International Association of Risk and Compliance Professionals (IARCP)

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International Association of Risk and Compliance Professionals (IARCP)1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.comTop 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's agenda, and what is next

Dear Member,

Have you seen the average salary and the demand for Basel III skills in IT jobs?International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 2

Source: IT Jobs Watch, that provides a unique perspective on today's information technology job market (no affiliation).

Read more at Number 1 blow.

Also, are you good in disaster management?

According to Pentti Hakkarainen, Deputy Governor of the Bank of Finland, one aspect of disaster management is keeping particularly risky or vulnerable business in a separate legal unit thus making it easier to divest/withdraw without exposing the rest of the operations for contagion by cutting linkages rapidly.Read more at number 3 below. Welcome to the Top 10 list.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 3Amazing: The average salary and the demand for Basel IIIskills in IT jobs advertised across the UK

The table looks at the demand for Basel III skills in IT jobs advertised across the UK.

Included is a guide to the average salaries offered in IT jobs that have cited Basel III over the 3 months to 6 March 2013 with a comparison to the same period in the previous 2 years.Long-term interest rates

Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve System, at the Annual Monetary/Macroeconomics Conference The past and future of monetary policy, sponsoredby the Federal Reserve Bank of San Francisco, San Francisco, CaliforniaRe-evaluating the universal banking model: Can the Volcker, Vickers or Liikanen rules make banks safer?

Remarks by Mr Pentti Hakkarainen, Deputy Governor of the Bank of Finland, at the 4th Future of Banking Summit, organised by Economist Conferences, ParisInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 4Reflections on reputation and its consequences

Speech by Ms Sarah Bloom Raskin, Member of the Board of Governors of the Federal Reserve System, at the 2013 Banking Outlook Conference, Federal Reserve Bank of Atlanta, Atlanta, GeorgiaOpinion of the European Insurance and Occupational Pensions Authority on Supervisory Response to aProlonged Low Interest Rate EnvironmentInvestigations by the Financial Supervisory Authority into issues connected with the banking collapse have now concluded

Investigations by the Financial Supervisory Authority (FME) into the events preceding the banking collapse in the autumn of 2008, which began immediately following the failure of the three large commercial banks, have now concluded.

FME investigated a total of 205 cases.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 5A very interesting presentation

Icelands pre- and post-crisis experienceSECURITIES AND EXCHANGE COMMISSIONNotice of Filing of ProposedRule Change to Require that Listed Companies Have an Internal Audit Function

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (Act) and Rule 19b-4 thereunder, notice is hereby given that on February 20, 2013, The NASDAQ Stock Market LLC (Nasdaq or Exchange) filed with the Securities and Exchange Commission (Commission) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the Exchange.The European crisis and the development of the European Union

Speech by Mr Lars Rohde, Governor of the National Bank of Denmark, at the European Affairs Committees consultation: The European crisis andthe development of the European Union, former Upper Chamber of the Danish Parliament, CopenhagenInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 6Promoting an inclusive financial sector in Pakistan

Speech by Mr Yaseen Anwar, Governor of the State Bank of Pakistan, at the Closure Ceremony of Term Sarmaya Certificate (TFC) issued by Tameer Microfinance Bank, KarachiInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 7Amazing: The average salary and the demand for Basel III skills in IT jobs advertised across the UK

The first table below looks at the demand for Basel III skills in IT jobs advertised across the UK.

Included is a guide to the average salaries offered in IT jobs that have cited Basel III over the 3 months to 6 March 2013 with a comparison to the same period in the previous 2 years.

The second table is for comparison and provides aggregates for all of the Quality Assurance & Compliance category.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 8International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 9Source: IT Jobs Watch, that provides a unique perspective on today's information technology job market (no affiliation).

To learn more: http://www.itjobswatch.co.uk/jobs/uk/basel%20iii.doInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 10Long-term interest rates

Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve System, at the Annual Monetary/Macroeconomics Conference The past and future of monetary policy, sponsored by the Federal Reserve Bank of San Francisco, San Francisco, California

I will begin my remarks by posing a question: Why are long-term interest rates so low in the United States and in other major industrial countries?

At first blush, the answer seems obvious: Central banks in those countries are pursuing accommodative monetary policies to boost growth and reduce slack in their economies.

However, while central banks certainly play a key role in determining the behavior of long-term interest rates, theirs is only a proximate influence.

A more complete explanation of the current low level of rates must take account of the broader economic environment in which central banks are currently operating and of the constraints that that environment places on their policy choices.

Let me start with a brief overview of the recent history of long-term interest rates in some key economies.

Chart 1 shows the 10-year government bond yields for five major industrial countries: Canada, Germany, Japan, the United Kingdom, and the United States.

Note that the movements in these yields are quite correlated despite some differences in the economic circumstances and central bank mandates in those countries.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 11Further, with the notable exception of Japan, the levels of the yields have been very similar indeed, strikingly so, with long-term yields declining over time and currently close to 2 percent in each case.

The similar behavior of these yields attests to the global nature of the economic and financial developments of recent years, as well as to the broad similarity in how the monetary policymakers in the advanced economies have responded to these developments.

