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International Association of Risk and Compliance Professionals (IARCP)
1200 G Street N W 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
George Lekatis President of the IARCP

Dear Member, According to Mr Kiyohiko G N ishimura, Deputy Governor of the Bank of Japan (to the 6th I rving Fisher Committee Conference, Bank for International Settlements, Basel, 29 August 2012), ―the Bank monitors shadow banking entities and activities through various channels‖.

Wow! Look at that. Even secret services should become very jealous, especially the ones that don‘t monitor such activity. What a plan!
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H e continues:
―Amongst these channels, direct monitoring of major shadow banking entities is of course the most significant. Thus, the bank has increased the number of staff directly monitoring major securities companies. However, it is practically impossible to conduct dialogues with all financial institutions of a shadow banking nature, and moreover, shadow banking activities tend to change rapidly with developments in financial markets.‖

I t is a very interesting speech.

Read more at N umber 7B, just after the very interesting speech of Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan. Welcome to the Top 10 list.

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Some Thoughts on Global Risks and Monetary Policy Charles L. Evans, President and Chief Executive Officer Federal Reserve Bank of Chicago

EBA, EIOPA and ESMA Joint Consultation Paper on Draft Regulatory Technical Standards on the uniform conditions of application of the calculation methods under Article 6.2 of the Financial Conglomerates Directive (JC/CP/ 2012/ 02)

Cryptographic Key Management Workshop 2012 Purpose: NIST is conducting a two-day Key Management Workshop on September 10-1 1. The subject of the workshop is the technical and administrative aspects of Cryptographic Key Management Systems (CKMSs) that currently exist and may be required for U.S. Federal use in the future.

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Short Selling Regulation Update Market Maker & Primary Dealer Exemption N otification Procedure The European Securities and Markets Authority (ESMA) is publishing this notice to alert financial market participants to its upcoming consultation on the market making and authorised primary dealer exemption under the EU‘s Short Selling Regulation (SSR) and the procedure to be followed by firms and regulators in dealing with notifications of intention to use the exemption.

Preliminary Annual Report on U.S. Holdings of Foreign Securities Preliminary data from an annual survey of U.S. portfolio holdings of foreign securities at year-end 2011 were released.

Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank Foreign banks between financial crisis and financial stability

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Economic activity and prices in Japan and monetary policy

Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Ishikawa, 2 August 2012.
Market intelligence, market information and statistics in central banking Keynote Speech by Mr Kiyohiko G N ishimura, Deputy Governor of the Bank of Japan, to the 6th Irving Fisher Committee Conference, Bank for International Settlements, Basel, 29 August 2012.

News Release - The dog and the frisbee – paper by Andrew Haldane In a paper given at the Federal Reserve Bank of Kansas City‘s 36th economic policy symposium in Jackson H ole, Wyoming, Andrew H aldane – Executive Director for Financial Stability and member of the Financial Policy Committee – explores why the type of complex financial regulation developed over recent decades may be sub-optimal for crisis control

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VII Annual Seminar on Risk, Financial Stability and Banking São Paulo A very interesting presentation What caused the Global Financial Crisis?

Central Bank of Ireland Publishes July 2012 Money and Banking Statistics The Central Bank of I reland published the July 2012 Money and Banking Statistics Loans and other credit

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NUMBER 1

Some Thoughts on Global Risks and Monetary Policy
Charles L. Evans, President and Chief Executive Officer Federal Reserve Bank of Chicago

Introduction
Thank you for the invitation to speak to you today. I am very happy for the opportunity to participate in Market News International seminar and to offer my thoughts on the U.S. and world economies.
We live in an amazingly interconnected world — a world in which financial markets are linked by the instantaneous transmission of information and business activity is intertwined among nations. For a long time, U.S. consumers and firms have been an important source of demand for Asian economies.

This comes with pluses and minuses: Without the robust growth in the U.S. in 1997–98, the Asian financial crisis may well have been much worse than it actually was; in contrast, the recession and sluggish growth in the U.S. over the past five years have weighed heavily on the demand for products from Asia.
My comments today will focus primarily on the outlook for the U.S., but with an eye on its potential impact on Asian economies. Of course, here I have to cover the substantial downside risks to the forecast stemming from both the European debt situation and the U.S. fiscal cliff. I will also discuss how this outlook and other economic analyses shape my views for the appropriate stance of monetary policy.
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Before I turn to the focus of today‘s discussion, I would like to remind you that the views expressed are my own and do not necessarily represent those of the Federal Open Market Committee (FOMC) or the Federal Reserve System.

Outlook
Let‘s start with the economic outlook. We are all too familiar with the fact that the financial crisis that unfolded in 2007 and 2008 precipitated a global recession that was unusually deep and lengthy in the U.S. and other advanced economies.

Perhaps this shouldn‘t have been surprising.
The detailed analysis by Carmen Reinhart and Kenneth Rogoff (2009) concludes that recessions caused by financial crises generally are severe and are followed by anemic recoveries. By any yardstick, this certainly describes the U.S. recovery to date: Output growth has averaged only 2-1/ 4 percent annually, and resource gaps remain huge.

In particular, the unemployment rate remains over 8 percent — well above the 5-1/ 4 to 6 percent rate most FOMC participants view as being consistent with a fully employed labor force over the longer run.
Both public and private sector forecasts see relatively modest rates of growth over the next few years. For example, most recent forecasts by the private sector have 2012 gross domestic product (GDP) growth at less than 2 percent; a pace that may not even be enough to keep up with potential.

Growth in 2013 is expected to be only moderately higher.
Moreover, both the European debt situation and the looming U.S. fiscal cliff impart substantial downside risks to the forecast. Even absent any negative shocks, such tepid growth rates would close the large existing resource gaps only very gradually.
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Indeed, I expect that we will face unemployment well above sustainable levels for some time to come.

Implications for Asia
In the aftermath of the Great Recession, most Asian economies enjoyed a return to solid levels of growth. Today, however, growth in Asia faces some new challenges. One of these challenges is that Asian economies will not be immune to the tepid growth prospects facing the world‘s advanced economies. Forecasts for growth in Asia have been marked down over the past year, reflecting in part the impact of the downgrade in the outlook for Asian exports for the U.S. and the euro area. For example, the U.S. and the euro area account for about one-third of China‘s merchandise exports. The recession and weak recoveries in those economies were big factors in the Chinese current account surplus falling from about 10 percent of GDP in 2007 to less than 3 percent in 2011.

This weakness remains a consideration as we look forward; indeed, it is an important reason why the I nternational Monetary Fund (I MF) is projecting that the Chinese current account surplus will fall even more by 2013.
International trade is an excellent thing: Exploiting comparative advantages raises living standards for all nations. However, all countries can‘t simultaneously export their way out of their problems. For the world as a whole, the current account has to balance. Thus, countries with large external surpluses face risks to their economies posed by slowdowns in their trading partners. Aggregate world growth must reflect aggregated domestic demands. So if demand is going to be sluggish in a large share of the world economy, other nations must take up the slack, or world growth will fall.

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Inflation
With regard to inflation, as you know, the FOMC‘s long-run inflation objective is 2 percent as measured by the price index for personal consumption expenditures (PCE). For a number of reasons, I don‘t foresee much risk that inflation will rise above reasonable tolerance levels relative to this objective. First, we see evidence of low expectations for inflation and growth in the today‘s historically low Treasury yields.

If there were warning signs of dangerous inflationary pressures, the ten-year rate wouldn‘t be in the neighborhood of 1-3 /4 percent!
Second, even with the latest increase in oil prices, energy and commodity prices remain well off their recent peaks as the global outlook dims. Third, as I just noted, the output gap remains large and is likely to close only slowly. In this economic environment, wage pressures are practically nonexistent.

And it is hard to envision how major persistent inflation pressures will emerge without a parallel increase in wage costs. Such parallel price and wage increases were a big part of the 1970s inflation, a scenario some fear repeating today.
Fourth, inflationary dynamics depend in large part on the momentum generated by people‘s expectations of future inflation; currently, inflation expectations are well anchored, which will tend to keep inflation from moving either up or down. Putting all of these factors together along with the fact that core inflation averaged 1.8 percent over the past year, I conclude that inflation will likely remain near or below our 2 percent target over the medium term.

Sources of Risk and Their Implications
I would now like to turn to two important downside risks to the outlook for growth.
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This will be a bit of a U.S.-centric view, but clearly these risks also have important implications for growth here in Asia and the rest of the world.

Europe
Let me begin with the European debt situation. Obviously, the developments in Europe pose a significant downside risk to the U.S. economy and world economic growth more broadly. The direct effects of slower European growth on the U.S. economy would be relatively small. The eurozone nations account for less than 15 percent of U.S. merchandise exports. Thus, according to standard elasticity estimates, even a moderate eurozone recession would reduce U.S. exports by only a couple of tenths of GDP. The indirect effects of eurozone developments could, however, be more severe, both in the U.S. and Asia. One possible channel would be through financial contagion.

If losses on euro-centric assets put a large enough dent in the balance sheets of financial institutions that lend to U.S. households and businesses, the increases in the cost and availability of credit would reduce growth in the U.S. with possible spillover effects into Asia as well. Clearly, this is a risk worth monitoring.
Fortunately, though, U.S. financial institutions are in much better shape to handle such potential losses than they were in 2008. Recognizing the risks posed by the European debt situation, U.S. institutions have reduced their direct exposure to European assets and tightened lending standards to European banks. On the regulatory front, the most recent stress tests made large U.S. banks demonstrate that they would have adequate capital even in the event of a sharp European recession with contagion to global financial markets.

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A second possible channel would be through the effects of uncertainty on current demand.
Throughout the recovery, U.S. business and household sentiment has been very fragile. Every hint of bad news seems to generate a wave of increased caution and an associated pullback in spending as firms and families seek to protect their individual balance sheets. After what the U.S. economy went through in the Great Recession, this skittishness is understandable — particularly if one can envision a very large downside to the news event. And, as I just noted, given developments in Europe, there certainly are some serious downside scenarios one can envision, even if they are not the most likely outcomes. So it would be no surprise if yet another wave of uncertainty put a further dent in consumption and investment.

U.S. fiscal cliff
Another risk to the U.S. economy comes from the so-called fiscal cliff.

Under current U.S. law, numerous tax and spending provisions enacted in various stimulus packages dating as far back as 2001 are scheduled to expire on January 1, 2013.
In addition, if no budget agreement is reached by Congress, there will be significant automatic spending sequestration and other spending cuts in January. According to projections made by the Congressional Budget Office (CBO), if all these things took place, real GDP growth would be reduced by about 4 percentage points in 2013. I ‘ m not saying that a pullback of this magnitude should be the base-case scenario. The orders of magnitude are just too big to be a base case.

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But when you go through the various items and make guesses at which may stay and which may go, it is easy to envision scenarios that include a marked increase in fiscal restraint in 2013.
In addition, given the political process, it seems unlikely that we will know much about the size or composition of the cuts until late in the process. It‘s also easy to see how the rhetoric of public negotiating stances could produce an atmosphere that causes already jittery households and businesses to put some spending plans on hold.

In sum, a messy resolution to the fiscal cliff problems presents an important downside risk to U.S. growth prospects and, by extension, to world economic growth.
And even the possibility of such an outcome could be a drag in the second half of the year.

Policy Choices
Let me now switch gears and talk about my views regarding the choices facing monetary policymakers in the U.S. Yes, we have substantial liquidity already in place in our financial system. On the surface, this looks like substantial monetary accommodation. But as a large body of economic theory tells us, for this liquidity to be sufficiently accommodative, the public needs to expect that we will keep it in place for as long as is necessary to restore the economy to a sound footing. This is why I believe we should clarify the Fed‘s forward guidance with regard to the future course of policy. Let me now go into the details behind these thoughts.

An explicit economic state-contingent policy
In weighing alternative policy approaches, I think the best way to provide forward guidance is by tying our policy actions to explicit measures of economic performance.
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There are many ways of doing this, including setting a target for the level of nominal GDP.
But recognizing the difficult nature of that policy approach, I have a more modest proposal: I think the Fed should make it clear that the federal funds rate will not be increased until the unemployment rate falls below 7 percent. Knowing that rates would stay low until significant progress is made in reducing unemployment would reassure markets and the public that the Fed would not prematurely reduce its accommodation.

Based on the work I have seen, I do not expect that such policy would lead to a major problem with inflation.
But I recognize that there is a chance that the models and other analysis supporting this approach could be wrong. Accordingly, I believe that the commitment to low rates should be dropped if the outlook for inflation over the medium term rises above 3 percent. The economic conditionality in this 7 /3 threshold policy would clarify our forward policy intentions greatly and provide a more meaningful guide on how long the federal funds rate will remain low. In addition, I would indicate that clear and steady progress toward stronger growth is essential. Because we are not seeing that now, I support further use of our balance sheet to provide even more monetary accommodation. In June we decided to continue our Maturity Extension Program, which puts downward pressure on long-term interest rates by extending the average maturity of the Federal Reserve‘s securities portfolio. I thought that was a useful step. However, I believe it is time to take even stronger steps, such as the purchase of more mortgage-backed securities, to increase the degree of monetary support for the recovery.

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As suggested recently by my colleagues Eric Rosengren and John Williams, these could be open-ended purchases, meaning that they would continue at a certain rate until there was clear evidence of improvement in economic conditions.
To me, one example of clear evidence would be a resumption of relatively steady monthly declines in unemployment for two or three quarters. Once this momentum was confidently established, the Fed could stop adding to our balance sheet but keep the funds rate at zero. The funds rate would remain unchanged in my thinking, until the unemployment rate hit at least 7 percent or the medium-term inflation outlook deteriorated dramatically and rose above 3 percent. Later, reductions in the Fed‘s balance sheet assets would occur sometime after the first increase in the funds rate. This corresponds to the general exit principles the FOMC agreed upon last year. Presumably, the pace of asset reductions would be measured and consistent with a continued, robust recovery in the context of price stability.

Accommodation in the Context of a Symmetric I nflation Target and Balanced Policy
I can‘t tell you how often people look at me in horror when I say that we should adopt a conditional policy that tolerates the risk of inflation exceeding our target by as much as 1 percentage point. How can I accept inflation rising above our stated target? I sn‘t this blasphemy for a central banker?

In January, in the same framework document that announced our 2 percent inflation target, we also stated a number of principles for the conduct of monetary policy.
One was that policy would take a balanced approach in achieving the two legs of the Federal Reserve‘s dual mandate — maximum employment and price stability.
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An explicit real-side mandate makes the Federal Reserve different than most central banks.
While just about all central banks follow a flexible inflation targeting approach, in which they seek to minimize real-side fluctuations in pursuit of their inflation objective, most are explicitly charged only with an inflation objective. But for the Fed, maximum employment is an explicit part of our policy mandate. I strongly support the policy principles document we released in January. But we‘re still hearing questions about whether our inflation goal is symmetric and about the specifics of how policy will be implemented under the balanced approach articulated in this framework. As Chairman Bernanke (2012) stated at his April press conference, the 2 percent inflation goal is a symmetric objective and not a ceiling on inflation. Symmetry means that inflation below 2 percent should be viewed as the same policy miss as if inflation overran 2 percent by equal amount. We need to take symmetry seriously. If we disproportionately recoil at inflation a little above 2 percent versus a little below, then we are not symmetrically weighing policy misses. And we will not average 2 percent inflation, which is our goal. There is some risk of this misperception taking hold. Consider the FOMC‘s latest Summary of Economic Projections (SEP), which includes the projections of all FOMC participants, voters and non-voters alike. In it, several forecasts have the funds rate rising before 2014, even though throughout the projection period most see inflation at or below 2 percent and unemployment well above the sustainable rate indicated by the long-run projections. Without further explanation, it‘s difficult to see how this is consistent with a symmetric inflation goal and a balanced approach to achieving the two legs in our dual mandate.
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I believe the FOMC can do better at describing our thinking with respect to tolerance bands around our long-run inflation and unemployment goals.
Clarification would increase both transparency and accountability. Importantly, it would reassure economic agents that Fed policy would not tighten prematurely. To me, a symmetric inflation goal and a balanced approach to policy mean that if we are missing our employment mandate by a large amount, but are close to our inflation target, then we should be willing to undertake policies that could substantially reduce the employment gap even if they run the risk of a modest, transitory rise in inflation that remains within a reasonable tolerance range of our target. I believe such actions, such as the 7/ 3 threshold policy I have been advocating, would produce smaller net losses relative to our dual mandate goals than would current policy.

Conclusion: The Need for a Vibrant Economy to Cushion Risks
Finding a way to deliver more accommodation — whether it is monetary or fiscal — is particularly important now because delays in reducing unemployment are costly. An unusually large percentage of the unemployed have been without work for quite an extended period of time; their skills can become less current or even deteriorate, leaving affected workers with permanent scars on their lifetime earnings. And any resulting lower aggregate productivity also weighs on potential output, wages and profits for the economy as a whole. The damage intensifies the longer that unemployment remains high.

