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The Unfinished Reform: Towards a More Resilient, Transparent and Accountable Global Financial System - Keynote speech at Santander Investor Day 2015 welcome dinner

 

Keynote Speech by Angel Gurría

Secretary-General, OECD

London, United Kingdom

23 September 2015

(As prepared for delivery)

 

 

Dear Ana, Dear Guests:

 

I am delighted to be with you tonight at this Welcome Dinner of the 2015 Santander Investor Day Conference. The OECD and Banco Santander have a long-standing relationship. Santander is a member of our Business and Industry Advisory Council (BIAC), and a frequent visitor to many OECD fora, such as our financial roundtables and our International Economic Forum on Latin America and the Caribbean.

 

Thanks to its strong and low-risk business model, Santander has navigated pretty well through the crisis, and has adapted to the new market and regulatory environments with capital adequacy and sounder balance sheets. We see you as a key partner in our effort to improve the global financial system, the topic I am going to address here today.

 

 

Six years after Pittsburgh: Important progress

 

It is now exactly six years since I was in Pittsburgh with G20 leaders to set out an ambitious financial reform agenda. Since then, the G20 has been working with partners – including the OECD, the Financial Stability Board, the World Bank and the IMF – to strengthen and support financial markets through better micro-prudential supervision and macro-prudential oversight, to address issues such as liquidity, solvency, and accounting principles, and to tackle leverage problems within the financial system.

 

We have delivered on the promises to create a better, sounder financial system that serves our citizens and helps to build the trust our economies need. According to OECD estimates of banks’ ‘distance-to-default’, measures of banks’ safety have massively improved for all major banks in the United States, in Europe, in Latin America and Asia. By 2014, with a few exceptions, all the large global banks we looked at had moved to the safe region, and most of them very comfortably so. These are important achievements, but we still have a lot of work to do.

 

 

However, still a lot of work ahead

 

Current bank lending remains below its long-term trend in major OECD economies, with small- and medium-sized enterprises being mostly affected. As we reported in our latest Interim Economic Outlook a few days ago, year-on-year credit growth in the euro area as a whole has only recently turned positive, and in most euro area countries it remains below zero. Major deficiencies remain in improving banks’ conduct, and enforcement actions are coming to the fore "with depressing frequency" as Bank of England’s Governor and FSB Chair Mark Carney said recently.

 

Implementation is a work in progress, on top of which it can be hard to disentangle the effects of reforms from other factors and post-crisis economic developments. Closing regulatory loopholes, and striving for cross-border harmonisation of reform remain a challenge. For example, achieving a regulatory level playing field in bank regulation has been difficult, not only in national implementation of Basel capital requirements, but also in structural bank reforms.

 

And there is also the question of what are the ‘intended’ effects of reform? Is reduced bank lending as an outcome of a smaller and safer banking sector universally intended by all constituents? How do we assess the downside of ‘safer’ banks - the limitations of their support for economic growth, especially financing innovative SMEs?

 

More generally, to what extent do we recognise that pre-crisis financial intermediation, levels of financing and risk-taking behaviour were unsustainable and cannot be a benchmark? We do not have clear responses to all these questions, but we strongly believe that continued, intense dialogue between regulators and stakeholders can bring us closer to addressing these issues.

 

 

We need to build a financial sector that works for people

 

At the OECD we are working intensely with Member and Partner countries to ensure that the financial system can perform its vital role as an efficient intermediary between savers and borrowers.

 

We need sound and efficient financial markets and institutions, operating according to rules and procedures that are fair, transparent, and free from conflicts of interest, instilling consumer and investor confidence. Such considerations are at the heart of the recently launched OECD Trust and Business Project, which aims to work with governments, business, and civil society to bridge the gap between the rules set for business and their implementation.   

 

We must also ensure the contribution of finance to growth, focussing on financing the real economy - especially SMEs - and the role of institutional investors in long-term investment financing. Santander Advance Programme, which offers financial solutions to help SMEs spur internationalisation and foster job creation and talent in countries like Spain, Mexico and Portugal, is a great example. Its Breakthrough Programme for SMEs here in the UK has also had notable results. An OECD/G20 Task Force established in 2013 aims to support these efforts to finance the real economy.

 

Our new report, the OECD Business and Finance Outlook, finds that the international financial system needs greater competition and openness if the world economy is to be put on a more stable path. Our recommendations include:

 

1. Reforming bank structures in a cross-border consistent way

While global regulatory efforts have focused on banks’ capital requirements, the OECD has consistently argued that higher regulatory capital is not enough. Structural bank reforms, separating investment and ‘traditional’ banking are still needed to address problems of too-big-to-fail institutions and their interconnectedness, especially via exposures to the likes of derivatives. The OECD is working with the IMF, the FSB, and the G20 to promote and help implement these reforms focusing on cross-border consistencies and global financial stability. 

 

2. Removing obstacles to international capital flows

The global financial and economic crisis has also had an impact on the openness of our economies with regard to international capital flows. But national policies to manage capital flows have spillover effects on other countries, calling for international monetary and financial policy co-ordination. In this regard, the OECD Codes of Liberalisation, first adopted in 1961, have seen their importance validated by the crisis and stand out as instruments to promote transparency and multilateral co-operation, and support global capital openness in order to recoup a collective liquidity benefit. 