Of course, Japanese yields are clearly a case apart, as Japan has endured an extended period of deflation, while inflation in the other four countries has been positive and generally close to the stated objectives of the monetary authorities.

But even Japanese yields have shown some tendency to fluctuate along with other benchmark yields, and they have also declined over the period shown.

In my comments, I will delve more deeply into the reasons why these long-term interest rates have fallen so low.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 12

This examination may be useful both for understanding the current stance of policy and also for thinking about how rates may evolve.

In short, we expect that as the economy recovers, long-term rates will rise over time to more normal levels.

A return to more normal conditions in financial markets would, of course, be most welcome.

Many commentators have noted, however, that both an extended period of low rates and the transition back toward normal levels may pose risks to financial stability.

In the final portion of my remarks, I will discuss some aspects of how the Federal Reserve is approaching these risks.

Why are long-term interest rates so low?

So, why are long-term interest rates currently so low?

To help answer this question, it is useful to decompose longer-term yields into three components:

One reflecting expected inflation over the term of the security;

Another capturing the expected path of short-term real, or inflation-adjusted, interest rates;

And a residual component known as the term premium.

Of course, none of these three components is observed directly, but there are standard ways of estimating them.Chart 2 displays one version of this decomposition of the 10-year U.S.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 13Treasury yield based on a term structure model developed by Federal Reserve staff.

The broad features I will emphasize are similar to those found by other authors using a variety of methods.

All three components of the 10-year yield have declined since 2007.

The decomposition attributes much of the decline in the yield since 2010 to a sharp fall in the term premium, but the expected short-term real rate component also moved down significantly.

Lets consider each component more closely.

The expected inflation component has drifted gradually downward for many years and has become quite stable.

In large part, the downward trend and stabilization of expected inflation in the United States are products of the increasing credibility of the Federal Reserves commitment to price stability.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 14

In January 2012, the Federal Open Market Committee (FOMC) underscored this commitment by issuing a statement since reaffirmed at its January 2013 meeting on its longer-run goals and policy strategy, which included a longer-run inflation target of 2 percent.

The anchoring of long-term inflation expectations near 2 percent has been a key factor influencing long-term interest rates over recent years.

It almost certainly helped mitigate the strong disinflationary pressures immediately following the crisis.

While I have not shown expected inflation for other advanced economies, the pictures would be very similar again, except for Japan.

With the expected inflation component of the 10-year rate near 2 percent and the rate itself a bit below 2 percent recently, it is clear that the combination of the other two components the expected path ofshort-term real interest rates and the term premium must make a smallnet negative contribution.

The expected path of short-term real interest rates is, of course, influenced by monetary policy, both the current stance of policy and market participants expectations of how policy will evolve.

The stance of monetary policy at any given time, in turn, is driven largely by the economic outlook, the risks surrounding that outlook, and at times other factors, such as whether the zero lower bound on nominal interest rates is binding.

In the current environment, both policymakers and market participants widely agree that supporting the U.S. economic recovery while keeping inflation close to 2 percent will likely require real short term rates, currently negative, to remain low for some time.

As shown in chart 2, the expected average of the short-term real rate over the next 10 years has gradually declined to near zero over the past few years, in part reflecting downward revisions in expectations about theInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 15

pace of the ongoing recovery and, hence, a pushing out of expectations regarding how long nominal short-term rates will remain low.

As the persistence of the effects of the crisis have become clearer, the Federal Reserves communications have reinforced the expectation that conditions are likely to warrant highly accommodative policy for some time:

Most recently, the FOMC indicated that it expects to maintain an exceptionally low level of the federal funds rate at least as long as the unemployment rate is above 6.5 percent, projected inflation between one and two years ahead is no more than a half percentage point above the Committees 2 percent target, and long-term inflation expectations remain stable.

In discussing the role of monetary policy in determining the expected future path of real short-term rates, I have cheated a little:

What monetary policy actually controls is nominal short-term rates.

However, because inflation adjusts slowly, control of nominal short-term rates usually translates into control of real short-term rates over the short and medium term.

In the longer term, real interest rates are determined primarily by nonmonetary factors, such as the expected return to capital investments, which in turn is closely related to the underlying strength of the economy.

The fact that market yields currently incorporate an expectation of very low short-term real interest rates over the next 10 years suggests that market participants anticipate persistently slow growth and, consequently, low real returns to investment.

In other words, the low level of expected real short rates may reflect not only investor expectations for a slow cyclical recovery but also some downgrading of longer-term growth prospects.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 16

Chart 3, which displays yields on inflation-indexed, long-term government bonds for the same five countries represented in chart 1, shows that expected real yields over the longer term are low in other advanced industrial economies as well.Note again the strong similarity in returns across these economies, suggesting once again the importance of common global factors.

While indexed yields spiked up around the end of 2008, reflecting market stresses at the height of the crisis that undercut the demand for these bonds, these effects dissipated in 2009.

Since that time, inflation-indexed yields have declined steadily and now stand below zero in each country.

Apparently, low longer-term real rate expectations are playing an important role in accounting for low 10-year nominal rates in other industrial countries, as well as in the United States.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 17

The third and final component of the long-term interest rate is the term premium, defined as the residual component not captured by expected real short-term rates or expected inflation.