Failure to act aggressively now could lower the capacity of the economy for many years to come.
Such potential costs would come with the continuation of a subpar pace of economic recovery.

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The significant risks I discussed earlier – financial disruption from a worsening of the situation in Europe or a messy resolution of U.S. fiscal policy – raise the specter of an even more worrisome outcome.
At the moment economic growth is not much above stall speed. Another negative shock could send the economy into recession. And if a recessionary dynamic takes hold, it would be especially difficult to regain momentum. I have outlined some policy actions that I think can take us in the direction of a more vibrant and resilient economy. Given the risks we face, I think it is vital that we make such moves today. I don‘t think we should be in a mode where we are waiting to see what the next few data releases bring. We are well past the threshold for additional action; we should take that action now. Thank you.

Note
Charles L. Evans is the ninth president and chief executive officer of the Federal Reserve Bank of Chicago. I n that capacity, he serves on the Federal Open Market Committee (FOMC), the Federal Reserve System's monetary policy-making body. The Federal Reserve Bank of Chicago is one of 12 regional Reserve Banks across the country. These 12 banks — along with the Board of Governors in Washington, D.C. — make up our nation's central bank. As head of the Chicago Fed, Evans oversees the work of roughly 1400 employees in Chicago and Detroit who conduct economic research, supervise financial institutions, and provide payment services to commercial banks and the U.S. government. Before becoming president in September of 2007, Evans served as director of research and senior vice president, supervising the Bank's research on monetary policy, banking, financial markets and regional
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economic conditions. Prior to that, Evans was a vice president and senior economist with responsibility for the macroeconomics research group.
His personal research has focused on measuring the effects of monetary policy on U.S. economic activity, inflation and financial market prices. I t has been published in the Journal of Political Economy, American Economic Review, Journal of Monetary Economics, Quarterly Journal of Economics, and the Handbook of Macroeconomics. Evans is active in the civic community. He is a board member at Chicago Metropolis 2020 and the Metro Chicago Information Center, and a trustee at Rush University Medical Center. Evans has taught at the University of Chicago, the University of Michigan and the University of South Carolina. H e received a bachelor's degree in economics from the University of Virginia and a doctorate in economics from Carnegie-Mellon University in Pittsburgh.

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NUMBER 2

EBA, EIOPA and ESMA
Joint Consultation Paper on Draft Regulatory Technical Standards on the uniform conditions of application of the calculation methods under Article 6.2 of the Financial Conglomerates Directive (JC/ CP/2012/02)

I. Responding to this Consultation
EBA, EIOPA and ESMA (the ESAs) invite comments on all matters in this paper and in particular on the specific questions stated in the attached document ―Overview of questions for Consultation‖ at the end of this paper. Comments are most helpful if they: - respond to the question stated; - indicate the specific question to which the comment relates; - contain a clear rationale; - provide evidence to support the views expressed/ rationale proposed; and - describe any alternative regulatory choices EBA should consider.

II. Executive Summary
The CRR /CRD I V proposals (the so-called Capital Requirements Regulation - henceforth ‗CRR‘- and the so-called Capital Requirements
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Directive – henceforth ‗CRD‘) set out prudential requirements for banks and other financial institutions which are expected to apply from 1 January 2013.
In anticipation of the finalisation of the legislative texts for the CRR/ CRD IV, the EBA, EIOPA and ESMA (hereafter the ESAs) through the Joint Committee, have developed the draft RTS in accordance with the mandate contained in Article 46(4) of the CRR and Article 139 of CRDIV (amending Article 21 a (2a) of the Directive 2002/ 87/ EC) on the basis of the European Commission‘s proposals.

This Article provides the ESAs through the Joint Committee, to develop draft Regulatory Technical Standards (RTS) with regard to the conditions of the application of the Article 6(2) of the Directive 2002/ 87/ EC (hereafter the Directive).
Further the ESAs have developed the draft RTS having regard to Article 230 in connection with Articles 220 and 228 of the Directive 2009/ 138/ EC2. To the extent that the texts may change before their adoption, the ESAs shall adapt its draft RTS accordingly to reflect any developments. The RTS included in this consultation have to be submitted to the EU Commission by 1 January 2013. Please note that the ESAs have developed the present draft RTS based on the European Commission‘s legislative proposals for the CRR /CRD I V. They have also taken into account major changes subsequently proposed by the revised texts produced by the Council of the EU and the European Parliament, during the ordinary legislative procedure (co-decision process). Following the end of the consultation period, and to the extent that the final text of the CRR/ CRD IV changes before the adoption of the RTS, the ESAs will adapt the draft RTS accordingly to reflect any developments.
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Main features of the RTS
This consultation paper puts forward draft RTS in order to ensure that institutions that are part of a financial conglomerate apply the appropriate calculation methods for the determination of required capital at the level of the conglomerate. They are based in particular on the following elements:

General Principles
o Elimination of multiple gearing; o Elimination of intra-group creation of own funds; o Transferability and availability of own funds; and o Coverage of deficit at financial conglomerate level having regard to definition of cross-sector capital.

Technical calculation methods 1. Method 1: ―Accounting consolidation method‖:
The FICOD provides in relation to Method 1 that the own funds are calculated on the basis of the consolidated position of the group. According to this general provision, the calculation of own funds should be based on the relevant accounting framework for the consolidated accounts of the conglomerate applicable to the scope of the Directive. The use of ―consolidated accounts‖ eliminates all own funds‘ intra-group items, in order to avoid double counting of capital instruments. According to the Directive provisions, the eligibility rules are those included in sectoral provisions.

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2. Method 2: ―Deduction and aggregation method‖.
This method calculates the supplementary capital adequacy requirements of a conglomerate based on the accounts of solo entities. It aggregates the own funds, deducts the book value of the participations in other entities of the group and specifies treatment of the proportional share applicable to own funds and solvency requirements. All intra-group creation of own funds shall be eliminated.

3. Method 3: ―Combination of methods 1 and 2‖.
The use of combination of accounting consolidation method 1 and deduction and aggregation method 2 is limited to the cases where the use of either method 1 or method 2 would not be appropriate and is subject to the permission by the competent authorities.

I I I. Background and rationale
The supplementary supervision of financial entities in a financial conglomerate is covered by the Financial Conglomerates Directive 2002/ 87/ EC, hereafter known as the Directive. This Directive provides for competent authorities to be able to assess at a group-wide level the financial situation of credit institutions, insurance undertakings and investment firms which are part of a financial conglomerate, in particular as regards solvency (including the elimination of multiple gearing of own funds instruments).

The nature of RTS under EU law
Draft RTS are produced in accordance with Article 10 of the ESAs regulation. According to Article 10(4) of the ESAs regulation, they shall be adopted by means of Regulations or Decisions.
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According to EU law, EU regulations are binding in their entirety and directly applicable in all Member States.
This means that, on the date of their entry into force, they become part of the national law of the Member States and that their implementation into national law is not only unnecessary but also prohibited by EU law, except in so far as this is expressly required by them. Shaping these rules in the form of a Regulation would ensure a level-playing field and would facilitate the cross-border provision of services.

Background and regulatory approach followed in the draft RTS
These draft RTS are produced in accordance with CRD IV/ CRR proposals, which provide that the EBA, ESMA and E IOPA (hereafter the ESAs), through the Joint Committee, shall develop draft regulatory technical standards with regard to the conditions of the application of the calculation methods with regard to Article 6(2) of the Directive and shall submit those draft regulatory technical standards to the Commission by 1 January 2013. The proposed draft RTS covers the uniform conditions for the use of the methods for the determination of capital adequacy of a financial conglomerate under the Directive. They elaborate on Technical principles applying to all of the three methods provided for by Directive; and also contain an Annex providing further detail for Method 2. The requirements contained in the draft RTS are mainly directed at institutions, although some of them are directed at competent authorities.

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IV. Draft Regulatory Technical Standards on the uniform conditions of application of the calculation methods under Article 6.2 of the Financial Conglomerates Directive
Commission Delegated Regulation (EU) No XX/ 2012 supplementing Directive xx/ XX/ EU [CRD] of the European Parliament and of the Council of [date], Regulation (..) No xx/ XXXX [CRR] of the European Parliament and of the Council of [date] and Directive 2002/ 87/ EC [Financial Conglomerates Directive] of the European Parliament and of the Council of [date] with regard to regulatory technical standards for the uniform conditions of application of the calculation methods under Article 6.2 of the Financial Conglomerates Directive of XX Month 2012 THE EUROPEAN COMMISSION, Having regard to the Treaty on the Functioning of the European Union, Having regard to the [proposal for a] Regulation (...) No xx/ xxxx of the European Parliament and of the Council of dd mm yyyy on prudential requirements for credit institutions and investment firms Regulation xx/ xxxx [CRR] and in particular Article 46 (4) thereof. Having regard to the [proposal for a] Directive (...) No xx/xxxx of the European Parliament and of the Council of dd mm yyyy on the access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms [CRDI V] and in particular Article 139 thereof. Having regard to the Directive 2002/ 87/ EC, as amended, of the European Parliament and of the Council on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate (hereinafter ―the Directive‖) and in particular to Article 6(2) and Annex 1 thereof. Whereas:

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(1)Directive 2002/ 87 /EC provides in Chapter I I , Section 2, rules on capital adequacy of financial conglomerates, such that the elements of own funds are available at the level of a Financial Conglomerates are always at least equal to the capital adequacy requirements as calculated in accordance with Annex I of the Directive.
(2)Regulation (...) No xx/ xxx (‗CRR‘) provides in Article 46, within Part I I , Chapter 2, Section 3, Sub-Section 2 and in the context of common equity Tier I rules, requirements for deduction where consolidation or supplementary supervision are applied. This section of the CRR provides empowerments to the European Commission to adopt delegated acts (regulatory technical standards) in accordance with articles 10-14 of the Regulation (EU) No 1093 /2010 establishing the European Banking Authority (‗EBA‘), Articles 10-14 of the Regulation (EU) No 1094/ 2010 establishing the European I nsurance and Occupational Pensions Authority (‗E IOPA), and Articles 10-14 of the Regulation (EU) No 1095/ 2010 (‗ESMA), establishing the European Securities and Markets Authority. These acts will complete the EU single rulebook for institutions in the area of own funds. (3)Directive (...) No xx/xxx (‗CRDIV‘) provides in Article 139 that the Directive 2002/ 87/ EC shall be amended, such that the EBA, EIOPA and ESMA through the Joint Committee, to develop draft Regulatory Technical Standards (RTS) with regard to the conditions of the application of the Article 6(2) of the Directive. (4)For effective supervision of Financial Conglomerates, supplementary supervision should be applied to all such conglomerates, the cross-sectoral financial activities of which are significant, which is the case when certain thresholds are reached, no matter how they are structured.

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Supplementary supervision should cover all financial activities identified by the sectoral financial legislation and all entities principally engaged in such activities should be included in the scope of the supplementary supervision, including asset management companies and alternative investment fund management companies.
(5)Without prejudice to sectoral rules, supplementary supervision of the capital adequacy rules is necessary to bring more convergence in the application of the calculation methods listed in Annex 1 of the Directive. (6)For financial conglomerates which include significant banking or investment business and insurance business, multiple use of elements eligible for the calculation of own funds at the level of the financial conglomerate (multiple gearing) as well as any inappropriate intra-group creation of own funds must be eliminated. (7)The financial conglomerate should seek an acceptable timeframe for the transferability of funds across entities within the financial conglomerate, which shall depend on whether the specific entity is subject to the Directive 2009/ 138/ EC or the CRDIV / CRR. Moreover for an entity subject to the CRD IV/ CRR this timeframe should be expediated based on the fact that due to the nature of their activities, they are more vulnerable to a rapid deterioration in confidence and/or sudden resolution situation. (8)In addition any non-sector-specific own funds, in excess of sectoral requirements, need to originate from entities which are not subject to transferability/availability impediments. (9)It is important to ensure that own funds are only included at conglomerate level if there are no impediments to the transfer of assets or repayment of liabilities across different conglomerate entities, including across sectors. ( 1 0 ) I f there is a deficit of own funds at the level of the financial conglomerate, the financial conglomerate should inform the coordinator on the measures taken to cover this deficit.
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(11)Further convergence in the way that financial conglomerates apply these rules shall ensure the robust and consistent application of the methods of calculation.
(12)For bank-led conglomerates it is necessary to apply the most prudent method of calculation for the treatment of insurance holdings to avoid regulatory arbitrage. ( 1 3 ) I t is important that sector-specific own funds cannot cover risks above sectoral requirements.

The financial conglomerate should first count sector-specific own funds against their requirements (while respecting sectoral rules and limits) for each relevant entity or group of entities. If there is an excess of sector-specific own funds, this should not be recognised at conglomerate level.
(14)When calculating supplementary capital adequacy of a financial conglomerate, in respect to non-regulated financial entities within the financial conglomerate, both a notional capital requirement and a notional level of own funds shoud be calculated. (15)Under Solvency I I , method 1 is applied on the basis of consolidated data which are set out at Level 2 and not on the basis of consolidated accounts. (16)Further changes to the capital adequacy rules may be addressed in the European Commission‘s review of Directive 2002/ 87/ EC. ( 1 7 ) I t is necessary that the new regime for treatment of methods of consolidation enters into force the soonest possible following the entry into force of the CRR /CRD IV and Solvency I I . (18)This Regulation is based on the draft regulatory technical standards submitted jointly by the EBA, EIOPA and ESMA to the Commission. (19)The EBA, EIOPA and ESMA have conducted open public consultations on the draft regulatory technical standards on which this
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Regulation is based, analysed the potential related costs and benefits, in accordance with Article 10 of Regulation (EU) No 1093/ 2010, Article 10 of Regulation (EU) No 1094/ 2010, Article 10 of Regulation (EU) No 1095/2010,and requested the opinion of the Banking Stakeholder Group established in accordance with Article 37 of Regulation (EU) No 1093/2010, I nsurance Stakeholder Group and the Occupational Stakeholder Group established in accordance with Article 37 of Regulation (EU) No 1094/2010, and the European Securities and Markets Stakeholder Group established in accordance with Article 37 of Regulation (EU) No 1095/ 2010.

HAS ADOPTED THIS REGULATION:
TIT LE I Subject matter and definitions Article 1 Subject matter
This Regulation lays down rules of the uniform conditions of application of the calculation methods under Article 6.2 of the Directive.

Article 2 Definitions
1.Definitions of the CRD IV/ CRR, Directive 2002 /87/ EC and Directive 2009/ 138/ EC shall apply to this Regulation. 2.Capital instruments are those capital instruments eligible under CRR (Regulation 2012/…./ EC) and those capital instruments referred to as ―own funds‖ in Directive 2009 /138 /EC. 3.Ultimate responsible entity is the entity within the financial conglomerate that is responsible for determining the capital for the financial conglomerate having regard to the following minimum criteria: control, the dominant entity from the market‘s perspective (market listed
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entity) and the ability to fulfill specific duties towards its subsidiaries and its supervisor.
4.‗indirect holding‘ as defined under definition 17 of Article 22 of CRR [to be added if not in final CRR text]. 5.Insurance-led financial conglomerate is a financial conglomerate whose most important sector is insurance as defined under Article 3(2) of the Directive. 6.Bank-led financial conglomerate is a financial conglomerate whose most important sector is banking as defined under Article 3(2) of the Directive. 7.Investment firm-led financial conglomerate is a financial conglomerate whose most important sector is investment services as defined under Article 3(2) of the Directive.

TIT LE I I Technical Principles

Article 3 Elimination of multiple gearing and the intra-group creation of own funds
The ultimate responsible entity shall ensure that own funds, which have been created by intra-group transactions, be it direct or indirect, shall be eliminated for the purpose of determining the required capital on a consolidated basis.

Article 4 Transferability and availability of own funds
1. For all entities of a financial conglomerate, own funds, in excess of sectoral solvency requirements, shall be considered available to absorb losses elsewhere in the financial conglomerate provided that all of the following conditions are fulfilled:
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(a)There are no practical, legal, regulatory, contractual or statutory impediments to the transfer of funds or repayment of liabilities across conglomerate entities in due course.
This is the case when the transfer of own funds from one conglomerate entity to another is not barred by a restriction of any kind and there are no claims of any kind from third parties on these assets. The ultimate responsible entity of the financial conglomerate shall confirm to the satisfaction of the coordinator that the conditions set out in this point are met. (b)For the purpose of assessing the transferability of funds to entities subject to 2009 /138 /EC, ―in due course‖ shall mean no later than 9 months; for the purpose of assessing the transferability of funds to entities subjected to CRR, ―in due course‖ shall mean no later than, three calendar days with no impediments on the coordinator requiring a faster transfer if necessary. 2.Own funds, in excess of sectoral solvency requirements, which do not meet the criteria under point 1 shall be excluded from the conglomerate‘s own funds. 3.The financial conglomerate shall demonstrate that measures have been taken to mitigate the risk that transfer of funds would have a material effect on the transferor‘s solvency.