 

3. Improving corporate governance is also vital

Improving our financial markets requires improving the corporate governance of financial institutions. This is an area where fostering the right values and building a culture of integrity requires a clear “tone from the top”. Santander has set a positive example, with its balanced board, equal rights among shareholders and transparent remuneration system.

The G20/OECD Principles of Corporate Governance, endorsed at the recent G20 Finance Ministers’ and Central Bank Governors’ Meeting in Ankara, provide guidance on responsibilities of the Board in articulating a culture that embeds these values and translating them into governance measures. Implementation is, of course, the key challenge.

 

4) Finally, our Business and Finance Outlook recommends focusing on financial consumers

Another lesson of the crisis was the need to pay more attention to the negative impacts of finance on households and individual consumers. Financial consumer protection is a necessary condition of financial market integrity and efficiency. Recognising this, OECD work with the G20 on financial consumer protection complements our long-standing efforts to enhance financial literacy. Our holistic and coordinated approach aims to: enhance individuals’ financial literacy; promote access to financial products that meet consumers’ needs; and establish strong protections for consumers. This is an area where we can also partner with you.

 

 

Final comments on Latin America

 

Now before concluding, let me make some final comments on our perspective on the economic and financial situation of Latin America, a topic of common interest here.

 

Latin America seems to be entering a new normal, marked by slower growth and slower progress reducing poverty. Regional growth has decelerated from the average 5% of the previous decade to a meagre 1% in 2014, and it’s expected to reach -0.6% this year and 0.8% in 2015 in 2016.  

 

The regional average hides considerable inter-country differences. Trade dynamics explain much of this heterogeneity. The NAFTA Mexico is projected to grow by 2.4% and 3.0% in 2015 and 2016. Net energy importers in Central America and the English-speaking Caribbean, which benefit from lower crude prices, also have positive growth perspectives. While Brazil is facing a recessionary cycle, with GDP growth of -2.6% in 2015 and -0.6% in 2016, and Argentina still less than 1% in both years.

 

The loss of investment momentum is a key factor behind the current slowdown. While investment’s contribution to growth was pivotal in 2010 in the aftermath of the crises, it had a negative contribution to growth by 2014. External headwinds, notably lower commodity prices, the gradual retrenchment of monetary easing in the US and tighter financial conditions, are impacting investment plans. This adds to some (probably) short-lived domestic factors, such as policy uncertainty and the passing of reform bills (notably on taxes in some countries such as Argentina, Chile, Colombia, Ecuador, El Salvador and Venezuela). Public investment was not strong enough to compensate for this, actually, in some cases, it reinforced it.

 

The region is still facing enormous structural and long term challenges. Practically all Latin American countries need to shift more resources from low to higher-productivity sectors. Improved infrastructure and logistics performance are needed to bolster structural change, strengthen regional integration, serve a larger consumer demand and attract greater foreign direct investment. Employable skills and innovation are also crucial. Latin American firms are 13 times more likely than Pacific Asian firms to face serious operational problems due to a shortage of human capital. While the growth of SMEs is constrained by difficult access to and high cost of credit, particularly in the case of long-term credit.

 

Luckily we now have stronger financial systems. Latin America has learned from its long history of banking crises the importance of good financial system regulation. Today, the financial systems in the region are generally healthy and have a good regulatory framework. For instance, in Brazil, which is currently facing a more difficult economic situation, the exposure of the financial system to shocks has decreased due to the accumulation of foreign exchange reserves, the strict limitations on foreign-currency funding of banks, and the fact that non-performing loans have fallen since 2012.

 

However, today Latin America could be less able to face risks than it was in 2008. Increasing public and private expenditure and insufficient savings ratios led to a deterioration of current account balances even before the recent decline in commodities prices. Fiscal deficits increased significantly in several countries, including those where countercyclical fiscal policies adopted in 2009 were not reversed during the subsequent recovery. Indebtedness levels of firms and families are higher in several countries. And efforts to increase productivity in the region have been insufficient, mainly because of the lack of structural reforms (with the recent exception of Mexico through El Pacto).

 

There are also challenges related to regulatory compliance. For example, some banks in the region have begun to expand into other countries in the region. This shows the strength of these banks, but also brings risks that national regulators are not yet used to. Therefore, it is important that Latin American countries implement Basel III to avoid major regulatory discrepancies between domestic and foreign banks, considering that the parent companies of European banks operating in the region are already implementing it. While some countries are ahead of the rest of the OECD, like Mexico, others in the region are lagging behind: in Brazil, Basel III standards will enter into effect gradually with full implementation by 2019. Similarly, Chile, a financially sound economy that has not undergone a banking crisis since the 1980s, has not yet implemented Basel III recommendations.

 

In all these areas and challenges, I am sure that there is a lot that we can do together to build a more resilient, more transparent and more efficient financial system, in Latin America and the world, to promote more inclusive and sustainable growth.

 

I will stop here, so we can address other issues of interest in the Q&A session. 

 

Thank you very much.


 

 

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