As I noted, the largest portion of the downward move in long-term rates since 2010 appears to be due to a fall in the term premium, so it deserves some special discussion.

In general, the term premium is the extra return investors expect to obtain from holding longterm bonds as opposed to holding and rolling over a sequence of short-term securities over the same period.

In part, the term premium compensates bondholders for interest rate risk the risk of capital gains and losses that interest rate changes imply for the value of longer term bonds.

Two changes in the nature of this interest rate risk have probably contributed to a general downward movement of the term premium in recent years.

First, the volatility of Treasury yields has declined, in part because short-term rates are pressed up against the zero lower bound and are expected to remain there for some time to come.

Second, the correlation of bond prices and stock prices has become increasingly negative over time, implying that bonds have become more valuable as a hedge against risks from holding other assets.

Beyond interest rate risk, a number of other factors also affect the term premium in practice.

For example, during periods of financial turmoil, the prices of longer-term Treasury securities are often driven up by so-called safe-haven demands of investors who place special value on the safety and liquidity of Treasury securities.

Indeed, even during more placid periods, global demands for safe assets increase the value of Treasury securities.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 18

Many foreign governments and central banks, particularly those with sustained current account surpluses, hold substantial international reserves in the form of Treasuries.

Foreign holdings of U.S. Treasury securities currently amount to about$5-1/2 trillion, roughly half of the total amount of marketable Treasury debt outstanding.

The global economic and financial stresses of recent years triggered first by the financial crisis, and then by the problems in the euro area appear to have significantly elevated the safe-haven demand forTreasury securities at times, pushing down Treasury yields and implying a lower, or even a negative, term premium.

Federal Reserve actions have also affected term premiums in recent years, most prominently through a series of Large-Scale Asset Purchase (LSAP) programs.

These programs consist of open market purchases of agency debt, agency mortgage-backed securities, and longer term Treasury securities.

To the extent that Treasury securities and agency-guaranteed securities are not perfect substitutes for other assets, Federal Reserve purchases of these assets should lower their term premiums, putting downward pressure on longer-term interest rates and easing financial conditions more broadly.

Although estimated effects vary, a growing body of research supports the view that LSAPs are effective at bringing down term premiums and thus reducing longer-term rates.

Of course, the Federal Reserve has used this unconventional approach to lowering longer-term rates because, with short-term rates near zero, it can no longer use its conventional approach of cutting the target for the federal funds rate.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 19

Accordingly, this portion of the decline in the term premium might ultimately be attributed to the sluggish economic recovery, which prompted additional policy action from the Federal Reserve.

Lets recap.

Long-term interest rates are the sum of expected inflation, expected real short term interest rates, and a term premium.

Expected inflation has been low and stable, reflecting central bank mandates and credibility as well as considerable resource slack in the major industrial economies.

Real interest rates are expected to remain low, reflecting the weakness of the recovery in advanced economies (and possibly some downgrading of longer-term growth prospects as well).

This weakness, all else being equal, dictates that monetary policy must remain accommodative if it is to support the recovery and reduce disinflationary risks.

Put another way, at the present time the major industrial economies apparently cannot sustain significantly higher real rates of return; in that respect, central banks so long as they are meeting their price stability mandates have little choice but to take actions that keep nominallong-term rates relatively low, as suggested by the similarity in the levels of the rates shown in chart 1.

Finally, term premiums are low or negative, reflecting a host of factors, including central bank actions in support of economic recovery.

Thus, while the current constellation of long-term rates across many advanced countries has few precedents, it is not puzzling:

It follows naturally from the economic circumstances ofthese countries and the implications of these circumstances for the policies of their central banks.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 20

How are long-term rates likely to evolve?

So, how are long-term rates likely to evolve over coming years?

It is worth pausing to note that, not that long ago, central bankers would have carefully avoided this topic.

However, it is now a bedrock principle of central banking that transparency about the likely path of policy, in general, and interest rates, in particular, can increase the effectiveness of policy.

In the present context, I would add that transparency may mitigate risks emanating from unexpected rate movements.

Thus, let me turn to prospects for long-term rates, starting with the expected path of rates and then turning to deviations from the expected path that may arise.

If, as the FOMC anticipates, the economic recovery continues at a moderate pace, with unemployment slowly declining and inflation expectations remaining near 2 percent, then long-term interest rates would be expected to rise gradually toward more normal levels over the next several years.

This rise would occur as the markets view of the expected date at which the Federal Reserve will begin the removal of policy accommodation draws nearer and then as accommodation is removed.

Some normalization of the term premium might also contribute to a rise in long-term rates.

To illustrate possible paths, Chart 4 displays four different forecasts of the evolution of the 10-year Treasury yield over coming years.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 21The black line is the forecast reported in the December 2012 Blue Chip Financial Forecasts survey.

The green line gives the Congressional Budget Office forecast published in February, and the blue line presents the median from the Survey of Professional Forecasters, as reported in the first quarter of this year.

Finally, the purple line shows a forecast based on the term structure model used for the decomposition of the 10-year yield in chart 2.

