit, the leaders of the 19 biggest economies in the world and the European Union agreed that "all standard OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest." Furthermore, they acknowledged that "OTC derivative contracts should be reported to trade repositories and that non-centrally cleared contracts should be subject to higher capital requirements." The EU is implementing this commitment with its new rules. The phasing-in period referred to in the Commission's declaration, for non-financial firms, is a period of three years.
P a g e | 142
Certified Risk and Compliance Management Professional (CRCMP) distance learning and online certification program.
Companies like IBM, Accenture etc. consider the CRCMP a preferred certificate. You may find more if you search (CRCMP preferred certificate) using any search engine.
The all-inclusive cost is $297. What is included in the price:
A. The official presentations we use in our instructor-led classes (3285 slides)

The 2309 slides are needed for the exam, as all the questions are based on these slides. The remaining 976 slides are for reference. You can find the course synopsis at: www.risk-compliance-association.com/Certified_Risk_Compliance_ Training.htm
B. Up to 3 Online Exams
You have to pass one exam. If you fail, you must study the official presentations and try again, but you do not need to spend money. Up to 3 exams are included in the price. To learn more you may visit: www.risk-compliance-association.com/Questions_About_The_Certif ication_And_The_Exams_1.pdf www.risk-compliance-association.com/CRCMP_Certification_Steps_ 1.pdf
C. Personalized Certificate printed in full color

Processing, printing, packing and posting to your office or home.
P a g e | 143
D. The Dodd Frank Act and the new Risk Management Standards (976 slides, included in the 3285 slides)
The US Dodd-Frank Wall Street Reform and Consumer Protection Act is the most significant piece of legislation concerning the financial services industry in about 80 years. What does it mean for risk and compliance management professionals? It means new challenges, new jobs, new careers, and new opportunities. The bill establishes new risk management and corporate governance principles, sets up an early warning system to protect the economy from future threats, and brings more transparency and accountability.
It also amends important sections of the Sarbanes Oxley Act. For example, it significantly expands whistleblower protections under the Sarbanes Oxley Act and creates additional anti-retaliation requirements.
You will find more information at: www.risk-compliance-association.com/Distance_Learning_and_Cert ification.htm

Risk Management Presentation Monday February 18 2013

Written by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Risk Management Presentation Monday February 18 2013

Written by

Copyright:

Available Formats

Page |1

Read more at Number 1 below. Also

What is the National Banking Era?

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Basel iii monitoring, still with Basel i figures

Basel I I I monitoring Questionnaire and instructions

Anti-M oney Laundering: Stronger rules to respond to new threats

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

N ew DARPA program seeks performers for transient electronics demonstration

Regulatory Priorities for 2013

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Bank for I nternational Settlements

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Basel iii monitoring, still with Basel i figures

Basel I I I monitoring Questionnaire and instructions

Scope of the exercise

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Section 2. Reserve requirements prior to the Federal Reserve

Section 2.1 I ntroduction of reserve requirements

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Section 2.2 The purpose of the reserve

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Section 2.3 Enforcing the reserve requirement

Section 2.3 Use of interbank deposits in the reserve

Section 2.4 Some empirical observations on reserve holdings

Section 3. Reserve requirements and liquidity during panics

Section 3.1 Usability of the reserve during a panic

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Section 3.2 Evidence on Use of the Reserve During a Panic

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Section 3.4 Discussion

Section 4. The Panic of 1907

Section 4.1 Brief history of the Panic of 1907

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Section 5. Reserve requirements after the founding of the Federal Reserve

As noted by Rodkey (1934):

Section 6. Lessons and concluding remarks

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Anti-M oney Laundering: Stronger rules to respond to new threats

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

extends its scope to address new threats and vulnerabilities

promotes high standards for anti-money laundering

2. What is terrorist financing?

2.3 H ow do M ember States cooperate in this field?

2. Why a revision of the international standards?

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

4.2. H ow did the European Commission decide to update the EU rules?

Why a revision of the Third Anti-M oney Laundering Directive?

What about the other elements of the framework?

4.3 H ow the directive complies with FATF revised international standards?

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

N ew DARPA program seeks performers for transient electronics demonstration

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Subsequently, I also increased our share of investment in fixed-income instruments.

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

_____________________________________________________________ I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com