EXPLANATORY TEXT for consultation purposes
This text is consistent with Annex 1 of the Directive which states ―when calculating own funds at the level of the financial conglomerate, competent authorities shall also take into account the effectiveness of the transferability and availability of the own funds across the different legal entities in the group, given the objectives of the capital adequacy rules‖.

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Point 1(a) aims to ensure that own funds are only included at conglomerate level if there are not impediments to the transfer of assets or repayment of liabilities across different conglomerate entities, including across sectors.
If the conglomerate cannot confirm to the satisfaction of the coordinator that there are no inherent impediments in relation to a given entity, that entity‘s own funds in excess of its sectoral requirements cannot be included at conglomerate level. The impediments to be considered include practical, regulatory, contractual or statutory ones. Point 1(b) establishes an acceptable timeframe for the transferability of funds across conglomerate entities. There is a differentiation based on the fact that entities subject to CRR, due to the nature of their activities, are more vulnerable to a rapid deterioration in confidence and/ or sudden resolution situation.

Article 5 Deficit of own funds at the financial conglomerate level
1.When the difference calculated according to method 1, 2 or 3 as detailed in Annex 1 of the Directive is negative, the financial conglomerate shall ensure that the deficit is remedied with cross-sector own funds elements as defined in point 2 below. 2.When calculating own funds at the level of the financial conglomerate, cross sector own funds are elements eligible for: (a)Common Equity Tier 1 in accordance with Regulation …/ 2012/ EC [or Tier 1 Unrestricted Basic Own Funds in accordance with Directive 2009/ 138/ EC], or (b)Elements that meet both sets of rules for Additional Tier 1 in accordance with Regulation … /2012/ EC and Tier 1 [Restricted Basic Own Funds in accordance with Directive 2009/ 138/EC], or
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(c) elements that meet both sets of rules for Tier 2 in accordance with Regulation … /2012/ EC and for Tier 2 in accordance with Directive 2009/ 138/ EC.
3. Cross-sector own funds elements mentioned in point 2 shall only be taken into account if their transferability and availability across the different legal entities in the financial conglomerate meet the conditions set out in Article 4.

EXPLANATORY TEXT for consultation purposes
The text is based on the Technical principles in Annex 1 of the Directive ―Whichever method is used, when the entity is a subsidiary undertaking and has a solvency deficit, or, in the case of a non-regulated financial sector entity, a notional solvency deficit, the total solvency deficit of the subsidiary has to be taken into account.
Where in this case, in the opinion of the coordinator, the responsibility of the parent undertaking owning a share of the capital is limited strictly and unambiguously to that share of the capital, the coordinator may give permission for the solvency deficit of the subsidiary undertaking to be taken into account on a proportional basis.‖ In line with the Directive only cross-sector own funds are allowed as a remedy to a conglomerate deficit. That is, from the point at which a conglomerate deficit is observed, that shortfall amount shall be covered by the issuance of cross-sector own funds, regardless of the cause of the conglomerate deficit. The financial conglomerate shall inform the coordinator about the deficit and the measures to cover this deficit without delay.

Article 6 Consistency
1. The Method of Calculation selected from those methods defined in Annex 1 of the Directive shall be applied in a consistent manner over time.
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2. For the purpose of Article 6(2) and Annex 1 of the Directive, for a banking led conglomerate, where Article 46 (1) of the CRR is applied, the coordinator, after consulting with other competent authorities concerned, shall decide the most prudent method to be applied by the financial conglomerate.

Article 7 Consolidation
For the purpose of Art 6(2) and Annex 1 of the Directive, Method 1 of the Directive 2009/ 138/ EC shall be considered as equivalent to the consolidation as defined under Method 1 of the Directive, for insurance-led financial conglomerate. The equivalence assessment is valid provided that the scope of the group under Solvency I I is the same under the Directive or the difference in the scope is not material.

EXPLANATORY TEXT for consultation purposes
This text is based on the Directive 2009/ 138/ EC, Article 230 in connection with Articles 220 ss. The Solvency I I I mplementation measures will need to be considered once they have been published. According to Directive 2009/138 /EC, for the calculation of group own funds all the multiple use of eligible own funds and intra-group creation of capital should be eliminated. Moreover, own funds of other financial sectors should be calculated according to the relevant sector rules. As a result, both Method 1 of the Directive 2009/ 138/ EC and Method 1 of the Directive are consistent with the main objectives of the supplementary supervision since they ensure that: all double-counting is

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removed; own funds are calculated in accordance with the definitions and limits established in the relevant sectoral rules.
The equivalence assessment is valid provided that the scope of the group under Solvency I I is the same under the Directive or the difference in the scope is not material.

Article 8 Solvency requirement
1. For the purpose of the calculation of the supplementary capital adequacy requirements of the regulated entities in a financial conglomerate, a solvency requirement shall satisfy either of the points laid down in (a) and (b):
(a)Where the rules for the insurance sector are to be applied, solvency requirement means the Solvency Capital Requirement as defined by Article 100 or 218 of Directive 2009/ 138/ EC as applicable, including any capital add-on applied in accordance with Articles 37, 231(7) or 232 of the same directive as applicable, and any other capital or own funds requirement applicable under Union legislation. (b)Where the rules for the banking or investment services sector are to be applied, solvency requirement means the sum of own funds requirements as defined by Articles 87 to 93 of CRR, combined buffer requirements as defined by Article 122 of CRD IV, and specific own funds requirements as defined by Article 100 of [CRDIV], and any other requirement applicable under European Union law.

Article 9 The financial conglomerate's own funds and capital requirements
1. Except where expressly stated in this Regulatory Technical Standard, the financial conglomerate's own funds and capital requirements shall be calculated in accordance with the definitions and limits established in the relevant sectoral rules.
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2.The own funds of asset management companies shall be calculated according to Article 2 (l) of Directive 2009 /65/ EC; the capital requirements are calculated according to Article 7(1) (a) of Directive 2009/ 65/ EC.
3.The own funds of alternative investment fund managers shall be calculated according to Article 9 of Directive 2011/ 61/ EU.

Article 10 Sector specific own funds
1. Sector specific own funds, are recognised for the coverage of risks at the sectoral level only and cannot be used to cover risks of another sector and shall not be included (above or) beyond the sectoral level. Sector specific own funds are own funds recognised under sectoral rules that do not fall within one of the following categories: (a)Common Equity Tier 1, Additional Tier 1 and Tier 2 own funds under [CRR]; or

(b)Tier 1 unrestricted basic own funds, Tier 1 restricted basic own funds, and Tier 2 basic own funds under Directive 2009/ 138/ EC.
2. Risks originating from the other sector shall not be covered by sector specific own funds.

EXPLANATORY TEXT for consultation purposes
Article 10 sets out that sector-specific own funds cannot cover risks above sectoral requirements. In practice, this means that, for each relevant entity or group of entities, conglomerates need to first count sector-specific own funds against their requirements (while respecting sectoral rules and limits). If there is an excess of sector-specific own funds, this shall not be
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recognised at conglomerate level.
In addition, as stated in Article 4, any non-sector-specific own funds in excess of sectoral requirements need to originate from entities which are not subject to transferability/availability impediments.

Article 1 1 Treatment of cross sector holdings for the calculation of capital requirements
Where an insurance holding of a bank-led financial conglomerate or an investment firm-led financial conglomerate is eliminated pursuant to Articles 14.3 and 14.4 or Article 15.2 or the application of these Articles as part of Method 3, no capital charge for that holding shall be applied at the financial conglomerate level for the purpose of supplementary supervision, even if a capital charge is applied at sectoral level.

EXPLANATORY TEXT for consultation purposes
At sectoral level, holdings may receive a risk weight or capital charge. At the financial conglomerate level, the same holding may be deducted or eliminated from own funds through consolidation, making the risk weight or capital charge superfluous. This capital charge shall thus not be applied for the purposes of the calculation of the conglomerates solvency requirements.

Article 12 Non-regulated financial entities
1. For a non-regulated mixed financial holding company and for a non-regulated entity held by a mixed financial holding company, the own funds and the capital requirements attributable to the non-regulated financial sector entities shall be calculated according to the most important sector in the financial conglomerate in accordance with Article 3(2) of the Directive.
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2. The own funds and the solvency requirements attributable to other non-regulated financial entities shall be calculated according to the sectoral rules of the sector (insurance or banking) to which the non regulated entity is designated.

EXPLANATORY TEXT for consultation purposes
A ―mixed financial holding company‖ is defined under Article 2(15) of the Directive. Whichever method is used, for the purpose of the calculation of the supplementary capital adequacy of a financial conglomerate, both a notional capital requirement and notional level of own funds should be calculated for non-regulated financial entities. These should be calculated according to the rules of the sector to which the non regulated entity belongs, or according to the most important sector in the conglomerate, having regard to Annex 1 of the Directive ―In the case of a non-regulated financial sector entity, a notional solvency requirement is calculated in accordance with section I I of this Annex, notional solvency requirement means the capital requirement with which such an entity would have to comply under the relevant sectoral rules as if it were a regulated entity of that particular financial sector; the notional solvency requirement of a mixed financial holding company shall be calculated according to the sectoral rules of the most important financial sector in the financial conglomerate‖.

Article 13 Transitional and grandfathering arrangements
The sectoral rules applied in the calculation of conglomerate own funds and solvency requirements shall take into account any transitional or grandfathering arrangements in force at sectoral level.

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TIT LE I I I Technical calculation methods
Article 14 Method 1 Calculation criteria
1.The own funds of a financial conglomerate shall be calculated on the basis of the consolidated accounts (according to the relevant accounting framework) applied to the scope of supplementary supervision of the Directive. 2.The calculation of own funds shall take into account the removal of intra group balances, transactions and income and expenses related to the process of accounting consolidation. 3.For bank-led and investment firm-led conglomerates, unconsolidated significant investments in a financial sector entity pursuant to Article 40 of the CRR shall be fully deducted, if the entity belongs to the insurance sector as defined in Article 2(8) of the Directive. 4.Unconsolidated non significant investments are deducted in accordance with the treatment described in Article 43 of CRR. 5.For bank-led and investment firm-led conglomerates, the sectoral treatment in Part 2, Title I I of the CRR shall apply to all unconsolidated investments, participations and holdings of a conglomerate entity, provided that: (a)The conglomerate entity is a credit institution or an investment firm; and

(b)The investment, participation or holding is in a credit institution or in an investment firm.
6. Without prejudice to points 3 and 4, any other own funds issued by one conglomerate entity and held by another, if not already eliminated in the accounting consolidation process, shall be deducted.
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7.Joint controlled entities shall be treated in accordance with sectoral rules.
8.The valuation of assets and liabilities calculated for the purposes of Directive 2009/ 138/ EC shall be used at the level of the financial conglomerate. 9.Where asset or liability values are subject to the calculation of prudential filters and deductions in accordance with those required under CRR, the asset or liability values used shall be those attributable to the relevant entities under CRR, excluding assets and liabilities attributable to other entities of the financial conglomerate. Where calculation of a threshold or limit is required in order to respect sectoral rules, the threshold or limit shall be calculated on the basis of the consolidated data of the financial conglomerate and after the removal of holdings called for by these standards. 10.Where credit institutions/ investment firms and related entities are consolidated under CRR, the same entities shall be considered together. 11.Where insurance and related entities are consolidated under Directive 2009/ 138/ EC, the same entities shall be considered together. 12.Conglomerate entities that are not consolidated under CRR or Directive 2009/ 138/ EC shall be treated separately. 13.For the purpose of the calculation of solvency requirements, each sector shall respect the requirements as calculated under the relevant sectoral rules. When summing the relevant sectoral solvency requirements there shall be no adjustment other than as foreseen by Article 1 1 of Title I I or as caused by adjustments to sectoral thresholds and limits pursuant to point 9 of this Article 14.

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EXPLANATORY TEXT for consultation purposes ACCOUNTI NG CONSOLIDATI ON AND JOINT CONTROLLED ENTITIES (Points 1, 2 and 7)
Under Method 1, the Directive requires the calculation of the own funds of the conglomerate on the basis of the consolidated position of the group. In addition, any inappropriate intra-group creation of own funds must be eliminated. In order to ensure these provisions are respected, points 1 and 2 of Article 14 requires the conglomerate to use consolidated accounts (applied to the scope of the conglomerate) as the starting point for the calculation of the own funds. In doing so, the conglomerate must allow all eliminations of own funds arising from the process of accounting consolidation to take place. Joint-controlled entities are to be proportionally consolidated in line with point 6.

OTHER IN TRA-GROUP CREATION OF OWN FUNDS (Point 6)
In line with the Directive‘s principles, Article 3 of this Regulation calls for the elimination of all own funds that have been created by intra-group transactions, be it direct or indirect. For the avoidance of doubt in the context of Method 1, point 5 further specifies that all intra-group creation of own funds should be eliminated on top of accounting consolidation, if not already eliminated as part of the accounting consolidation process. Such additional elimination may be required in particular where the treatment of the participation called for by the Directive is different from that provided for by accounting rules, considered that accounting rules
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doesn‘t consider the multiple gearing issue.

CROSS SECTOR HOLDINGS AN D OTH ER H OLDINGS (Points 3, 4 and 5)
For bank-led and investment firm-led conglomerates, the calculation of own funds at the level of the conglomerate should also take into account that the sectoral rules allow institutions to risk weight and not deduct some cross-sector holdings. For this reason, in order to ensure the elimination of multiple gearing at the level of conglomerate, point 3 of Article 14 requires the deduction of holdings that are neither consolidated nor eliminated (by deduction) at sectoral level, where those holdings are in entities belonging to the insurance sector. Point 4 describes the treatment of unconsolidated non-significant investment holdings where those holdings are in entities belonging to insurance entities. Point 5 describes the treatment of other holdings, specifying that other holdings are treated according to sectoral rules (see the table in Annex I I ).

SOLVENCY 2 VALUATION CRITERIA (Points 8)
For insurance parts of the conglomerate, given that Article 75 of Directive 2009/ 138/ EU sets out specific valuation rules for assets and liabilities, point 8 of Article 14 specifies that assets and liabilities for those entities within the conglomerate should follow the valuations calculated for the purpose of Directive 2009/ 138/EU. This point is aimed at ensuring that the calculation of the elements of own funds at the level of conglomerate is consistent with sectoral rules.

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RECALCULATI ON OF LI M ITS AND THRESHOLDS, TAKING I NTO ACCOUNT REMOVAL OF H OLDINGS (Points 9)
Once the accounting consolidation has been carried out, as well as the other provisions already mentioned, amounts of CET1 attributable to conglomerate entities that are subject to CRR at sectoral level, as well as amounts of holdings belonging to such entities that are neither deducted nor consolidated, will change.

So the calculations based on CET1 in Article 45 of CRR, which measure the threshold for the deduction of deferred tax assets and significant investments, should be recalculated.
The recalculation should take into account the effect on CET1 of the conglomerate accounting consolidation process, proportional consolidation in accordance with point 7, the removal of holdings in point 3, and any other factors stemming from the conglomerate calculation that have led to a change in CET1 . In the calculation according to Article 45 of CRR for an entity or group of entities, the deferred tax assets and significant investments to be taken into account are only those belonging to that entity or group of entities within the conglomerate. These rules are provided for in point 9.

MULTI -LAYER CONGLOMERATES (Points 10, 1 1 and 12)
This Regulation recognises that financial conglomerate structures may be very complex and involve different layers (see graph example below).

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In cases like this, where a banking group controls an insurance group, which – in turn – controls a bank, in order to calculate the limits or thresholds provided at sectoral level, the data of the banking group at the top of the group shall not be calculated jointly with the data belonging to the bank (B) controlled by the insurance group. In this case, bank (B) calculates a threshold on its Deferred Tax Assets. Bearing in mind that the Directive states the elements eligible for the calculation of the own funds are those that qualify in accordance with the relevant sectoral rules, point 10 calls for the relevant groupings at sectoral level to be maintained also at the conglomerate level for the purposes of calculating limits and thresholds.

SOLVENCY REQUIREMENTS (Point 13)
Finally, point 13 specifies that the calculation of solvency requirements is based on the sum of sectoral and notional requirements, except for the provision included in Article 1 1 (no capital charge for holdings that are consolidated or deducted at the conglomerate level).

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See also the Annex - Summary of the treatment of holdings and participations for the purpose of the calculation of the own funds of the conglomerate.