While these forecasts embody a wide range of underlying models and assumptions, the basic message is clear long-term interest rates are expected to rise gradually over the next few years, rising (at least according to these forecasts) to around 3 percent at the end of 2014.

The forecasts in chart 4 imply a total increase of between 200 and 300 basis points in long-term yields between now and 2017.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 22

Of course, the forecasts in chart 4 are just forecasts, and reality might well turn out to be different.

Chart 5 provides three complementary approaches to summarizing the uncertainty surrounding forecasts of long-term rates.The dark gray bars in the chart are based on the range of forecasts reported in the Blue Chip Financial Forecasts, the blue bars are based on the historical uncertainty regarding long-term interest rates as reflected in the Board staffs FRB/US model of the U.S. economy, and the orange bars give a market-based measure of uncertainty derived from swaptions.

These three different measures give a broadly similar picture about the upside and downside risks to the forecasts of long-term rates.

Rates 100 basis points higher than the expected paths in chart 4 by 2014 are certainly plausible outcomes as judged by each of the three measures, and this uncertainty grows to as much as 175 basis points by 2017.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 23

Note, though, that while the risk of an unexpected rise in interest rates has drawn much attention, the level of long-term interest rates also could prove to be lower than forecast.

Indeed, by the measures shown in chart 5, the upside and downside risks to the level of rates are roughly symmetric as of 2017.

We also have some historical experience with increases in rates during tightening cycles to consider.

For example, in 1994, 10-year Treasury yields rose about 220 basis points over the course of a year, reflecting an unexpected quickening in the pace of economic growth and signs of building inflation pressures.

This increase in long-term rates appears to have reflected a mix of a pronounced rise in the expected path of the policy interest rate and some increase in the term premium.

A rise of more than 200 basis points in a year is at the upper end of what is implied by the mean paths and uncertainty measures shown in charts 4 and 5, but these measures still admit a substantial probability of higher and lower paths.

Overall, then, we anticipate that long-term rates will rise as the recovery progresses and expected short-term real rates and term premiums return to more normal levels.

The precise timing and pace of the increase will depend importantly on how economic conditions develop, however, and is subject to considerable two-sided uncertainty.

Managing risks associated with the future course of long-term interest rates

As I noted when I began my remarks, one reason to focus on the timing and pace of a possible increase in long-term rates is that these outcomes may have implications for financial stability.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 24

Commentators have raised two broad concerns surrounding the outlook for long-term rates.

To oversimplify, the first risk is that rates will remain low, and the second is that they will not.

In particular, in an environment of persistently low returns, incentives may grow for some investors to engage in an unsafe reach for yield either through excessive use of leverage or through other forms of risk-taking.

My Board colleague Jeremy Stein recently discussed how this behavior may arise in some financial markets, including credit markets.

Alternatively, we face a risk that longer-term rates will rise sharply at some point, imposing capital losses on holders of fixed-income instruments, including financial institutions.

Of course, the two risks may very well be mutually reinforcing:

Taking on duration risk is one way investors may reach for yield, and the losses resulting from a sharp rise in longer-term rates will be greater if investors have done so.

One might argue that the right response to these risks is to tighten monetary policy, raising long-term interest rates with the aim of forestalling any undesirable buildup of risk.

I hope my discussion this evening has convinced you that, at least in economic circumstances of the sort that prevail today, such an approach could be quite costly and might well be counterproductive from the standpoint of promoting financial stability.

Long-term interest rates in the major industrial countries are low for good reason: Inflation is low and stable and, given expectations of weak growth, expected real short rates are low.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 25

Premature rate increases would carry a high risk of short-circuiting the recovery, possibly leading ironically enough to an even longer period of low long-term rates.

Only a strong economy can deliver persistently high real returns to savers and investors, and the economies of the major industrial countries are still in the recovery phase.

So how can financial stability concerns which the Federal Reserve takes very seriously be addressed?

Our strategy, undertaken in cooperation with other regulators and central banks, has a number of elements.

First, we have greatly increased our macroprudential oversight, with a particular focus on potential systemic vulnerabilities, including buildups of leverage and unstable funding patterns as well as interest rate risk.

Under the umbrella of our interdisciplinary Large Institutions Supervision Coordinating Committee, we pay special attention to developments at the largest, most complex financial firms, making use of information gathered in our supervision of the institutions and drawn from financial market indicators of their health and systemic vulnerability.

We also monitor the shadow banking sector, especially its interaction with regulated institutions; in this work, we look for factors that may leave the system vulnerable to an adverse fire sale dynamic, in which declining asset values could force leveraged investors to sell assets, depressing prices further.

We exchange information regularly with other regulatory agencies, both directly and under the auspices of the Financial Stability Oversight Council.

Throughout the Federal Reserve System, work in these areas is conducted by experts in banking, financial markets, monetary policy, and other disciplines, and at the Federal Reserve Board we have establishedInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 26

our Office for Financial Stability Policy and Research to help coordinate this work.

Findings are presented regularly to the Board and to the FOMC for use in its monetary policy deliberations.

