F. Geithner, President and Chief Executive Officer
Remarks by President Timothy F. Geithner
before the Institute of International Bankers
It is a pleasure to join you today for this meeting of the
Institute of International Bankers. The financial institutions
you represent play a major role in our financial system. The
IIB has played an important part in shaping financial policy
in the United States, by reminding us with force and persistence
of the impact of our actions on the standards of fairness
and equality of opportunity that we strive to maintain.
The U.S. financial system has a number of features that help
to make it attractive to participants from all around the
The structure of our financial system is characterized by
a diversity of channels for financial intermediation, with
a relatively larger role for the capital markets and a smaller
role for banks, than is true in most other major economies.
And we have preserved, despite substantial consolidation,
a system that comfortably accommodates the largest globally-active
financial institutions side by side with a competitive and
diverse array of regional and community banking organizations.
We are very open to the presence of foreign financial institutions,
and perhaps as important, have traditionally been very open
to attracting non-U.S. financial talent to work in our markets.
While the number of foreign banking organizations operating
in the US has contracted over the last decade, the overall
importance has grown. Foreign banking organizations now account
for 45 percent of total banking assets in the United States,
up from around 40 percent a decade ago, and they account for
a substantial share of total securities underwriting in this
Our framework for supervision and regulation is supportive
of innovation. Much of the most transforming innovations in
finance started in our markets or were adopted more quickly
and more broadly here than in many other financial systems.
The U.S. system, relative to the model in many other countries,
has involved a continuous, risk-focused process of supervision
and a strong enforcement mechanism working alongside the supervisory
community. In addition, we have traditionally assigned a more
important role to market discipline, importantly through a
strong disclosure regime, in reinforcing the supervisory regime,
than has been the case in other markets.
Our system is successful in matching capital with ideas, in
allocating savings to where returns are highest, in creating
opportunities for households to better withstand the costs
of change and dislocation that are inevitable offshoot of
an open and dynamic market economy, and in spreading risk
to where it can be best absorbed. The high degree of competition
and flexibility that characterize our approach helps drive
the pace of innovation, both in new forms of financial instruments
and in new ways to manage risks.
No financial system, of course, is without vulnerability.
And we face a number of important challenges in making sure
our system is as strong as it can to be. But the substantial
competition from a diverse set of financial institutions,
including a strong presence by foreign financial institutions,
is an integral part of what makes our financial system work
well. Our system would not be as efficient or as innovative,
and our financial institutions would not be as strong, if
we were less open or less committed to giving all institutions
similar national treatment and equality of opportunity.
I thought I would give you a brief overview of the some of
the key challenges we face as supervisors and those that confront
the risk management community.
The fundamentals of the present U.S. expansion seem relatively
strong, with confidence in its sustainability increasing.
As the balance of risks to the outlook have evolved, and the
financial markets have built in expectations of a move to
less accommodative financial conditions, this is a good time
to assess how well the U.S. financial system is positioned
to deal with this transition, and to withstand the effects
of future stress, if that were to materialize.
From our perspective, the U.S. financial system is in reasonably
strong shape. Risk adjusted capital ratios are strong, and
earnings have been robust. Non-performing loan ratios are
very low -- at about one percent on average across the banking
industry. The financial markets are pricing risk in exposure
to financial institutions at what are still relatively low
Securitization and the rapid growth in credit risk transfer
instruments have enabled risk to be spread more broadly. Risk
management practices have improved in sophistication and rigor.
Firms have made substantial investments in improving the strength
and resilience of their technology and systems infrastructure.
Payments and settlements systems have stronger safeguards
in place. The overall capacity of the system to handle large
hedging volume has increased substantially.
Despite the fact that we have experienced a sustained period
of accommodative monetary and financial conditions, net credit
growth to the private sector has been moderate. The overall
financial position of the corporate sector is strong. New
household borrowing has grown rapidly, but the broad measures
of the ratio of debt service to income remain at a level of
roughly 13 percent, and estimates suggest that only a quarter
of total household debt is exposed to rising interest rates
in the near term. Net credit growth to emerging markets has
been moderate relative to past periods. Growth in commercial
bank assets has picked up a bit in recent quarters, but remains
significantly below the pace of the second half of the 1990s.
As the financial markets have built in expectations of a gradual
rise in the fed funds rate over the next two years, financial
institutions have had some time to position themselves for
an environment of higher interest rates and volatility. There
have been adjustments in credit spreads and other risk assets,
which in some areas had fallen to historically low levels,
but these reversals have been tempered by what it still overall
a favorable view of corporate credit fundamentals. And it
is worth drawing attention to the fact that the average duration
of the mortgage market has increased significantly over the
last nine months to the point where the amount of hedging
pressure on interest rates related to extension risk is likely
to be contained even as interest rates rise.
The fact that these adjustments have begun ahead of any change
in monetary policy probably will help diminish the strains
in the financial system that might otherwise be expected to
accompany this type of transition. Even so, risk managers
need to be attentive to, and react appropriately to, the pressures
that could emerge following this extended period of low interest
rates and a steep yield curve.