Article 15 Method 2 Calculation criteria
1. For the purpose of calculating Method 2 as set out in Annex I part I I of the Directive: (a)The proportional share applicable to own funds and solvency requirements shall relate to the proportion of the subscribed capital which is directly or indirectly held by the parent undertaking or undertaking which holds a participation in another entity of the group; (b)The book value of participations in other entities of the group shall be the book accounting value for the parent undertaking or for the undertaking that holds a participation in another entity of the group; (c)Where the own funds of a holding is subject to a prudential filter, the filtered amounts shall be: i)Added to the book value mentioned in b), if the filtered amount increases regulatory capital; or ii)Deducted from the book value mentioned in b), if filtered amount decreases regulatory capital. (d) For the purpose of point (c), the filtered amounts pertains to the net amount affecting own funds of the holding. 2. For bank-led and investment firm-led conglomerates, significant investments in a financial sector entity pursuant to Article 40 of the CRR, if the entity belongs to the insurance sector as defined in Article 2(8) of the Directive, shall be: (a) Fully deducted, where the holding is not a participation as defined in Article 2(1 1) of the Directive, and
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(b) Treated according to Method 2, where the holding is a participation as defined in Article 2(1 1). 3.For insurance-led conglomerates, participation as defined in Article 2(11) of the Directive shall be considered for the application of point 1. 4.For the purpose of the first point, to eliminate the intra-group creation of own funds, the eligible amount of intra-group investments in any capital instruments that are eligible as regulatory capital, respecting relevant sectoral limits, shall be eliminated.

EXPLANATORY TEXT for consultation purposes
Point 1(c) addresses cases where prudential filters affect the own funds of a participation for prudential purposes by adding back unrealised losses or subtracting unrealised gains, for example in the case of a holding held in the Available For Sale category. If this is the case, the effect of the prudential filter should be reversed [by adjusting the book value of the participation to be deducted]. Without this reversal the filtering of unrealised gains would unduly reduce own funds after deduction of accounting book value, while the filtering of unrealised losses would unduly flatter own funds after the deduction of accounting book value. Referring to the formula in the Annex: if, because of the application of a prudential filter the Own Funds term xi(OFi-REQi) changes, then its effect should be neutralized by an offsetting adjustment in the book value term: BVi. See also the Annex - Summary of the treatment of holdings and participations for the purpose of the calculation of the own funds of the conglomerate.

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Article 16 Method 3 Calculation criteria
1. The competent authorities may permit the financial conglomerate to use a combination of methods 1 and 2, only where the financial conglomerate can demonstrate to the competent authorities that its request has been made: (a) Further to its best effort to apply either, Methods 1 or 2; and (b) Having regard to the cases in Article 6 (5) of the Directive. 2.If several entities are collectively of non neglible interest, the competent authorities shall take this into account in assessing the request to use Method 3. 3.The application of the specific combination of Methods 1 and 2 to entities within the financial conglomerate that was permitted by competent authorities shall be applied in a consistent manner over time. 4.The coordinator shall consult the other relevant competent authorities before taking a decision on whether to permit the use of the combination of methods 1 and 2.

EXPLANATORY TEXT for consultation purposes
Article 6 (5) (a) (b) and (c) of the Directive states: ―(a) I f the entity is situated in a third country where there are legal impediments to the transfer of the necessary information, without prejudice to the sectoral rules regarding the obligation of competent authorities to refuse authorisation where the effective exercise of their supervisory functions is prevented; (b) I f the entity is of negligible interest with respect to the objectives of the supplementary supervision of regulated entities in a financial conglomerate;
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(c) If the inclusion of the entity would be inappropriate or misleading with respect to the objectives of supplementary supervision.
However, if several entities are to be excluded pursuant to (b) of the first subparagraph, they must nevertheless be included when collectively they are of non-negligible interest.‖

TIT LE I V Final provisions Article 17
This Regulation shall enter into force on the twentieth day following that of its publication in the Official Journal of the European Union. This Regulation shall be binding in its entirety and directly applicable in all Member States. Done at Brussels, For the Commission The President [For the Commission On behalf of the President [Position]

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ANNEX I Calculation methodology for Method 2 – Deduction and aggregation method
1. General principles
The calculation of method 2 shall be carried out on the basis of the regulatory reporting required under the applicable accounting framework of each of the entities in the group following the formulaic expression below:

where own funds (OFi) exclude intra-group capital instruments. The supplementary capital adequacy requirements (scar) shall thus be calculated as the difference between: (1)The sum of the own funds (OFi) of each regulated and non-regulated financial sector entity (i) in the financial conglomerate; the elements eligible are those which qualify in accordance with the relevant sectoral rules; and (2)The sum of the solvency requirements (REQi) for each regulated and non-regulated financial sector entity (i) in the group (G); the solvency requirements shall be calculated in accordance with the relevant sectoral rules; and the book value (BVi) of the participations in other entities (i) of the group. In the case of non-regulated financial sector entities, a notional solvency requirement shall be calculated according to Article 1 1. Own funds and solvency requirements shall be taken into account for their proportional share (x) as provided for in Article 6(4) and in accordance with Annex I .
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The difference shall not be negative.

ANNEX I I - Summary of the treatment of holdings and participations for the purpose of the calculation of the own funds of the conglomerate

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V. Accompanying documents a. Draft Cost- Benefit Analysis / I mpact Assessment
1. Introduction
According to CRDIV / CRR proposals, the EBA, EIOPA and ESMA (hereafter the ESAs) through the Joint Committee, shall develop draft regulatory technical standards with regard to the conditions of the application of the Article 6(2) of the Directive, and shall submit those draft regulatory technical standards to the Commission by 1 January 2013. The Technical Standard describes how institutions following the consolidation methods set out in this Directive shall calculate own funds in the parent institution in a financial conglomerate. The standard introduces restrictions on which elements of own funds in subsidiaries and other participated entities of a financial conglomerate can be used in the calculation of own funds. The main rationale underpinning this Technical Standard is to avoid an ―inflated‖ calculation of own funds of cross-sector financial conglomerates. This Technical Standard focuses on harmonising the calculation of financial conglomerates‘ own funds.

2. Problem definition
A lesson learned from recent financial crises is that the regulation of supplementary supervision, in particular the current set of rules on determining own funds at the conglomerate level, deserves a thorough rethink. For example, in the recent past it became clear that parent institutions could report strong levels of own funds, giving an impression of a robust solvency.

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In some cases that impression turned out to be misleading as significant amounts of own funds were, in practice, locked-in in the subsidiaries.
This consequently rendered the Directive‘s assumption of availability of funds at the conglomerate level rather uncertain - because of a lack of harmonisation of rules on conglomerate own funds. This affects the ability of conglomerates‘ own funds to absorb losses, which makes financial conglomerates more fragile than figures on own funds would suggest.

Multiple gearing
Uncertainties in the application of the methods for determining own funds at the conglomerate level may have led to undesirable levels of multiple gearing. This Technical Standard therefore builds upon the Directive and contributes to achieving its objective to eliminate the multiple use of elements eligible for the calculation of own funds at the level of the financial conglomerate (see for example Recital 7, Article 31 point 2, and Annex I , section I of the Directive).

Methods to determine Own funds at the Financial Conglomerate Level.
Uncertainties in the guidance about the choice of methods for determining own funds at the conglomerate level may have led to an arbitrary combination of the methods that are offered under Annex I of the Directive.

This Technical Standard therefore provides additional clarity on the calculation methods for conglomerate own funds.

3. Objectives of the Technical Standard
The objective of this Technical Standard is to achieve a more consistent
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harmonisation of the calculation methods of Own Funds listed in Annex I of Directive.
This should translate in increased efficiency and effectiveness of conglomerate supervision by competent authorities, more clarity on the availability and transferability of own funds for the conglomerate, as well as tightly controlled levels of multiple gearing.

4. Options
Annex I of the Directive, describes three methods to calculate a conglomerate‘s own funds. This Technical Standard concentrates on the application of these methods. There is not a wide selection of options available for this Technical Standard. Any choice made with respect to this Technical Standard derives from the text of relevant Directives, predominantly the sectoral directives, CRR /CRD4 and Solvency I I.

The guiding principles used by this Technical Standard to achieve more consistent harmonisation of calculation methods mentioned in Annex I of the Directive are:
1.To offer clarity in rules regarding transferability and availability of conglomerate own funds, 2.To eliminate the multiple use of elements eligible for the calculation of own funds at the level of the financial conglomerate, 3.To avoid double deduction of items and amounts from own funds, and 4.To respect sectoral rules.

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Method 1
Method 1 is based on consolidated position of the conglomerate in order to avoid multiple gearing. For this purpose, the RTS requires the elimination of all intra-group creation of own funds; the scope of the group is defined according to article 2, point 12 of the Directive. Adjustments are required to sectoral rules in the treatment of banking cross holdings and some instructions not included in the Directive are provided for unregulated entities. According to the Directive provisions, the capital requirements are calculated as sum of sectoral requirements without the elimination of intra-group transactions.

Method 2
The description of this method in its current form is already quite prescriptive and unambiguous. However, this Technical Standard elaborates on two issues that may lead to disharmonised interpretations: i.The proportional share applicable to own funds and solvency requirements; ii.The interpretation of the book value of participations in other entities of the group. With respect to the latter issue, this Technical Standard uses the book value from the accounts of the parent as a starting point, but applies adjustments to any book values subjected to prudential filters in order to safeguard consistency in the calculation of this method‘s deduction of book value.

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The method requires, according to the general principle of avoiding inappropriate creation of intra-group own funds, the deductions of all the intra-group investments in capital instruments eligible according to sectoral rules.
This provision ensure also an equivalence between this method of calculation of the own funds and the others allowed according to the Directive.

Method 3
The use of combination of methods 1 and 2 is limited only to the cases where the use of either method 1 or method 2 solely would not be appropriate due, for example, to the lack of information on specific entities within the group.
The use of method 3 shall need the permission of the competent authorities or the coordinator after consultation of the relevant other competent authorities. The combination method 3 shall be applied in a consistent manner over time. The supervisory consent is needed in order to prevent regulatory arbitrage.

5. Impacts
This technical standard‘s objective is to achieve a more consistent harmonization of the methods mentioned in Annex I of the Directive. This may limit the degree of freedom with respect to the ways of calculating own funds of conglomerates. The expected impact compared to the sectoral rules for insurance-led conglomerate that apply method 1 of the Directive, where the scope of the insurance group under Solvency I I is not the same as the financial conglomerate under the Directive (see Article 7), is due mainly to the line by line consolidation of the items of the banking subsidiaries and
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banking joint controlled entities instead of the consolidation procedures provided under the Solvency 2 framework.
In the case the scope is the same or difference is not material, insurance-led conglomerate applies Solvency 2 rules as they will be defined in the implementing measures Solvency 2. For banking-led and investment firm-led conglomerate the main expected impact compared to the sectoral rules is due to the consolidation of the insurance subsidiaries and joint controlled insurance entities that are risk weighted or deducted according to CRR. Both insurance and banking group shall also adjust, where applicable, the amount of the threshold and parameters used for their eligibility limits (for example, thresholds on Deferred Tax Assets and on deduction of holdings under Article 45 of CRR), considering the effect of the consolidation of cross sector holdings at conglomerate level. Insurance, bank and investment firm-led conglomerates shall take into account of limits to transferability and availability of own funds as foreseen in the Technical Standard. A cost factor relates to the alignment of the entities to the requirements of this Technical Standard. Such costs may arise if current national regulations need to be amended to comply with the Technical Standard. Another cost factor may arise in the cases where competent authorities are called upon to approve the use of Method 3. Lastly, this Technical Standard may also affect the business model for a group to organize itself as a financial conglomerate. There are a number of expected benefits related to this Technical Standard. They are: i. More consistency in the selection and application of the methods of
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Annex I of the Directive;
ii.Increased efficiency and effectiveness of conglomerate supervision; iii.More clarity on the amount, availability, and transferability of own funds within a financial conglomerate; iv. More effective loss absorption of the capital held by conglomerates; v.An increased standardization of the use of the methods, leading to lower costs of their application; and vi. A contribution to greater financial stability.

b. Overview of questions for Consultation
1.What are the cost implications of a requirement for conglomerates to follow the clarifications for calculating own funds and solvency requirements described in this paper? If possible, please provide estimates of incremental compliance cost that may arise from the requirements, relative to following the Directive in the absence of the Regulatory Technical Standards. 2.How, in your opinion would the proposed clarifications impact on conglomerates‘ business models? 3.How far would the suggested clarifications change current market practices? 4.Are the Technical Principles in Title I I sufficiently clear?I f not, what areas require further clarification? 5.Are there any areas of ambiguity in the way that the Technical Principles in Title I I apply to the three consolidation methods? 6.Are there any areas of ambiguity in the way that Method 1 needs to be carried out?
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7.How much of an operational burden is the use of consolidated accounts of the conglomerate as a starting point for Method 1? Is there an alternative more straightforward method/ way to eliminate the intra-group creation of own funds?
8.Do you foresee any problems in applying sectoral rules to own funds under Method 1? I f so, what refinements to the method would you propose? 9.Are they any areas of ambiguity in the way that Method 2 needs to be carried out? 10.For the purpose of assessing the transferability of ―funds‖ to entities subject to CRR, under Article 4, is ―three calendar days‖ a sufficient timeframe in a period of stress?

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NUMBER 3

Cryptographic Key Management Workshop 2012
Purpose: NIST is conducting a two-day Key Management Workshop on September 10-1 1. The subject of the workshop is the technical and administrative aspects of Cryptographic Key Management Systems (CKMSs) that currently exist and may be required for U.S. Federal use in the future. The first day will review the DRAFT NIST Special Publication 800-130 (―A Framework for Designing CKMS‖) and the DRAFT NIST Special Publication 800-152 (―A Profile for U.S. Federal CKMS‖) and solicit comments from the workshop participants on the DRAFT documents. The second day will focus on CKMS capabilities in future security products and services in new U.S. Federal Information Systems. Input from Workshop participants will be solicited regarding the utility and feasibility of these capabilities as well as suggestions for other technical capabilities required in future CKMSs. Call for Presentations During the development of SP 800-130 (the Key Management Framework) and SP 800-152 (the Profile document), NIST identified a number of properties as particularly hard problems associated with secure Cryptographic Key Management Systems (CKMS). These problems include: - Cryptographic - Agility - Scalability - Anonymity - Unlinkability
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- Unobservability
- Usability - Compromise recovery - Multi-level security domains - Negotiating and enforcing domain security policies, including a Policy Language for enabling negotiation and enforcement -Interaction between domains, each with its own security policies

The second day of the workshop will focus on these and other hard problems.
NIST requests the submission of abstracts for presentation about these and other problems associated with key management systems. Start Date: Monday, September 10, 2012 End Date: Tuesday, September 1 1, 2012 Location: NIST-Gaithersburg, MD - Administration Building/ Lecture Room B Audience: Industry, Government, Academia Format: Workshop All attendees must be pre-registered to gain entry to the N IST campus. Photo identification must be presented at the main gate to be admitted to the conference. International attendees are required to present a passport.

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NUMBER 4

Short Selling Regulation Update
Market Maker & Primary Dealer Exemption N otification Procedure The European Securities and Markets Authority (ESMA) is publishing this notice to alert financial market participants to its upcoming consultation on the market making and authorised primary dealer exemption under the EU‘s Short Selling Regulation (SSR) and the procedure to be followed by firms and regulators in dealing with notifications of intention to use the exemption. The SSR becomes applicable from 1 November 2012, but allows participants to notify securities regulators of their intention to use the exemption from 1 September 2012. To ensure a level playing field between market participants, consistency of market practice and convergence of supervisory practices across the EEA Member States ESMA intends to publish a consultation paper on guidelines on market making activities and on the common approach to the application of the exemption in mid-September, being finalised after 1 November. Without prejudice of the outcome of the consultation, the intention is that this consultation paper is used as an interim benchmark by securities regulators for the application of the exemption and by market participants in their notification to competent authorities.

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NUMBER 5

Preliminary Annual Report on U.S. Holdings of Foreign Securities
Preliminary data from an annual survey of U.S. portfolio holdings of foreign securities at year-end 2011 were released. Final survey results, which will include additional detail as well as revisions to the data, will be reported on October 31, 2012. The survey was undertaken jointly by the U.S. Department of the Treasury, the Federal Reserve Bank of New York, and the Board of Governors of the Federal Reserve System.

A complementary survey measuring foreign holdings of U.S. securities also is conducted annually.
Data from the most recent such survey, which reports on securities held on June 30, 2012, are currently being processed. Preliminary results are expected to be reported on February 28, 2013.

Overall Preliminary Results
The survey measured the value of U.S. holdings of foreign securities at year-end 2011 of approximately $6.8 trillion, with $4.5 trillion held in foreign equities, $2.0 trillion held in foreign long-term debt securities (original term-to-maturity in excess of one year), and $0.4 trillion held in foreign short-term debt securities.