Second, recognizing that our monitoring of the financial sector will always be imperfect, we are using regulatory and supervisory tools to help ensure that financial institutions are sufficiently resilient to weather losses and periods of market turmoil arising from any source.

Indeed, reflecting expectations embodied in the new Basel III andDodd-Frank standards, the largest and most complex financial firms have substantially increased both their capital and their liquidity in recent years.

Our current round of stress testing of the largest bank holding companies, to be completed early this month, examines whether the largest banking firms have sufficient capital to come through a seriously adverse economic downturn and still have the capacity to perform their roles as providers of credit.

In a related exercise, we are also asking banks to stress-test the adequacy of their capital in the face of a hypothetical sharp upward shift in the term structure of interest rates.

Third, our approach to communicating and implementing monetary policy provides the Federal Reserve with new tools that could potentially be used to mitigate the risk of sharp increases in interest rates.

In 1994 the period discussed earlier in which sharp increases in interest rates strained financial markets the FOMCs communication tools were very limited; indeed, it had just begun issuing public statements following policy moves.

By contrast, in recent years, the Federal Reserve has provided a great deal of additional information about its expectations for the path of the economy and the stance of monetary policy.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 27Most recently, as I mentioned, the FOMC announced unemployment and inflation thresholds characterizing conditions that will guide the timing of the first increase in the target for the federal funds rate.

Further, the FOMC stated that a highly accommodative stance of monetary policy is likely to remain appropriate for a considerable time after our current asset purchase program ends.

By providing greater clarity concerning the likely course of thefederal funds rate, FOMC communication should both make policy more effective and reduce the risk that market misperceptions of the Committees intentions would lead to unnecessary interest rate volatility.

In addition, the Federal Reserve could, if necessary, use its balance sheet tools to mitigate the risk of a sharp rise in rates.

For example, the Committee has indicated its intention to sell its agency securities gradually once conditions warrant.

The Committee also noted, however, that the pace of sales could be adjusted up or down in response to material changes in either the economic outlook or financial conditions.

In particular, adjustments to the pace or timing of asset sales could be used, under some circumstances, to dampen excessively sharp adjustments in longer-term interest rates.

Conclusion

Let me finish with some thoughts on balancing the risks we face in the current challenging economic environment, at a time when our main policy tool, the federal funds rate, is near its effective lower bound.

On the one hand, the Feds dual mandate has led us to provide strong support for the recovery, both to promote maximum employment and to keep inflation from falling below our price stability objective.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 28

One purpose of this support is to prompt a return to the productive risk-taking that is essential to robust growth and to getting the unemployed back to work.

On the other hand, we must be mindful of the possibility that sustained periods of low interest rates and highly accommodative policy could lead to excessive risk-taking in some financial markets. The balance here is not an easy one to strike.

While the recent crisis is vivid testament to the costs of ill-judgedrisk-taking, we must also be aware of constraints posed by the present state of the economy.

In light of the moderate pace of the recovery and the continued high level of economic slack, dialing back accommodation with the goal of deterring excessive risk-taking in some areas poses its own risks to growth, price stability, and, ultimately, financial stability.

Indeed, as I noted, a premature removal of accommodation could, by slowing the economy, perversely serve to extend the period of low long-term rates.

For these reasons, we are responding to financial stability concerns with the multipronged approach I summarized a moment ago, which relies primarily on monitoring, supervision and regulation, and communication.

We will, however, be evaluating these issues carefully and on an ongoing basis; we will be alert for any developments that pose risks to the achievement of the Federal Reserves mandated objectives of price stability and maximum employment; and we will, of course, remain prepared to use all of our tools as needed to address any such developments.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 29Re-evaluating the universal banking model: Can the Volcker, Vickers or Liikanen rules make banks safer?

Remarks by Mr Pentti Hakkarainen, Deputy Governor of the Bank of Finland, at the 4th Future of Banking Summit, organised by Economist Conferences, Paris

Thoughts on the reasons why the universal bank model exists, i.e. why it is valuable

There are benefits from combining different business lines under one roof

There are a number of reasons why banks combine several business lines under one roof:

strive for optimal use of capital

diversification of risk as distribution of profits and losses of different business lines are less than fully correlated

synergies from combination of different expertises

servicing the multiple needs of clients, especially in the case of corporate clients (one-stop-shopping)

There is now one way of structuring a universal bank.

E.g. some universal banks have numerous business lines under one legal unit, whereas other universal banks operate as a holding group of separate companies.

The business lines or legal units can be defined based on e.g. business areas or functions and/or geographical reach.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 30

The way banks aim to be structured is crystallised in the strategy, but e.g. M&A history and ability to achieve organic growth has had a great impact on how universal banks are structured today.

However, some banks already see the value of applying a universal bank model where various business activities are clearly structured and business lines are legally separated

Even without regulation requiring so, many banks already manage different business lines separately, which closely resembles a structure with different legal units.

Banks find management, risk management and HR/recruiting easier if the business is separated along logical units, i.e. functions/activities which fall naturally together.

From a risk management perspective, portfolios are already managed separately.

In some cases an important driver for legal separation of businesses is Disaster management, i.e. keeping particularly risky or vulnerable business in a separate legal unit thus making it easier to divest/withdraw without exposing the rest of the operations for contagion by cutting linkages rapidly.