The agenda for the supervisory community remains dominated
by the following broad priorities:
- We are moving ahead with Basle II to bring a more sophisticated
assessment of capital adequacy and risk management techniques
to the supervisory framework.
- Our ongoing supervisory examinations continue to concentrate
on strengthening the internal management and control infrastructure
across the various dimensions of risk management and compliance.
- We are supporting the important efforts underway to better
align U.S. and international accounting standards and to
improve the quality and integrity of public disclosure.
- We are working to encourage firms to proceed with their
investments in greater resilience and geographic range called
for in the Interagency Paper on Sound Practices to Strengthen
the Resilience of the U.S. Financial System.
- We continue to encourage efforts to strengthen all aspects
of our national payments and settlement systems.
- And we are engaged across a number of fronts internationally
to provide a more integrated framework of supervision that
better matches the integration of national financial systems
and the increased global reach of the largest financial
As part of our supervisory process we monitor closely the
evolution in risk management practice across a broad array
of financial institutions. Through horizontal reviews that
focus on specific dimensions of risk management, we have a
reasonably good sense of where the frontier in risk management
practices is across the industry, and understand where the
gap between this frontier and average practice is the greatest.
The size of this gap in practice can increase in market conditions
where competitive pressures and a search for return works
to erode discipline.
I thought it might be useful to highlight some of the areas
where leading practice is farthest ahead of typical practice.
Leading practice does not imply that there is a definitely
superior model that we expect all firms to converge to over
time. In most of these areas, there is some diversity in what
defines the frontier of excellence. We recognize this, even
as we encourage firms to put in place stronger and more sophisticated
systems more commensurate with the complexity of the risks
they are taking.
- Comprehensive aggregation of credit exposure:
The most sophisticated among large diversified financial
institutions have well-developed systems for aggregating
credit exposure, with a common methodology and results available
relatively quickly, across the full range of transactions
and business lines they engage in with a single entity or
groups of entities with correlated risks.
- Stress testing and scenario analysis:
Firms at the leading edge have moved well beyond reliance
on “value-at–risk” complemented by stress
tests of discrete shocks. They employ stress tests built
around more exacting, forward-looking scenarios integrating
large moves in a number of variables, more tailored to the
risk profile of the firm and current market conditions,
and the reactions of other market participants and counterparties.
- Counterparty credit risk management: The
most sophisticated firms use much more careful and sophisticated
approaches for measuring potential future exposure, and
they analyze how exposures may respond in conditions of
significant market stress. With respect to hedge fund exposure
in particular, the leading firms employ comprehensive evaluation
of the risk profile of the hedge fund to set credit thresholds
and terms and a more disciplined approach to setting sufficiently
high levels of initial margin.
- Measuring and Managing Interest Rate Risk:
Leading institutions assess their exposure to interest rate
risk in a comprehensive manner across the firm’s business
lines. The most advanced approaches are able to assess the
impact of rate, spread and implied volatility movements
under multiple scenarios in both normal and stressed market
conditions. These institutions also strive to achieve a
balance between shorter term earnings impacts, and the longer-term
preservation of economic value.
- Liquidity risk: Similar evolution has occurred
in liquidity management with leading practice now subjecting
dynamic cash flow projections to a range of adverse scenarios
relevant to the risk profile of the firm (such as a sustained
loss of access to funding or a significant ratings downgrade
or a systemic disruption to market liquidity) to assess
the impact on funding.
- Compliance risk management: Many firms are
working to enhance their overall corporate compliance management
processes, and the supervisors expect that firms will employ
strong risk management practices with appropriate levels
of testing. In response to the more exacting requirements
of the Bank Secrecy and Patriot Acts and anti-money laundering
controls, leading firms have now moved beyond manual systems
with very limited capacity to look at patterns of transactions
over time and across businesses and countries, and have
put in place automated systems for monitoring transactions
with more sophisticated filters for identifying suspicious
patterns of behavior. The quality of internal compliance
controls in the leading firms has advanced in other areas
as well, with higher level oversight of an independent compliance
function with more rigorous policies to address conflicts
of interest involving hedge funds and proprietary trading
and the flow of confidential information across the firm.
These are examples of leading practice, and they are not
at this point standard operating procedure across the range
of institutions where they should be. Systematically assessing
the evolving frontier of leading risk management practice
is a useful way to ensure that we continue to build on the
significant improvements in the overall stability and resilience
of the U.S. financial system that have been achieved over
the past two decades. This is important to do on a continuing
basis to strengthen the shock absorbers in the financial system.
It is important to do even when, or perhaps particularly when
the overall economic environment looks quite favorable, as
it does today.
We look forward to working with the foreign banking community
to continue to identify ways in which risk management practices
can be strengthened. It is in our mutual interest to insure
that the practices employed broadly by the industry continue
to move towards the frontier of risk management practices.