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The previous such survey, conducted as of year-end 2010, measured the value of U.S. holdings of $6.8 trillion, with $4.6 trillion held in foreign equities, $1.7 trillion held in foreign long-term debt securities, and $0.4 trillion held in foreign short-term debt securities.

[1] The stock of foreign securities for December 31, 2011, reported in this survey may not, for a number of reasons, correspond to the stock of foreign securities on December 31, 2010, plus cumulative flows reported in Treasury‘s transactions reporting system.

The final report on U.S. holdings of foreign securities as of end-year 2011 will contain an analysis of the relationship between the stock and flow data.

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NUMBER 6
Dr Andreas Dombret Member of the Executive Board of the Deutsche Bundesbank

Foreign banks between financial crisis and financial stability
Speech held to mark the 30th anniversary of the Association of Foreign Banks in Germany

1 I ntroduction
Ladies and gentlemen Let me begin by offering the Bundesbank‘s warm congratulations to you, Mr Winter, and all the members of the Association of Foreign Banks in Germany on its jubilee 30th anniversary.

Thirty years is quite a long period of time – nearly one-third of a century – and something of a landmark.

As the old saying used to go, ―Never trust anyone over 30‖.
That catchphrase was popularised by the 1968 student movement – the students who used it are now themselves over 60! Trust is indeed the key word. I ts importance is being learned by governments and banks alike as the sovereign debt and financial crisis tightens.

So it is a good thing that the day-to-day dealings between the banking associations and individual banks, on the one hand, and central banks and supervisory authorities, on the other, are characterised by mutual confidence and trust – notwithstanding the necessary arm‘s-length relationship between central banks and supervisory authorities, on the one hand, and banks and their associations, on the other.
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I can say that because I have worked in both camps.
I was once a foreign banker myself. Since joining the Bundesbank in 2010, I have had a chance to see things from the other perspective. I would like to take this opportunity to thank you for the constructive cooperation I have been privileged to enjoy with all banking associations over the past two years. I hope that this cordial relationship will continue in future – including after the possible emergence of a new, overarching single European supervisory body. If it is carefully conceived and constructed, it could make an important contribution to safeguarding financial stability. And it might well refashion the current triangular relationship between banks, supervisors and central banks. Let me nail my colours to the mast right away: I do not believe that it is absolutely essential for the central bank to have ultimate supervisory responsibility in order to capitalise on the synergies provided by central banks‘ macroeconomic and macroprudential expertise.

The crucial requirement is the efficient exchange of information.

2 Stimulating competition
In his book Fault Lines - How Hidden Fractures Still Threaten the World Economy, former IM F chief economist Raghuram Rajan argues that a fault line is created when two different financial systems based on different principles interact. He is referring to the contrasting cultures of the capital markets and relationship banking.

Financial market integration has certainly increased the possibilities of contagion.
However, I do not believe that the ―fault line‖ necessarily runs along the border between the capital market and relationship banking.

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Seen from the perspective of a universal bank, drawing a rigid distinction between capital market orientation and a banking philosophy seems a huge oversimplification.
Germany‘s universal banks came through the financial crisis pretty well on the whole. And the contacts between foreign banks and German banks have stimulated and enlivened competition, benefiting both groups of banks. Moreover, it should be noted that the foreign banks operating in Germany, which each bear the specific hallmarks of their home country, are probably the most heterogeneous group of banks included in the Bundesbank‘s statistics. How important are foreign banks in Germany‘s banking system? For many foreign banks, traditional banking activities account for just a small part of their business. This makes their market share – currently 12.9% measured in terms of total assets – all the more remarkable. This trend has been driven by the arrival of new banks through mergers as well as growth, particularly in deposit business and instalment loans. The approximately 30,000 members of staff employed by foreign banks at the German financial centre do make quite a meaningful impact on employment. These figures point to a significant influence. In some business lines, especially those involving the capital markets, foreign banks have a much more prominent position than in traditional banking fields. Today, it is hard to imagine M&A activity in Germany without the influence of the Anglo-American banking culture. Foreign banks play an important role in advising and assisting on German corporate bond issues; the same goes for IPOs and capital increases.

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The financial crisis has naturally also led to the market withdrawal of individual foreign banks.
On the whole, however, it has thankfully not triggered a mass exodus of foreign banks from Germany – unlike in some other countries. For a long time, foreign banks struggled to gain a foothold in the German market. Banks that accept deposits and grant loans normally had to begin by setting up a branch network as a prerequisite for winning new customers.

The creation of the single market in Europe has made things much easier.
The European Passport made it possible to set up branches anywhere in the EU without requiring additional authorisation. However, barriers to market entry still remained. These included the high overhead costs of creating a branch network, the challenge of finding skilled staff, the continued strong importance of brand names, and the justifiably high reputation of German banks among German clients. In this tough business environment, foreign banks wanting to expand into Germany had to rely on innovation and cost-efficiency. They were given a helping hand by liberalisation and the technological advances of the internet in the 1990s; this gave foreign banks a fast and low-cost channel for communicating with customers. And they seized their chance. Some foreign banks therefore set up shop as online banks to conduct deposit business but also to engage in business with standardised consumer loans.

For retail customers this translated directly into a larger product range at lower prices.
That is good both for customers and for competition. Providing advice and expertise to enterprises is a key investment banking service, and one from which German firms have benefited.
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That requires putting down roots in the real economy and offering a real service.
And the last few years have taught us that foreign banks with roots in the real sector are unlikely to pull out in times of financial crisis. Integrated financial markets per se enhance economic growth and our prosperity. Foreign banks in Germany constitute a part of this financial market integration.

The downside of integration is that market players are much more interconnected, which means that crises spill over more quickly from one country to another.
This can lead to dislocations. However, that is simply the reality of today‘s financial world.

3 Capital: the key to greater trust
Having, or building up, sufficient capital is essential, particularly in the current climate. And it is also crucial to restoring confidence and trust.

In its last Financial Stability Review, the Bundesbank wrote that, in times of systemic stress, ―the task of restoring confidence is not merely the responsibility of an individual bank but also a call to arms for the system as a whole.‖
This demands not just adequate capitalisation of national banking systems but also convincing Europe-wide solutions. I ‘ ll make no bones about it: a level of capitalisation that just meets the minimum supervisory requirements would fall far short of what is needed, in my view.

I think it was the UK economist Charles Goodhart who told the following tale to illustrate the dangers of minimalist compliance.

A weary traveller arrives at a rural railway station. To his delight, he sees exactly one taxi waiting there and asks the driver to take him to his destination.
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To his amazement, the cabdriver tells him: ―I would love to take you there but cannot, I ‘m afraid.‖
―Why not?‖, he asks, flabbergasted. ―There is a local bye-law that says a taxi has to be here at all times.‖ ―But a taxi is here.‖ ―Ah yes, but if I take you home, there would no longer be a taxi waiting here. That would violate the bye-law.‖
This is what can happen with statutory minimum requirements. Only capital in excess of the minimum requirements is available to truly and independently absorb business risk. In an actual crisis, it is only this capital that can be used to buy the time needed, for instance, to write down impaired assets, adjust portfolios or restructure business units. In an ideal world, of course, such buffers should be built up before systemic events occur. That is the rationale behind capital cushions. They provide a certain breathing space before institutions are forced to unload risky assets and curb their lending. If the buffers are too small, however, the pressure to deleverage during a shock can become overwhelming and cyclical movements may be amplified. This is where public capital assistance comes into play. I n theory, it provides a counterweight and reduces deleveraging pressure.

4 Getting the basics right: aspects of a European system of banking supervision
The reality can be much rougher, however, for a euro-area country that is struggling to cope with the close interlinkages between the sovereign debt crisis and the banking crisis.

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The stability of the banking sector is then called into question because the country is no longer regarded as being fully capable of resolving its banking crisis unassisted.
For such cases, the EFSF has clear rules according to which other euro-area countries can step in to help that country. The affected country remains the partner for the donor countries‘ assistance. By providing such assistance, the donor countries are already taking on considerable risks. Extending this risk-sharing role, as is being proposed in connection with a banking union – in the form, for example, of a European restructuring fund or a European deposit insurance scheme – would necessitate far more extensive intervention in countries‘ national sovereignty and in their fiscal and economic policies. I hope you will agree with me that joint liability must not be allowed to be introduced covertly through the back door. Instead, joint liability must be predicated on two basic principles. One is the unity of liability and control. As long as control rests with nation-states, liability must rest there, too. This is important to avoid promoting excessively risky business models that threaten financial stability. Moreover, no incentives should be created to build a bloated financial industry in individual countries that is way out of proportion to the size of the real economy. The other principle that must be observed is taking the appropriate steps in the right order. The logical sequence requires, first, further moves towards European control, which in turn necessitate democratic legitimacy and accountability. I am firmly convinced that all concrete proposals must be informed by these considerations and guided by these principles.

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Moreover, many important details remain to be clarified. These remaining uncertainties have perhaps contributed to the intensity of the recent public debate on this topic.
In a situation marked by uncertainty it can even happen that one or two economics professors sign both a petition and the corresponding counter-petition. And this does not even have to be a contradiction if the two countervailing positions depart from different assumptions concerning the principles and the details of their implementation.

One of the questions regarding a possible pan-European banking supervision regime that still needs to be clarified is the range of countries that will be subject to it: should it cover all EU member-states or only the euro-area countries?
Given the interlinkages between financial institutions throughout the EU and against the background of the single market, I see merits in integrating all EU member-states in a European supervisory structure. This would strengthen the single market, it would be consistent with the Single Rule Book, and it would help to create a level playing field. Taking this logic further, it would make sense in principle for all banks to be supervised by this European authority. In line with the principle of subsidiarity, the European supervisory authority could then delegate the supervision of systemically unimportant banks to national authorities, subject to the proviso that such banks could then be brought back into the fold of European supervision on a case-by-case basis. I believe a Europe-wide prudential regime would definitely benefit from the operational involvement of national supervisory agencies. Such involvement, in fact, may well be essential. A key issue for central banks is the precise nature of their involvement in European banking supervision.

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There can be little doubt that they ought to play a role, given their wealth of macroeconomic and macroprudential expertise, as this is the only way to exploit synergies.
The question, however, is how this can be best accomplished. I believe that central banks do not necessarily need to assume ultimate responsibility for supervision. The key imperative is, rather, for supervisory agencies and central banks to cooperate efficiently and, above all, to exchange information. In my view, this would be consistent with central bank involvement in operational supervision. In this manner, potential conflicts with ensuring the independence of monetary policy can be avoided and the credibility of central banks maintained. It follows from this that an agency other than the ECB could be given ultimate responsibility for supervision. Supervisory powers imply extensive rights of intervention which, in turn, require direct democratic legitimacy and accountability. Thus if the central bank were to have ultimate sovereign responsibility, its independence would have to be constrained. And let us not forget either that monetary policy decisions can also impact on banks‘ robustness. This might well cause a conflict of objectives. All of these arguments are, I believe, sound reasons not to transfer ultimate responsibility to the ECB but, instead, to a different authority headed by a council in which the banks‘ home countries are adequately represented. Such representation should reflect the size of each country‘s banking industry. In such a set-up, the ECB would undoubtedly play a particularly important and wide-ranging advisory role.

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Whatever solution is ultimately implemented, I am firmly convinced that monetary policy and prudential supervision should be kept as far apart as possible.
If a European supervisory regime is based on the right principles and its detailed workings are well thought out and implemented, it has a good chance of making a major contribution to financial stability.

5 Conclusions
Those are a few thoughts that I wanted to share with you going forward. Your anniversary has undoubtedly come at a critical juncture for the world of finance. The sovereign debt and banking crisis will probably keep us occupied for quite some time to come. The problems are deep rooted. The future will tell how well we have been able to cope with the challenges of our time. However, of this I am convinced: if the right measures are taken, a very good solution will emerge in the end.

On this note, I would like to congratulate you once again on your landmark anniversary and thank you for being such an attentive audience.

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NUMBER 7

A. Economic activity and prices in Japan and monetary policy
Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Ishikawa, 2 August 2012.

I. Recent financial and economic developments A. Global financial markets and overseas economies 1. Global financial markets
I would like to start with developments in global financial markets and overseas economies, which affect Japan‘s economy. Global financial markets have recently been characterized by a repetitive pattern of rising and declining pessimism reflecting developments in the European debt problem.

From the middle of 2011 toward the end of the year, strains in markets increased due to concerns over the sustainability of public finances in peripheral countries.
From the turn of 2012 toward early spring, there were phases of easing strains due to the introduction of measures to strengthen fiscal discipline in the member states of the European Union (EU), the decision on the second financial support program for Greece by the euro area member states and the I nternational Monetary Fund (IM F), and the agreement to raise the lending capacity of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). Nevertheless, markets became nervous again from early spring: there was talk of a euro crisis due to the turmoil in the domestic political situation in Greece, and in Spain yields on 10-year government bonds temporarily

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rose above 7 percent due to concerns about the stability of its financial system.
Subsequently, a new government was inaugurated in Greece, and the EU and Eurozone summits at the end of June emphasized the need to strengthen growth and agreed to take steps to establish a single supervisory body for eurozone banks with a view to making it possible for the ESM to recapitalize banks directly. These decisions raised hopes that the vicious circle between uncertainty over Spain‘s financial system and increasing government debt would be broken, and markets temporarily regained stability. This situation, however, did not last long. At present, yields on 10-year Spanish government bonds are hovering at around 7 percent. On the other hand, interbank funding markets have generally been stable since the beginning of 2012 due to the abundant liquidity provision by the European Central Bank (ECB). It appears, however, that it will take some more time until uncertainties are dispelled over the fiscal and economic structural reforms as well as over measures regarding the financial system in Europe. Thus, developments in the European debt problem continue to warrant careful attention.

2. Overseas economies
Under these circumstances, overseas economies have shown some improvement, albeit moderate, but on the whole they have not emerged from a deceleration phase. By region, economic activity in the euro area continues to be sluggish, despite signs of a pick-up in exports, because domestic demand in the area has been stagnant.
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Peripheral countries in particular have fallen into a vicious circle, in which the downturn in economic activity due to fiscal austerity measures and the deterioration in financial conditions lead to a further worsening of the financial conditions of governments and financial institutions.
As a result, disparities between economic sentiment in core countries such as Germany and in peripheral countries are widening. For example, the unemployment rate in Germany stands at around 5 percent, which is a historical low since the reunification of East and West Germany, while in Spain it has reached well over 20 percent and the youth unemployment rate is in excess of 50 percent. Moreover, the deterioration in the economies of peripheral countries is affecting business sentiment in core countries, and thus the European economy is likely to remain sluggish for the time being. Next, the U.S. economy is generally continuing to recover at a moderate pace. Private consumption has been firm due in part to an increase in real purchasing power reflecting the decline in gasoline prices, and the housing market has shown some signs of picking up. Business fixed investment has recently maintained its uptrend against the background of solid corporate profits. However, signs of weakness have been observed in business sentiment, and the momentum of growth in employment has recently been slowing. Furthermore, amid persisting strains from balance-sheet adjustments, households and firms are not likely to increase their spending due to concerns over the adverse impact of the European debt problem as well as uncertainty regarding the ―fiscal cliff,‖ that is, fiscal spending cuts scheduled to be implemented at the beginning of 2013 and the handling of tax cuts set to expire at the end of 2012.

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Taking these factors into account, the U.S. economy is likely to recover at only a moderate pace.
Emerging and commodity-exporting economies still have not emerged from a phase of sluggishness, but on the whole these economies have maintained relatively high growth backed by firm domestic demand. The pace of growth in the Chinese economy has slowed reflecting the deceleration in private real estate investment as a result of monetary tightening earlier, but there are also signs that the slowdown is bottoming out, such as the increasing trend in exports and bank lending. The Chinese government has accelerated approvals for infrastructure investment and introduced subsidies for energy-saving electrical appliances and other goods. With the pace of consumer price inflation decelerating, the authorities have also started stimulating the economy on the monetary front, lowering the benchmark lending rates for two consecutive months. Looking ahead, the growth rate of the Chinese economy is unlikely to reach dramatic levels, but it is likely to rise gradually as these policy measures start producing effects. In the NIEs and the ASEAN economies, exports have been affected by the slowdown in Europe and China, but domestic demand has been firm on the whole, and production has been recovering moderately. As for the outlook, including other emerging economies such as Brazil, the growth rate of emerging and commodity-exporting economies will likely increase gradually reflecting accommodative financial conditions and a recovery in real purchasing power following a decline in inflation rates.

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B. Japan‘s Economy
1. Economic activity
I will now explain the current state of, and outlook for, Japan‘s economy based on the overseas economic developments I have just outlined. Until the beginning of autumn 2011, Japan‘s economy picked up steadily following the plunge caused by the Great East Japan Earthquake, which struck just as the economy was recovering from the Lehman shock.