There are also benefits of being organised along separated business lines.

The pricing of internal funding of business units can be arranged at arms length with risk-adjusted transfer pricing.

Allocation of economic capital can be done by business line and even at the level of individual customers, which support decision making and carrying out the business in an optimal way.

Making the structure of universal banks clearer would simplify the governance of banks and improve risk management.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 31

I have some insights from practice on what the consequences of legal separation of business lines could be.

In my view legal separation would benefit in particular the governance and risk management of banks.

As the HLEG report states, I have also experienced that the cultures of traditional retail banking and investment banking/trading activities are very different and blended cultures can cause problems.

The nature of the business and the attitude towards risk-taking are different.

In investment banking and trading activities profits are generated by actively seeking risk-taking opportunities by opening risky positions.

Whether these risk exposures had good risk-adjusted return prospects, has often been of secondary importance.

Models and warning signs flagged by risk management were often disregarded; high risks were taken even if the probability of success was low and the potential downside was significant.

In traditional retail banking, profits are mainly earned from interest rate margin income from long term customer relationships in a more stable manner.

Credit quality assessment and pricing policy lie at the core of the business.

Also the time horizon differs markedly.In the trading activity the results settled and assessed every single day. In retail banking profits are generated over several years time period.The responsibility and independence of the management is enhanced if business lines are separated to legal entities.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 32Separation also facilitates management, risk management and HR/recruiting, as the objective and needs are clearer in a separately defined business unit.

Aligning incentives to the strategy of the business line by means of targets included in remuneration schemes will also be easier.

If the operations to be separated are logical units then it is most probable that required reporting systems to support governance are already in place.

Separation will also facilitate monitoring by external stakeholders thus improving market discipline, which can be seen as an extension to the internal corporate governance mechanisms.

Specifically, separation may improve transparency and reduce uncertainty about the quality of banks as an investment opportunity thus facilitating pricing of the separated parts.

This, on the other hand, would improve the access to market funding among above average quality banks

Moreover making the structure of universal banks clearer through separation of businesses also facilitates the task of supervisors and authorities responsible for resolution.

Separation will certainly facilitate the application of recovery and resolution measures hence reducing the likelihood of public bail-outs, which would in turn have dramatic implications for e.g. funding costs.

Differences between the proposals of Independent Commission on Banking and High level Expert Group

The difference in the location of the ring-fence is important, ...International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 33

John Vickers has made very insightful comments on the compatibility of the proposal of his group, the Independent Commission of Banking with the proposal of the High-level Expert Group.

I have a few comments on this theme:

ICB and HLEG proposals started from different directions; the approach taken by ICB started from the narrow banking philosophy, whereas HLEG focused on the most volatile parts of banking business.

However, the groups ended up with qualitatively similar proposals.

As John Vickers has stated already, the main question as regards the position of the ring-fence is Where should securities underwriting be; in the investment bank (such as in ICB) or in the deposit bank (as in HLEG)?

Another difference is that ICBs proposal includes geographical restrictions as non-EEA customers cannot be served by the deposit bank.

This highlights the focus on the viability of the UK banking sector in the ICB.

HLEG is based on the view that underwriting is closely connected with corporate banking and thus naturally belongs to the deposit bank.

From the corporate clients perspective, issuing a bond is an alternative way of financing to taking a bank loan.

From the banks perspective, there are similar elements in both, because both involve a customer credit quality assessment, although in underwriting the banks own position taking is normally quite limited.

It is true that a promise of market making can be an important complement to a successful underwriting of a bond.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 34

However, separate entities within the bank group can well provide the underwriting and market making services without any additional cost to the customer.

HLEG did emphasise the importance that authorities require additional separation if that is needed to make the recovery and resolution plans credible, a measure that would bring the HLEG separation proposal closer to the ICB ring-fencing proposal.

The proposals are also somewhat different with respect to the height of the ring-fence.

The ICB included restrictions on cross-ownership, for example.

As suggested by the Parliamentary Commission of Banking, tasked with the pre-legislative review of the bill, the ring-fence will now be electrified by giving authorities reserve powers to require full separation.

... but the difference in capital requirements imposed on retail banking may have greater implications for banks.

However, in my view the fundamental difference between the two proposals is the difference in capital requirements.

ICB imposes an extra capital requirement on the ring-fenced retail bank (~deposit bank).

The HLEG was more concerned of strengthening the capitalisation of the trading entity and therefore suggested a review of capital requirements on trading book requirements.

It also suggested a review on capital requirements on real estate related lending.

HLEG did, however, not make any explicit requirement on imposing higher capital requirements.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 35

I do recognise that the requirement to issue designated bail-in instruments can be interpreted as higher capital requirements.

These would, however, apply across business lines not only to the deposit bank.

Some banks might be able to implement separation without significant costs as many banks already have the needed governance system in place, whereas suggested changes to the funding structure (tougher capital requirements) could entail additional costs.

I tend to agree with the critiques that it can be challenging for the ring-fenced banks to remain viable as the relatively narrowly definedoperations might not be sufficient to generate the profits needed to buildup the required level of capital.

On the other hand, the HLEG proposal would not separate more activities than mandated, and this might be the voluntary outcome in some banks.

It would also be very important to ensure that capital requirements are aligned globally to ensure the level playing field of banks.

Now ICB proposal will set the UK banks and foreign subsidiaries in a disadvantaged position in comparison to foreign banks non-subsidiary operations in the UK and with non-UK banks which can provide UK customers with financing elsewhere.

Finally, I would like to highlight the importance of sufficient loss absorption capacity across business areas.

As highlighted in recent work by Anat Admati and Martin Hellwig, imposing higher capital requirements has a positive impact on bank incentives and behaviour.

Among other things, well-capitalised banks maintain their lending also during downturns.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 36

Proprietary trading and market making is the question whether they are separable or whether they should be separated?

The first argument for the approach taken by HLEG is based on the desired scope of the safety net.

It is important to note that in the proposed separation, the question is not whether certain type of market making supports the real economy or not; as a starting point, all banking activities support the real economy.

Instead, the question is whether there is a market failure of some degree in certain banking activities so that those activities need to be publicly supported by giving them access to insured deposits as a funding base.

I.e., is it so that market making cannot be carried out in a profitable manner without cheap funding from deposit taking?

If that is the case, then it means that market making is cross-subsidized.

To draw on a recent comment by Darrell Duffie the more limited the types of risks that are legally permitted by those within the safety net, the less opportunity for moral hazard I would like to highlight the importance of ensuring that as small a fraction of banking activity as possible, preferably only the activities essential to the functioning of the society, i.e. the deposit taking, payment system, and perhaps lending to households and SMEs, ought to benefit from a government safety net.

When deciding what activities are allowed to be funded with insured deposits, there may of course be a question of level playing field between different jurisdictions.

But that should be addressed via sufficient harmonisation of the structural measures taken, not by being too lax about extending the use of deposits.

In short, there appears to be no clear case that market making, excluding few exceptions, ought to benefit from explicit or implicit government guarantees.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 37

So, market making should not have access to insured deposits.

The second argument underlying the HLEG proposal relates to whether it is possible to make the distinction between proprietary trading and market making.

From a regulatory and supervisory perspective it is very challenging to draw a clear line between proprietary trading and market making.

E.g. in the US the implementation of the Volcker rule has been delayed as a result and when implemented the supervisors will have to rely on tedious transaction-by-transaction supervision.

In its pure form, market making is not about taking open positions and the price spreads given re very narrow.

Only when things do not go as planned inventory is building up and this is when we get closer to the territory of proprietary trading.

At the level of the trading floor, it is relatively easy to distinguish the proprietary trading and market making.

However, things can also be hidden if so desired, hence making the supervision potentially very difficult.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 38Reflections on reputation and its consequencesSpeech by Ms Sarah Bloom Raskin, Member of the Board of Governors of the Federal Reserve System, at the 2013 Banking Outlook Conference, Federal Reserve Bank of Atlanta, Atlanta, Georgia

Good afternoon. I want to thank the Federal Reserve Bank of Atlanta for inviting me to join you for todays 2013 banking outlook discussion.

There are a number of interesting and very relevant topics on your agenda, most of which are rightly focused on the financial and regulatory environment.

I would like to share some thoughts this afternoon on a broader topic, however, that may be due for a refreshed look: the relevance of a banks reputation.Lets start in an elementary way in constructing a concept of reputation: We know that reputation is not entirely a moral trait.

We understand that there is a distinction between character and reputation.

When we say that someone shows good character, we are usually referring to something at the core of their being or personality.

On the other hand, when we refer to a persons reputation, we recognize that reputation is our perception of the person, that it is externally derived and not necessarily intrinsic to that individual.

In other words, we understand that a person may not have complete control over the perception that has been created.

Reputation, through no fault of ones own, can be tarnished.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 39

In the same way, ones reputation can be golden, even though nothing was done to earn it.

But like the notion of character, reputation can be earned and it can be a type of stored value for when challenges to ones own reputation come later.

Now lets bring this distinction into the context of banks:

Many bankers have a sterling character, and they operate financial institutions with sterling reputations that reflect that basic character.

At the same time, there are bankers who, regardless of their personal character, manage financial institutions with reputations that have been tarnished.

Their banks reputations could have been tarnished by almost anything, but likely most tarnish is attributable to the subprime mortgage meltdown and the ensuing financial crisis that cost the economy trillions of dollars; left millions of Americans bankrupted, jobless, nderemployed, or homeless; triggered massive litigation; and shook the confidence of our nation to the core.

Many of the darkest manifestations of the financial crisis have finally begun to diminish: the boarded-up homes with overgrown lawns, the half-built skyscrapers, the We Buy Houses Cheap signs planted at exit ramps, the eviction notices nailed to front doors.

But even as the economy comes back to life, our memory of these events is still sharp and the reputational damage suffered by U.S. financial institutions during the crisis endures.

To be blunt, a lot of people have negative feelings about banks, which they distrust and blame for the huge infusions of taxpayer money into the financial system that were deemed necessary during the crisis.