Thereafter, however, it remained more or less flat on the whole until around the early spring of 2012 mainly due to the adverse effects of the slowdown in overseas economies and the appreciation of the yen.
More recently, with domestic demand remaining firm – led by reconstruction-related demand and private consumption – and exports continuing to show signs of picking-up, economic activity on the whole has started picking up moderately. The firmness in domestic demand is attributable to the following factors. Demand for restoration and reconstruction of social infrastructure and of disaster-stricken facilities and homes has led to increases in public investment, business fixed investment, and housing investment. Reconstruction-related demand has also been underpinned by changes in the behavior of firms and households triggered by the disaster. Examples are efforts to strengthen the earthquake resistance of buildings and facilities and to bolster business continuity systems, investment in the area of new energy sources, and the purchase of energy-saving products. Meanwhile, private consumption has been boosted by pent-up demand, that is, a recovery in demand following the temporary restraint due to the effects of the disaster, and by policy measures such as subsidies for purchasers of environmentally friendly cars.

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Private consumption has also been pushed up by an increase in spending on products and services provided by businesses targeting the elderly reflecting firms‘ efforts to enhance their line-up in this area.
Although considerable uncertainty remains regarding the outlook, Japan‘s economy, with domestic demand remaining firm and overseas economies emerging from their phase of deceleration, is expected to return to a moderate recovery path, as also shown in the June 2012 Tankan (ShortTerm Economic Survey of Enterprises in Japan) and the Regional Economic Report.

Given this situation in demand at home and abroad, the economy is likely to register a relatively high rate of growth in fiscal 2012, supported by a gradually increasing momentum in the virtuous circle of growth in production, income, and spending.
In fiscal 2013, with overseas economies continuing to see relatively high growth on the whole, the economy is expected to be firm, although the growth rate is expected to be somewhat lower than that in fiscal 2012, because the positive effects from reconstruction-related demand will gradually diminish. In the Bank of Japan‘s projection released in July 2012, the median of the Policy Board members‘ forecasts for Japan‘s real GDP growth rate is 2.2 percent for fiscal 2012 and 1.7 percent for fiscal 2013.

2. Prices
Next, I will talk about price developments. International commodity prices softened somewhat from autumn 2011, reflecting the slowdown in the global economy. After a slight rise in early spring of 2012, especially in crude oil prices against the backdrop of heightened geopolitical risk, they then fell back again through June 2012, and remained more or less flat thereafter.

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Most recently, prices of crude oil have bottomed out, while those of grains have risen due to unseasonable weather.
As for the outlook, international commodity prices as a whole are expected to rise at a moderate pace in line with the growth in overseas economies. Under these circumstances, the year-on-year rate of change in the domestic corporate goods price index (CGPI) has recently been negative. The CGPI is expected to decline moderately for the time being and then start to rise slowly reflecting the expected moderate increase in international commodity prices and the improvement in the negative output gap. Turning to the consumer price index (CPI) for all items less fresh food, the year-on-year rate of change since summer 2011 has been around 0 percent and is expected to stay at this level for the time being. Assuming that medium- to long-term inflation expectations remain stable, the year-on-year rate of change in the CPI is expected to gradually rise to a range of above 0.5 percent and less than 1 percent in fiscal 2013 as the negative output gap improves. Thereafter, it will likely be not too long before the rate reaches the Bank‘s current ―price stability goal in the medium to long term‖ of 1 percent. In the Bank‘s projection released in July 2012, the median of the Policy Board member‘s forecasts for the year-on-year rate of increase in the CPI (all items less fresh food) is 0.2 percent for fiscal 2012 and 0.7 percent for fiscal 2013.

C. Risks to the baseline scenario
The baseline scenario for Japan‘s economy described thus far is subject to both upside and downside risks. By far the most important risk is uncertainty regarding the outlook for
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overseas economies, and particularly the European debt problem.
Although concerns about the stability of Spain‘s financial system had temporarily subsided thanks mainly to the agreement reached at the EU and eurozone summits, in order to fundamentally resolve the debt problem it is nevertheless necessary in Europe to break the underlying negative feedback loop among fiscal balances, the financial system, and economic activity. At the same time, it is crucial that countries on the European periphery, whose international competitiveness has declined, steadily work on fiscal and economic structural reforms. Moreover, as part of the efforts toward deeper integration in the euro area, discussions are ongoing within the EU with the aim of establishing a banking union and a fiscal union, and I believe it is important to press ahead with these steps. In this situation, if reforms make steady progress, this would strengthen market confidence, which in turn would push up global economic growth. However, in core countries such as Germany, there are concerns that the financial burden of providing support to peripheral countries through, for example, greater fiscal integration would increase. Hammering out concrete steps, therefore, is likely to involve a great deal of complication. If in the meantime the European debt problem worsens, or the considerable sense of uncertainty continues for a prolonged period, this could weigh on the economic recovery in other areas such as the United States and China. External demand for Japan‘s exports is expected to once again become the driving force of Japan‘s economy after the earthquake-related reconstruction demand peaks out, but if exports remain sluggish, a virtuous circle may not take hold.
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For this reason, overseas economic developments warrant close attention. Next, risks stemming from domestic factors include uncertainty with regard to reconstruction-related demand as well as both upside and downside risks in how medium- to long-term growth expectations will be affected by the supply and demand balance of electricity and by innovation in energy-related technology. Another issue is the sustainability of Japan‘s public finances, concerns over which restrain consumer spending due to anxiety about the future and affect long-term interest rates. Given that social security spending will continue to exert upward pressure on fiscal expenditure, it is necessary to push ahead with structural reform of public finances on both the expenditure and the revenue side and maintain the public‘s confidence in fiscal discipline. Efforts to restore Japan‘s public finances are underway and are something that I will keep a close eye on. Both upside and downside risks persist also in import prices, particularly international commodity prices.

I I . Monetary policy
Next, I would like to turn to the Bank‘s conduct of monetary policy under the current economic situation. In order for Japan‘s economy to overcome deflation and return to a sustainable growth path with price stability, efforts to strengthen the economy‘s growth potential and support from the financial side are of the utmost importance. Based on this recognition, the Bank is currently providing support to raise Japan‘s growth potential through its fund-provisioning measure to support strengthening the foundations for economic growth, while at the same time pursuing powerful monetary easing continuously by steadily providing funds through, for example, purchasing financial assets.
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Moreover, the Bank is doing its utmost also to ensure stability in financial markets. In what follows, I will explain the Bank‘s measures in greater detail.

A. Pursuit of powerful monetary easing
I will begin with the Bank‘s pursuit of powerful monetary easing. In October 2010, the Bank introduced the comprehensive monetary easing policy, and has been easing financial conditions continuously since then. The comprehensive monetary easing policy consists of three measures: the implementation of a virtually zero interest rate policy by setting the target for the policy rate, the uncollateralized overnight call rate, at around 0 to 0.1 percent; the purchase of financial assets and funds-supplying operation through the Asset Purchase Program (hereafter the Program); and the clarification of the policy time horizon, that is, the clarification that these measures will remain in place until the Bank judges that price stability is in sight. In this context, financial conditions in Japan have continued to ease. The overnight call rate has been below the 0.1 percent level. With regard to long-term interest rates, yields on Japanese government bonds (JGBs) with a remaining maturity of three years or less are 0.1 percent, and those on 10-year government bonds are at the lowest level in about nine years. Firms‘ funding costs have also declined moderately, as shown, for example, by the fact that the average contracted interest rate on new loans and discounts is in the region of only 1 percent.

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1.Clarification of the policy time horizon based on ―the price stability goal in the medium to long term‖
At the Monetary Policy Meeting held in February this year, the Bank introduced ―the price stability goal in the medium to long term‖ as a part of its efforts to further clarify its determination to overcome deflation. ―The price stability goal in the medium to long term‖ is the inflation rate judged by the Bank to be consistent with price stability sustainable over the medium to long term. At present, the Bank judges ―the price stability goal in the medium to long term‖ to be within a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI and, more specifically, sets a goal of 1 percent for the time being. On this basis, the Bank has stated that for the time being it will aim to achieve the goal of 1 percent inflation in terms of the year-on-year rate of increase in the CPI through the pursuit of powerful monetary easing, which I mentioned earlier.

As you can see, by presenting its commitment regarding the policy time horizon, the Bank has further clarified its determination to pursue monetary easing.

2. Expansion of the Asset Purchase Program
The Program currently implemented by the Bank was established to further enhance monetary easing by encouraging a decline in longer-term interest rates and various risk premiums in a situation where there was little room for a further decline in short-term interest rates. Established on the Bank‘s balance sheet, the Program is used to purchase various financial assets – such as government securities, CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) – and to conduct fixed-rate funds-supplying operation. Since the establishment of the Program, the Bank has expanded its size
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successively, including in February and April of this year, so that the outstanding amount of asset purchases would reach about 65 trillion yen by around the end of 2012 and about 70 trillion yen by around the end of June 2013, thereby contributing to the pursuit of powerful monetary easing.
Furthermore, in April, in order to encourage a decline in longer-term interest rates, the Bank decided to extend the remaining maturities of JGBs and corporate bonds to be purchased under the Program from ―one to two years‖ to ―one to three years.‖

And in July, the Bank decided to remove the minimum bidding yields for outright purchases of treasury discount bills (T-bills) – which had previously been 0.1 percent per annum – and of CP in order to ensure that the outstanding amount of asset purchases under the Program would reach the planned amount.
For the same reason, the Bank also revised the categories of assets purchased and loans provided through the Program. The outstanding amount of the Program stood at 53 trillion yen as of July 20, and the Bank will continue to proceed with powerful monetary easing by steadily increasing the outstanding amount of the Program by about 17 trillion yen by around end-June 2013. It is expected that the effects of the continuing purchases of financial assets under the Program will strengthen further as the economy recovers.

B. The Bank‘s efforts to support strengthening the foundations for economic growth
I will now talk about the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility). The Bank introduced this measure in June 2010 to support strengthening the foundations for economic growth for the purpose of providing support for the critical challenge of enhancing the growth potential of Japan‘s
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economy, and has been providing long-term funds at a low interest rate to financial institutions in accordance with their efforts in terms of lending and investment for strengthening the foundations for economic growth.
The maximum duration of loans is four years, and the loan rate is currently set at 0.1 percent. The initial ceiling of the outstanding amount of loans was set at 3 trillion yen. Subsequently, in June 2011, the Bank introduced a new lending arrangement of 500 billion yen for the measure, through which it extends loans to financial institutions for their equity investments and asset-based lending (ABL). The loans for ABL allow financial institutions to use their expertise to identify and lend to potential growth firms without conventional collateral or guarantees. In March 2012, the Bank decided to further enhance the Growth-Supporting Funding Facility by ( 1 ) I ncreasing the ceiling for the outstanding amount of loans from 3 trillion yen to 3.5 trillion yen; (2)Establishing special rules for another new lending arrangement of 500 billion yen for small-lot investments and loans; and (3) establishing special rules for a new U.S. dollar lending arrangement of 12 billion U.S. dollars – equivalent to 1 trillion yen – using the U.S. dollar reserves already held by the Bank, for foreign currency-denominated investments and loans. The outstanding balance of the total loans disbursed by the Bank, including those extended under the special rules, stood at approximately 3.2 trillion yen as of the beginning of June. The first disbursement of U.S. dollar loans under the special rules is to take place in September.

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A breakdown of financial institutions‘ individual investment and lending for strengthening the foundations for economic growth in the period April 2010–March 2012 by designated business area shows that almost 30 percent of the total funds was provided to ―environment and energy business‖ and almost 20 percent was provided to ―medical, nursing care, and other health-related business,‖ but funds were also provided to business areas falling under the category of ―others,‖ such as lending or investment to revitalize local industries.
A wide range of financial institutions have been making a variety of efforts targeting their specific customer base or the region they serve, such as establishing new dedicated funds to support economic growth, so that the amount of lending and investment actually provided by financial institutions using the Growth-Supporting Funding Facility greatly exceeds the amount of loans disbursed by the Bank. The Bank, with its steady disbursement of loans, will continue to support the flow of funds to growth areas in order to contribute as much as possible as the central bank of Japan toward strengthening the foundations for economic growth.

C. Measures to ensure financial market stability
In addition to pursuing the measures just described, the Bank has been doing its utmost to ensure financial market stability by making use of various funds-supplying operations. Immediately after the earthquake in March 2011, the Bank provided ample funds on an unprecedented scale, exceeding the amount provided immediately following the Lehman shock. When the European debt problem worsened at the end of November 2011, the Bank lowered interest rates on U.S. dollar funds-supplying operations as part of coordinated measures among six major central banks in order to ensure stability in financial markets.

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At the same time, the central banks agreed to establish bilateral swap arrangements enabling the provision of liquidity in any of their currencies in addition to the already available U.S. dollar.

I I I. Issues related to strengthening the growth potential of Japan‘s economy A. The importance of strengthening the growth potential to overcome deflation
Earlier, I touched on the Bank‘s efforts to support strengthening the growth potential of Japan‘s economy.
Let me elaborate on the challenges we face in strengthening the growth potential. Japan‘s economic growth rate has been trending down due to the effects of the low birth rate and the aging of the population as well as to a decline in its international competitiveness. Consumption and investment have been restrained as a result of a decline in households‘ and firms‘ growth expectations, so that aggregate domestic demand has remained below the aggregate supply capacity of the economy for a prolonged period, exerting downward pressure on prices. With economic activity picking up, the output gap – that is, the difference between aggregate supply capacity and aggregate demand – has recently been narrowing. Nevertheless, aggregate demand continues to fall short of aggregate supply capacity by about 2 percent. While price developments are subject to various factors, including developments in international commodity prices, in order for Japan‘s economy to overcome deflation it is important to address the problem of

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insufficient demand, which is the key factor underlying deflation in Japan.
At the same time, in order to achieve sustainable economic growth amid the low birth rate and aging of the population, it is important to maintain sufficient supply capacity to meet new sources of demand.

B. Capturing global demand and creating demand through innovation
To resolve the problem of insufficient demand, it is essential to capture global demand, including demand from emerging economies, and to tap latent demand both at home and abroad.
With respect to capturing global demand to overcome the shortage of demand at home, in addition to making efforts to increase exports it is important to increase income from overseas investment. While income from foreign direct investment is not included in GDP, it does contribute to gross national income (GNI).

Moreover, advances in the international division of labor likely contribute to strengthening the economy‘s growth potential through the associated increase in exports of related goods and the shift of the domestic labor force into areas with growth potential.
Tapping latent demand, the other essential element in addressing insufficient demand, also requires efforts on a continuous basis. Markets for new types of goods and services usually grow only slowly at the initial stage. They then enter a phase of rapid growth until demand is saturated and growth slows again. In order to maintain the growth potential of the economy as a whole, it is therefore important to continuously secure demand both at home and abroad.
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To this end, it is necessary to accelerate innovation that taps latent demand for goods and services and consequently creates demand, which will give depth to areas with growth potential.
The demographic change resulting from the low birth rate and the aging of the population is also prompting changes in the demand structure. For example, consumption expenditure by households headed by a person aged 60 years or older, including the baby-boomer generation, now accounts for more than 40 percent of total private consumption.

Therefore, an important challenge is to supply goods and services that meet the needs of this generation in a timely manner.
Corporate profits and business sentiment at Japanese firms have been on an improving trend recently. This reflects not only the positive effects of subsidies and earthquake-related reconstruction demand, but in my view also shows that firms‘ active efforts to tap latent demand and address social challenges are paying off. Examples are businesses targeted at the elderly and in the areas of information and telecommunications as well as environment and energy, where challenges in terms of energy creation, energy saving, and energy storage need to be addressed with urgency. For example, in the automobile industry, environmentally friendly cars – such as hybrid cars with better environmental efficiency – have been selling briskly, and it is expected that related markets, such as those for rechargeable batteries, will also expand.

In the field of information and telecommunications, smartphones are coming into widespread use, providing the infrastructure for not only the distribution of digital books and music but also a whole range of new services.

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One example is the use of the Internet and the Global Positioning System (GPS) to provide services such as giving information on cafes and restaurants in the vicinity and guiding smartphone users there.
In the convenience store industry, the number of stores was said to be near saturation at one time. However, by expanding the range of products and services aimed at women and the elderly, such as introducing home deliveries, convenience stores have been able to increase their sales per store.

Looking ahead, it is extremely important that efforts toward innovation do not come in spurts but are sustained across a wide range of fields.

C. Maintaining the labor supply and improving productivity
In order to strengthen Japan‘s growth potential, it is also important to ensure that supply capacity is commensurate with demand. While the recent employment situation has been on an improving trend, labor supply still exceeds demand. There still remain problems that need to be solved, such as the extremely severe employment conditions for the young. However, Japan‘s working age population will continue to decline, and in the medium to long term labor supply may fall short of demand. Economic growth can be decomposed into two components: the rate of growth in the number of workers and that in productivity per worker. Assuming that the labor force participation rate remains unchanged, the negative growth contribution of the decline in the number of workers is forecast to increase to around 1.0–1.5 percent by the 2030s. Meanwhile, the average annual increase in labor productivity has been around 1 percent in recent years, so if things remain the same, Japan‘s potential growth rate will fall into negative territory.
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In order to mitigate the impact of these developments as much as possible, with regard to the labor force, it is important to increase labor market flexibility to allow workers to change industries more easily and to boost labor market participation of the elderly and of women who wish to work but are not currently working.
On the other hand, regarding labor productivity growth, this is actually quite high in Japan when compared with other major countries and may be difficult to raise further. However, since labor productivity is the ratio of aggregate value added to labor input costs, productivity growth could be improved if growth areas provide sufficient opportunities for the creation of high-value-added goods and services, so that firms can generate sufficient profits. This could then produce forward momentum through generating income, thus mitigating the impact of the decline in the working-age population. Given that Japan has a low birth rate and the fastest aging population in the world, achieving such a strengthening of the growth potential is extremely difficult and represents a challenge that requires the efforts of the nation as a whole, since it requires raising demand, labor supply, and productivity to the limits of Japan‘s potential. Based on this perspective, the Japanese government has compiled the ―Strategy for Rebirth of Japan‖ to create an environment allowing firms to meet the challenges of the task. The strategy places priority on eleven areas. These areas include ―green innovations,‖ which focuses on J apan‘s aim to lead the world in the energy revolution and create new industries and employment related to this field; ―life innovations‖ with the aim of turning businesses related to medical services and nursing care into growth industries, fostering new related industries and markets, and developing markets overseas; human resources development; and turning Japan into a tourism nation.
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In order to boost the efforts undertaken by firms, support from the financial side is essential, in addition to the creation of the right environment.
With this in mind, the Bank will continue exerting itself in its role together with firms, financial institutions, and the government.

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B. Market intelligence, market information and statistics in central banking
Keynote Speech by Mr Kiyohiko G N ishimura, Deputy Governor of the Bank of Japan, to the 6th Irving Fisher Committee Conference, Bank for International Settlements, Basel, 29 August 2012.

1. Introduction: statistics, market information and Irving Fisher
It is a privilege for me to address this keynote speech before the distinguished members of the I rving Fisher Committee. I am particularly thrilled, since the name Irving Fisher strikes a chord in my heart. Irving Fisher is an iconic figure at Yale University, where I earned my doctorate. In fact, he received the first Ph.D. in economics ever granted by Yale, in the year 1891. I vividly remember his life-size portrait hung above the mantelpiece of the 19th century mansion house, gazing solemnly at faculty members and graduate students. No new words are needed to attest to his monumental contributions to microeconomics, macroeconomics and monetary theory. He was also influential in laying the foundations of economic statistics, as exemplified in his popular The Making of Index N umbers. In fact he was not content with just theory: he went on to found by himself the Index N umber Institute that engaged in computing commodity price indices, and thus became one of the most popular providers of market information at the time.
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Unfortunately, however, he failed to recognize the significance of the Stock Market Crash of 1929.
Just three days before the crash, he wrote that stock prices were at a permanently high plateau. And even after the crash, he continued to assure investors that a recovery was just around the corner. This might testify to his failure in ―market intelligence‖, in detecting the signs of a fundamental change in the market place. In his latter days, though not immediately appreciated by the public and the profession, he presented a remarkable theory of debt deflation as an explanation of the Great Depression. In fact, this masterful piece of work is the precursor of the vast literature concerning financial stability, which is especially relevant in economic policy making in the aftermath of the financial crisis of 2008. What then can we central bank statisticians learn from these dramatic ups and downs in the life of I rving Fisher? In fact, this is the subject of this speech. In particular, I argue that, although reliable macroeconomic statistics are of course necessary for policy making, even good statistics are sometimes grossly insufficient to guide economic policy, especially when a seismic change occurs in the market and the economy. The recent financial crisis is an example of such change.

Thus, central bankers should incorporate ―market intelligence‖, which I will explain later, and non-statistical market information, into their arsenal of statistics.

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So a central bank statistician should be more than simply a compiler of well-defined statistics: they should become a sort of sleuth or intelligence agent, detecting signs of future developments that may change the world.
I proceed as follows. Section 2 outlines the value of economic information from the perspective of policy decision making. A key theme here is ―market intelligence‖, which is the active gathering and analysis of market information through central banking activities. To understand the importance of market intelligence, I present three examples, with respect to the past, the present, and the future. Section 3 presents a lesson from the past. I examine the so-called Paribas Shock of 2007, and argue for the absolute necessity of ―proactive‖ market intelligence to avoid this type of financial crisis.

Section 4 describes the current achievements of market intelligence in an area of pressing importance: property price statistics.
I show that it is possible to get reliable, unbiased information by combining various existing market information sources, even though individually they may have their own biases. Section 5 concerns the future: detecting problems in shadow banking. Shadow banking involves a complicated structure, so it is necessary to grasp its ―interconnectedness‖ to gauge the magnitude of potential problems. As an example, I explain the Bank of Japan‘s attempt to reveal the interconnectedness of the Tokyo money markets.

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Section 6 contains some concluding remarks on market intelligence and central bank statistics.

2. Economic information and policy making
Contemporary central banking faces two major challenges; one related to accountability, and the other to effective communication.

First, central banks should be accountable for their policies.
This is all the more important for those central banks that have independence in determining their monetary policy. Accountability means policy should be evidence-based, that is, based on clear reasoning relying on substantiated data.

Second, central banks should be effective communicators.
Markets and economies have become increasingly susceptible to changes in economic agents‘ expectations.

To ensure that policy is effective, central banks must communicate with the public in a persuasive manner.
Here again, data supporting policy decisions become important. Thus, for accountability and effective communication, ―numbers‖ or statistics become increasingly important. Moreover, data here means not only quantitative data; qualitative data are equally as important.

Knowns and unknowns in Central Bank policy
To understand the nature of the economic information central banks want to know, the following three-way classification may be helpful.

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The first type of information concerns ―known knowns‖. Here ―knowns‖ are whatever happened in the past. Thus, known knowns are information about what happened, and typical known knowns are contained in statistics. The second type is ―known unknowns‖. Here unknowns are those things that are happening at present or that will emerge in the future. They are known unknowns, since we already know that they are happening or will happen. You may have come across the word ―now-cast‖, which is an ―estimate‖ of what is happening now, used in contrast with a ―forecast‖ which predicts future events. A ―now-cast‖ is a typical example of a ―known unknown‖. Finally, there is the third type, called ―unknown unknowns‖, things previously unknown but potentially having a significant effect on the economy. Here I quote Donald Rumsfeld, the former U.S. Secretary of Defense, whose enigmatic statement gives perhaps some indication of their nature: ―But there are also unknown unknowns – the ones we don‘t know we don‘t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.‖ Keeping in mind this three-way categorization, let me ask the following question:

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What kind of information does a central bank policy maker want to know when he or she decides on policy?
And, in what way is it related to the three-way categorization? First of all, in contemplating appropriate aggregate demand management policy, the central bank policy maker wants to know the momentum of activity in the economy and financial markets. However, this is not in itself sufficient.

The experience of the recent financial crisis has shown that the central bank policy maker should also be aware of the signs of previously unknown factors, unknown but potentially significant changes in the economy and financial markets.
In fact, with respect to the former, i.e. macroeconomic momentum, we have made significant progress. There have been improvements in the comprehensiveness, accuracy and timeliness of macroeconomic statistics related to aggregate demand management. We now have a rich array of data, both quantitative as in GDP and CPI figures, and qualitative as in business surveys. Not only public but also private institutions produce and disseminate their own data. These are either known knowns (type 1), or known unknowns (type 2). Statistics provide valuable information about known knowns, and they become the foundation for estimating known unknowns. However, statistics are grossly insufficient when it comes to detecting unknown unknowns (type 3).

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Central-bank policy makers are frequently frustrated by deficiencies in the statistics available, which they find inadequate in helping them detect potential problems in the economy.
Perceived deficiency is especially keen in financial information. It should be noted that financial stability is now seen as a prerequisite for economic stability. Moreover, policy makers are alarmed by the increasingly strong negative feedback seen in recent years between financial malaise and economic stagnation. The rapid development of financial factors confounds the problem of detecting malign symptoms. Thus, guarding against previously unknown but potentially devastating factors has become one of the most important issues for policy makers. Thus, in November 2009, the G20 Finance Ministers and Central Bank Governors requested statisticians to fill the so-called data gaps. Twenty recommendations were submitted in the G20 Data Gaps Initiative (DGI) in order to establish timely reporting schemes for detecting both known unknowns (type 2), and unknown unknowns (type 3) .

The key to guarding against unknown unknowns
A central bank‘s intelligence activities are the key to guarding against unknown unknowns. These consist of two parts. The first is so-called ―market intelligence‖: the central bank‘s daily transactions with financial institutions, which provide various kinds of information about market participants, developments in financial products, as well as other ―news‖.
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These pieces of market information are valuable in creating a timely and accurate view of particular institutions and the market as a whole.
The gathering and analyzing of this information is the core of ―market intelligence‖. The second part of the central bank‘s intelligence activities is monitoring and feedback. Qualitative or supervisory information can be obtained from regular supervisory dialogue with regulated entities. They have valuable information, and by analyzing it thoroughly we get a grasp of the details of market information, which is then fed back to these institutions if necessary. It should be noted here that information coming from individual financial institutions may include subjective or in some cases biased content, regardless of whether it is market information or information acquired through regulatory monitoring.

We should be aware of these biases, and good market intelligence is needed to gauge the extent of such bias and to compensate for it.

3. Lessons from the past: necessity of proactive market intelligence
Let me now turn to three examples of central bank intelligence. The first example is its failure in the past. This is the so-called Paribas Shock of August 9, 2007, the precursor of the global financial crisis of 2008. On July 10, 2007, S&P and Moody‘s announced that they would be reviewing the ratings of several residential mortgage-backed securities (RMBS) backed by subprime housing loan assets.
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As a consequence, the AAA ratings of asset-backed commercial paper (ABCP) backed by these RMBS would also be downgraded accordingly.
This looked like a minor change in a marginal market of the US financial system. Unfortunately however, within just one year, it became the epicenter of a global financial crisis. To understand the problem, we should be aware of the special role of money market funds (MMFs) in the United States. US MMFs were considered to be extremely safe financial assets. One of the primary reasons for this was that MMFs were only allowed to invest in AAA-rated assets. Therefore, when ratings were downgraded for ABCP, MMFs did not reinvest in ABCP. Then, funds that originated ABCP and used it to raise money found themselves in fund-raising difficulties: funds under the Bear Stearns umbrella went bankrupt; BNP Paribas moved to freeze its affiliated funds‘ new applications and redemptions. These funds were the structured investment vehicles (SIV) created by banks to issue ABCP. When these SIVs were unable to find funding sources, their parent banks were forced to provide liquidity enhancement instead. At that time, nobody knew for certain which banks‘ SIVs were on the brink of extinction, and which banks had serious liquidity problems. Banks, which frequently lend each other money, suddenly became aware of counterparty risk, the risk that the other party in a transaction might suddenly go belly up.
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They began to worry that some bank somewhere might suddenly be unable to secure liquidity and fail.
Indeed, on August 9, a liquidity crisis actually occurred, with liquidity drying up quickly in the interbank market. Many European banks were among those facing liquidity difficulties. Chart 1 shows an unprecedented spike in the three month LIBOR-OIS spread, showing the heightened risk premium in the European interbank market.

A liquidity crunch in interbank markets started, and it spread immediately to the United States (Chart 2). Confronted with this situation, the European Central Bank (ECB) promptly announced that it was prepared to supply massive amounts of liquidity into the short-term money market.

This was the event that came to be known as the Paribas Shock.
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Lesson: necessity of proactive market intelligence
The circumstances surrounding the Paribas Shock naturally beg the question: Was this event avoidable? Or at least, was there any telling sign that this type of event was just around the corner? As the description of the event shows, there are four important pieces of information that the policy makers should have known and which would have helped prevent this event. The first is the asset position of the MMFs: their composition and quality. MMFs held a large amount of AAA-rated ABCPs of SIVs whose parents were European as well as US banks. These ABCPs were backed by US subprime loans, so that if the subprime loans were downgraded then these ABCPs would also be downgraded. The second vital information is possible side effects of the legal constraints upon the MMFs.
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MMFs could hold only AAArated assets so that, if US subprime loans were downgraded, MMFs could not reinvest in ABCPs of the SIVs.
The third and most crucial information policy makers should have had is knowledge of banks‘ involvement in their SIVs. To what extent were those banks obliged to support their SIVs with liquidity injections? Here it was not only a question of contractual arrangements, but reputations were also at stake. The fourth piece of vital information is knowledge about the inter-connectedness among banks in the interbank market. It is clear that existing statistics and routine market intelligence were grossly insufficient to gather the above four pieces of vital information. To my knowledge, few, if any, market participants flagged the alarms that should have been raised by any of these four points.

No statistics ever pointed out the danger.
However, there were several, though obscure, signs flagging a possible problem, so that a market intelligence unit alarmed by these signs might have detected the problem and could have helped policy makers avoid the disaster. In particular, there was a telling sign in the statistics about US MMFs. Chart 3 shows an upward trend in the total assets of the US MMFs in the first half of 2007.

The growth rate of MMFs was fast, though it did not look extraordinary.
However, if you look at the share of ―safe assets‖, it actually declined from the start of the year.
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So, this chart shows that by looking into these figures, one might have found some sign of abnormal risk taking in non-safe assets, including ABCP. Thus, if in addition, the market intelligence unit had detected the heavy involvement of banks in their SIVs issuing these ABCP, the unit might have sensed a possible danger of liquidity crisis in the interbank market, and might have been able to help the authorities prevent the crisis. In fact, after the Paribas Shock, the safe asset share jumped considerably and the total assets also skyrocketed, showing the strong flight to safety that devastated the ABCP market, and the ABS market in general. To sum up, it is not clear whether the liquidity crisis in the summer of 2007 could have been avoided. However, proactive market intelligence, that is, detection of possible problems in the market based on careful monitoring of market developments and thorough analysis of market statistics, might have helped contain if not avoid the turmoil in the interbank market, and thus might have ultimately lessened if not negated the severity of the financial crisis of the following year.
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Bearing this in mind, the Fed and other central banks, as well as private institutions, have begun to collect and compile a wide range of statistics that capture securitization.
In particular, Chart 4 shows details of the asset composition of US MMFs.

The chart indicates that MMFs may have already increased investment in commercial papers in 2006, the year before the Paribas Shock.

4. Present achievement: best use of existing market information
Let me now turn to the second example, which is the present achievement of market intelligence. This is about property prices, and the issue is the timing of the availability of market information. The financial crisis of 2008 was triggered by the bubble and subsequent bust in US house prices.

There is a wealth of evidence detailing the close relationship between property price bubbles and financial crises.
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International panel studies show more than two-thirds of 46 systemic banking crises were preceded by house price boom-bust patterns, while 35 out of 51 house price-bust episodes were followed by a crisis.
However, we have not had access to good property price indexes, based on sound economic foundations and comparable between countries and jurisdictions. Frustrated by this deficiency, in November 2009, the G20 Ministers and Central Governors designated property price indexes as one of the most important data gaps to be filled. To rectify the problem, several conferences were held under the leadership of Eurostat, which gathered a wide range of experts on property prices from theory to data compilation. Based on these conferences and public comments, the Handbook on Residential Property Price I ndices has been drafted, and the finalized version of the Handbook will be published very soon. Moreover, many countries and jurisdictions are now preparing their own property price indexes in accordance with the recommendations of the Handbook. In fact, I have learned that Japan‘s Ministry of Land, I nfrastructure, Transport and Tourism has almost completed the development of a new series of residential property price indexes using the procedure recommended in the H andbook, and the Ministry is about to start publishing new statistics just this morning.

Issue of timeliness
This is a great leap forward indeed towards having reliable and accurate property price information.
However, from the policy maker‘s viewpoint, the situation is still far from satisfactory.

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It should be emphasized that, for a policy maker, timely information is as important as, or in some cases more important than, reliable and accurate information.
According to this criterion, many property price indexes are not helpful in immediate policy making, since they inevitably lag behind market movements. To see why, let me give you the example of a typical Japanese property transaction.

Property transactions follow a series of stages several weeks apart from each other, and each stage usually entails different prices, namely:
the initial asking price, P1; the offered price, P2; the contract price, P3; and the price that is filed with the land registry office, P4. My collaborators and I have been able to get a unique data set of a large number of property transactions in Greater Tokyo which illustrates these four stages. Here I will present the results based on this data set. Chart 5 depicts the timeline graphically. From P1 to P2 takes on average ten weeks, form P2 to P3 five and a half weeks, and finally from P3 to P4 fifteen and a half weeks. Thus, from P1 to P4 takes almost thirty one weeks, more than a half year. We should also take into account the time taken to collect and compile the information, which is itself likely to be substantial, as in the case of GDP and CPI data.

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Thus, if the authorities use the most reliable transaction price data of P4, it will probably take almost a year. From the policy maker‘s viewpoint, this is often too late. To get the timeliest information about property market conditions, earlier reporting of P1, the initial asking price, is preferable. However, this is the asking price, not the transaction price. There might be a substantial bias in this asking price data because a seller wants to sell at a higher price, even though it may take much longer to strike a deal or he is never able to sell. In fact, Chart 6 shows the price distribution of P1, P2, P3 and P4. As expected, the initial asking price P1 has a higher average than the price P4 at the registry office (though there is the caveat that the sample population of P1 is not exactly the same as that of P4). Thus, we face an apparent trade-off: if you want timely information then you use P1, but it has non-negligible bias.
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If you want accurate information, then you use P4, but it has already become somewhat stale information by the time it is available.

Best use of market information
There is, however, an important way around this dilemma. It should be noted that the Handbook recommends hedonic quality adjustment in property price indexes based on detailed micro and macro market information. There are various ways to conduct hedonic quality adjustment, among which a hedonic quantile regression approach is one of the most sophisticated and robust. Remarkably, after applying this quality adjustment to both P1 and P4 of our data set, we find the quality-adjusted price distribution based on P1 is very close to, and almost indistinguishable from, the quality-adjusted price distribution based on P4. Let us look at Chart 7, the quantile-quantile plots of two distributions. In the quantile-quantile graph, if two distributions are identical then the plotted line is on the 45 degree line.
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The upper chart illustrates the result of raw or unadjusted data of P1 (initial asking price) and P4 (registered transaction price). This chart clearly shows the upward bias in the initial asking price relative to the registered transaction price. However, when quality is adjusted using a hedonic quantile regression method, the bias seems almost to have vanished, as shown in the lower chart. In a nut-shell, the result of this study shows that the initial asking price data, the timeliest of all price information, can be used as reliable information about property prices, so long as quality is appropriately adjusted using a hedonic quantile regression method. So we can benefit from the best use of market information, with respect to both reliability and timeliness.

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5. Guarding against future problems: shadow banking and basic information gathering
So far, we have examined the importance of market intelligence and the best use of market information in the past and the present. I am now looking towards the future, and considering what is needed to guard against future problems. The pressing problem that comes first to mind is that of shadow banking, a problem in the past, but still a potential problem in the future. Since regulations on banks are to be tightened further, new types of shadow banking may appear, little known at present but potentially threatening to financial stability in the future. Modern shadow banking activities are largely based on financial markets, and hence are likely to create innovation there. They change themselves rapidly in response to changes in market conditions and regulations. Moreover, they have broad interconnectedness with banks and other financial institutions. Given this situation, in what way should central banks gather valid and vital information about them? Here again, I believe that the key is to utilize various sources of market intelligence alongside other sources of information. Furthermore, I would like to stress that the intelligence work should be properly followed by the establishment of new statistics about shadow banking.

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Various approaches of market intelligence
Let me explain the efforts of the Bank of Japan in this respect. The Bank monitors shadow banking entities and activities through various channels. The nature and scope of the Bank‘s monitoring are depicted in Chart 8.

Amongst these channels, direct monitoring of major shadow banking entities is of course the most significant.
Thus, the bank has increased the number of staff directly monitoring major securities companies. However, it is practically impossible to conduct dialogues with all financial institutions of a shadow banking nature, and moreover, shadow banking activities tend to change rapidly with developments in financial markets.

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It should be noted that shadow banking entities are deeply involved in funding and investment with various financial institutions.
So indirect monitoring through banks, monitoring through the payments and settlements system, and market intelligence through market participants all become important. The Bank also closely watches shadow banking activities in securitization, securities lending and repos. For instance, we have started direct monitoring of hedge funds and investment trusts as well using market intelligence through market participants much more than before. Furthermore, although we do not directly monitor finance companies, since large finance companies are owned by banks, we monitor them by monitoring the banks. It is then crucial to cross-check the information gathered.

Chart 9 illustrates the point.
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In this regard, it is important to monitor banks as counterparties of shadow banking entities.
This is because bank activities are interconnected with shadow banking activities. Market information in the financial markets is also particularly valuable. Central banks are especially well-positioned to collect valuable information on the activities of participants in financial markets, since they not only gather information relevant to monetary policy, but they also operate payment and settlement systems. Information on market practices and financial innovations can often provide early warning of risks, and hence are especially important among the various kinds of market intelligence. The case in point is found in the subprime mortgage crisis in the United States. Securitized products were originated with financial engineering and distributed without appropriate risk assessment. This was partly due to an overly optimistic assessment of risk diversification. However, this risk became increasingly visible in the market as the market evolved into a new phase.

Feedback of market intelligence
Another important role of market intelligence is to feed information back to the market, and thus to find potential information gaps to be filled. For example, based on market intelligence, the Bank of Japan designs and compiles the ―Tokyo Money Market Survey‖, which provides an overall quantitative assessment of the money markets.
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The survey depicts, among other things, the current interconnectedness among financial institutions through repo transactions, as is shown in Chart 10.

This chart shows that securities companies borrow specific JGBs through SC repos mainly to cover their short position in bond trading. Most of their short-term money is funded through GC repos from trust banks, while some funds come from banks and money market dealers. This kind of quantitative understanding provides both new perspectives for central bank business and wider grounds for dialogue with financial institutions and market participants. In fact, the result of these dialogues will be examined and used by financial institutions to develop more sound business practices. Also, the feedback of any relevant information will be reflected in the next survey data. Starting this year, we will begin to conduct this survey regularly.

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Overall, market intelligence is absolutely crucial for central banks in maintaining the stability of the financial system.
I believe that this flexible system of monitoring shadow banking entities and activities, based on market intelligence, can provide a good pilot study for other central banks to consider when they want to identify emerging risks and vulnerabilities in their own countries and jurisdictions.

6. Concluding remarks
Let me now come to my conclusion. As we all know and feel, central banks around the world have faced serious challenges, especially since the financial crisis of 2008. Financial stability is now clearly marked as an essential prerequisite for economic stability, and it is thus the responsibility of central banks to maintain this stability. Moreover, the financial turmoil following the collapse of Lehman Brothers, and still lingering somewhat in the global market, has clearly proved that existing statistics are not sufficient for policy making, in particular policy making involving financial markets. Financial markets are fast moving and ―mutate‖ in many ways in a relatively short period of time. Therefore, I have argued in this speech that gathering and thoroughly analyzing market information, which is often described as market intelligence, is of the utmost importance and should be utilized proactively alongside conventional economic statistics. The reason I have stressed market intelligence, or more specifically, central bank intelligence, is that central banks have a clear comparative advantage in extracting valuable and vital information, especially from financial markets.
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Central banks are the unique organization that transacts with the widest range of financial market participants.
I have explained how this market intelligence works in the case of shadow banking in Japan. The most important point is to extend these intelligence activities to new financial institutions and products to detect possible problems. The existing framework at the Bank of Japan is versatile and can incorporate new elements relatively easily. However, problems remain about the depth or intensity of these intelligence activities: that is, the quantity and quality of information currently available may not be sufficient for detecting possible risks. Thus, we are only at the starting line, and there is still a long way to go. Finally, I should emphasize that market intelligence has significantly improved central banks‘ economic statistics, and will continue to do so in the future. We have learned from the failures in the summer of 2007, that we must extend the coverage and improve the quality of statistics concerning non-depository financial institutions. We can also take advantage of new methods and new information sources to get the best use of market information in constructing timely statistics, as shown in the case of property prices. In closing, I would like to emphasize again the point I stated in the Introduction, the point that I would most like to convey to you. Central bank statisticians should be more than good statisticians, simply maintaining the quality of existing statistics.

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They should also be good sleuths or intelligence agents, detecting signs of future developments that may change those statistics, and thus may change our world.
Thank you for your kind attention.

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NUMBER 8

News Release - The dog and the frisbee – paper by Andrew Haldane
31 August 2012 In a paper given at the Federal Reserve Bank of Kansas City‘s 36th economic policy symposium in Jackson H ole, Wyoming, Andrew Haldane – Executive Director for Financial Stability and member of the Financial Policy Committee – explores why the type of complex financial regulation developed over recent decades may be sub-optimal for crisis control. In doing so, he draws out a number of public policy lessons. The paper is co-written with a Bank colleague, Vasileios Madouros. Andrew Haldane presents evidence from a range of real-world settings to demonstrate that decision-making in a complex environment can benefit from the use of simple decision rules of thumb.

He argues that complex rules often: have punitively high costs of information collection and processing; rely on ―over-fitted‖ models that yield unreliable predictions; and can induce defensive behaviour by causing people to manage to the rules.
He argues that regulatory responses to financial crises, past and present, have been to increase complexity with: ―...a combination of more risk management, more regulation and more regulators‖. As the Basel Accords have evolved over time, he notes, so has opacity and complexity associated with increasingly granular, model-based risk-weighting. Meanwhile, detailed rule-writing in the form of legislation has increased dramatically, as has the scale and scope of resources dedicated to regulation.

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Andrew Haldane uses a set of empirical experiments to measure the performance of regulatory rules, simple and complex.
He finds that simple rules such as the leverage ratio and market-based measures of capital outperform more complex risk-weighted models and multiple-indicator measures in their crisis-predictive performance. He says that: ―The message from these experiments is clear and consistent. Complexity of models or portfolios generates robustness problems when understanding a complex financial system over plausible sample sizes. More than that, simplicity rather than complexity may be better capable of solving these robustness problems.‖ Andrew Haldane considers five policy lessons that financial regulation can draw from these findings. First, he suggests that the Basel framework could take: ―...a more sceptical view of the role and robustness of internal risk models in the regulatory framework...simplified, standardised approaches to measuring credit and market risk, on a broad asset class basis, could be used.‖

Second, he says the leverage ratio could be placed on an equal footing with capital ratios, an approach taken by the Bank of England‘s Financial Policy Committee, and market-based indicators of capital adequacy added to regulators‘ and investors‘ indicator set.
Third, Andrew Haldane calls for a fresh approach to financial supervision, one which is less rules-focussed and more judgment-based. He notes that this approach: ―...will underpin the Bank of England‘s new supervisory model when it assumes prudential regulatory responsibilities next year.‖ To be effective, he says that will require more experienced regulators working to a smaller, less detailed rulebook. He adds that greater simplicity and consistency in disclosure practices could also strengthen market discipline.

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Fourth, he considers the case for tackling complexity directly and at source.
He says that recent events have re-demonstrated the problems that arise in risk-managing large, complex banks: ―At present, no explicit regulatory charge is levied on those complexity externalities. Doing so would help protect the system against failure, while providing explicit incentives to simplify balance sheets.‖ Finally, Andrew Haldane notes that, while quantity-based restrictions such as the I ndependent Commission on Banking proposals in the UK and the Volcker rule in the US are robust to complexity and uncertainty, they risk being mired in detail in their implementation. He argues that cleaner solutions could be considered, or that the market could lead by encouraging banks to sell-off assets and reduce complexity. Andrew Haldane says that: ―Modern finance is complex, perhaps too complex...As you do not fight fire with fire, you do not fight complexity with complexity. Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity, not complexity.‖ That would require ―...an about-turn from the regulatory community from the path followed for the better part of the past 50 years.‖ But when it comes to financial regulation, concludes Andrew Haldane, ―...less may be more‖.

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NUMBER 9

VII Annual Seminar on Risk, Financial Stability and Banking
São Paulo A very interesting presentation

What caused the Global Financial Crisis?

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NUMBER 10

Central Bank of Ireland Publishes July 2012 Money and Banking Statistics
The Central Bank of I reland published the July 2012 Money and Banking Statistics

Loans and other credit
Loans to households continued to decline during July 2012 and were 3.6 per cent lower on an annual basis, following a decline of 3.7 per cent for the year ending June 2012. Lending for house purchase was 2.1 per cent lower on an annual basis in July 2012, while lending for consumption and other purposes declined by 7.8 per cent over the same period. Lending to households declined by €471 million during the month of July, following a net monthly increase of €55 million in June. Developments in July were mostly driven by a decline in loans for consumption of €225 million. Loans for house purchase also fell by €157 million, while loans to households for other purposes declined by €88 million. The monthly net flow of loans to households averaged minus €227 million in the three months ending July 2012, which consists of average net flows of minus €102 million in loans for house purchase, minus €73 million in loans for consumption purposes, and minus €52 million in lending for other purposes. Lending to I rish resident non-financial corporations (NFCs) declined by 3.4 per cent in the year ending July 2012, following an annual decline of 2.9 per cent in June 2012. On a monthly basis, loans to NFCs decreased by €297 million during July, following a decrease of €399 million in June.

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The monthly net flow of loans to NFCs averaged minus €345 million in the three months ending July 2012, compared with an average of minus €354 million in the three-month period up to end-June 2012.
Short-term loans to NFCs with an original maturity of up to one year, which includes the use of overdraft facilities, increased by €162 million during July 2012. This followed a decline of €571 million in June. Longer-term loans with an original maturity over five years also increased during July, by €214 million, while medium-term NFC loans fell by €673 million. On an annual basis, longer-term NFC loans with an original maturity over five years fell by 0.2 per cent in July 2012. Short-term N FC loans continued to increase, as loans with an original maturity up to one year grew by 0.6 per cent in the year ending July 2012. Meanwhile, NFC lending between one and five years original maturity declined by 10.6 per cent over the period. Credit institutions‘ holdings of debt and equity securities issued by the Irish private sector increased by €122 million during the month of July 2012, with an annual rate of change of minus 10.5 per cent. This follows a decline of 10.9 per cent for the year ending June 2012. The increase in holdings of private-sector securities during July reflects developments in holdings of debt securities issued by Other Financial Intermediaries (OFI s).

Deposits and other funding
Irish resident private-sector deposits were 0.8 per cent lower on an annual basis at end-July 2012, compared with a decline of 2.5 per cent over the year ending June. Deposits from households were 0.1 per cent lower on an annual basis in July, while deposits from I nsurance Corporations and Pension Funds (ICPFs) and OFIs fell by 3 per cent.
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Deposits from NFCs increased by 0.1 per cent over the same period. There was a month-on-month increase of €1.9 billion in Irish resident private-sector deposits during July 2012. This increase was dominated by developments in the OFI sector where deposits increased by €1.4 billion, partly reflecting inter-affiliate transactions. NFC deposits also increased by €465 million during July, while deposits from ICPFs increased by €216 million.

Household deposits fell by €159 million over the same period.
Private-sector overnight deposits increased by €1.4 billion during July 2012, largely reflecting developments in the OFI sector where overnight deposits increased by €1 billion. Overnight deposits from the NFC sector also increased in July, by €533 million, while ICPF overnight deposits grew by €47 million. Household sector overnight deposits declined by €248 million during the month.

Household deposits with agreed maturity up to two years increased by €214 million during the month of July 2012.
Deposits in this category from OFIs and ICPFs also increased during the month, by €223 million and €124 million, respectively. NFC deposits with agreed maturity up to two years fell by €60 million over the same period. Private-sector deposits from non-residents increased by €1.5 billion during July 2012, predominantly reflecting developments in the IFSC-based banks. There was a decrease of €678 million in deposits from other euro area private-sector residents during the month, while private-sector deposits from non-euro area residents increased by €2.2 billion. Total non-resident private-sector deposits were 5.3 per cent lower on an annual basis at end-July 2012, with deposits from other euro area
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private-sector entities being 8.5 per cent lower, and those from the non-euro area private sector 3.3 per cent lower.
Total deposits from non-residents, including deposits from MFIs, general government and the private sector, fell by €5.7 billion during July 2012, largely driven by developments in deposits from affiliated non-resident credit institutions. Credit institutions‘ borrowings from the Central Bank as part of Eurosystem monetary policy operations declined by €3.9 billion in July 2012.

The outstanding stock of borrowings from the Eurosystem by I rish resident credit institutions amounted to €84.4 billion at end-July.
Domestic market credit institutions accounted for €71.9 billion of this total outstanding stock. A number of credit institutions have issued debt under the Eligible Liabilities Guarantee scheme and have retained the bonds concerned for their own use. For methodological reasons these are not included in the Money and Banking Statistics tables. At end-July 2012, the outstanding amount of these bonds was €10.1billion.

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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_Tra ining.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_Certifica tion_And_The_Exams_1.pdf www.risk-compliance-association.com/ CRCMP_Certification_Steps_1.p df

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C.Personalized Certificate printed in full color.
Processing, printing, packing and posting to your office or home.

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_Certific ation.htm

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

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