These reputational consequences whether justified or not are to be expected.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 40

Sociologists and economists have long remarked upon the central role that social trust plays in healthy markets.

Market transactions depend on a whole series of assumptions that people must be able to rely on, including the soundness of money, the enforceability of contracts, the good will of their partners, the integrity of the legal system, and the common meanings of language.

Social trust is the glue that holds markets and societies together.

In the context of banking, social trust and reputation are related concepts.

Banks themselves in crisis or not are particularly vulnerable to reputational consequences because of their public role.

The principal social value of financial institutions is their ability to facilitate the efficient deployment of funds held by investors (and entities that pool these funds) to productive uses.

This value is maximized when the cost to the entity putting capital to work is close to the price demanded by the entity that seeks a return on its investment.

In traditional banking, this means that financial intermediation occurs most effectively when the interest rate charged for use of funds in lending is close to the interest rate paid for deposits.

As the difference between the two grows (which would be attributable to amounts extracted by intermediaries as compensation for essential intermediation), the costs of borrowing for the purposes of creating productive projects become higher than they should be, with arguably negative reputational consequences.

Given these particular reputational dimensions associated with financial institutions, might financial regulators have an interest in considering reputational harms analytically?International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 41

Could there be benefits to understanding the ways that an individual financial institutions reputation or that of the financial industry as a whole might have particular effects on, for example, safety and soundness, financial inclusion, or financial innovation?

In my remarks today, I want to consider various aspects of how reputational harm manifests itself in banks and begin a dialogue with you about how we might refresh our thinking about this category of risk.

I will start with a description of some factors that can affect a banks reputation, especially in the wake of the financial crisis.

Next, I will talk about ways in which reputation matters, including how supervisors can use their unique ability to see inside the institutions that they examine to uncover some early indicators of reputational problems.

I will then turn to other reasons why policymakers may want to think about reputation.

One reason involves possible consequences regarding financial inclusion; that is, a customers ability to have a relationship with his or her bank that puts them in the position to save, access credit in a sustainable way, and understand the nature of the financial transactions in which they participate.

Reputation also may help or hinder a banks ability to innovate, so I will introduce this topic next.

Finally, I want to frame a discussion around the recent cybersecurity threats that banks are facing and place them in the context of reputational risk so that they too can be discussed constructively.

Of course, I preface these remarks with the admonition that these views are my own and may not be representative of those of the Federal Reserve Board.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 42

The financial crisis and the reputation of financial institutions

It has been more than five years since this country began experiencing a financial crisis that reverberated well beyond Wall Street.

This crisis was unique, and many of its marks on individuals and communities remain.

It was a crisis in which significant numbers of both subprime and prime mortgage defaults quickly spread across whole cities and regions until the impact was felt throughout the country.

The devastation was magnified by waves of foreclosures, significant drops in house values, job losses, and, ultimately, significant reductions in household wealth, which have been responsible, in part, for the slow recovery we confront today.

The causes of the crisis and the subsequent devastation are myriad, but to large swaths of the American public who have experienced the devastation, the causes rest squarely on the shoulders of financial institutions, especially the largest institutions.

Further, many Americans direct their anger at not only banks, but policymakers as well.

Because the economy pulled back from the brink of depression only through a massive and unprecedented infusion of public dollars, American taxpayers feel that they were forced into a position of accepting that the government had to put a lot on the line to save the financial system from ruin.

And many of those taxpayers are still unhappy about such a massive government intervention that seemed to aid banks that were not held to account, while distressed households were left to pay the price.

Unfortunately, in the publics view, little has happened to restore their trust and confidence in financial institutions.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 43

Since the crisis, the publics views of banks have been informed for better or worse by their experiences and those of their families and neighbors, who may have lost their homes, their jobs, or their household wealth.

Many attempted unsuccessfully to modify their underwater mortgages, even when they were current on their payments.

Against this backdrop, the publics lack of trust and confidence has been magnified by, among other things, the Occupy Wall Street movement, payday loans, overdraft fees, raterigging settlements in London Interbank Offered Rate (LIBOR) cases, executive compensation and bonuses that seem to bear no relationship to performance or risk, failures in the foreclosure process, and a drumbeat of civil litigation.

In the Internet age, the impact of consumer distrust is amplified: anyone can easily, cheaply, and anonymously create, organize, and participate in a protest.Participants do not have to gather physically to make their action felt. A recent survey found that

60 percent of American adults use social media, such as Facebook or Twitter, and

66 percent of those social media users (39 percent of all American adults) have used social media to engage on civic and political issues, including by encouraging other people to take action on a political or social issue.

Take, for example, the impact of the consumer backlash that erupted in late 2011 when one of the nations largest banks attempted to charge a $5 monthly fee for its debit card.

A California woman, frustrated with the banks decision to impose the fee, created a Facebook event, dubbed Bank Transfer Day, and invited her friends to join her in transferring their money from large banks to credit unions on that day.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 44

In the five weeks leading up to Bank Transfer Day, this Facebook event received extensive press coverage and resulted in billions of dollars in deposits reportedly shifting out of large banks.

The bank targeted by the Facebook protest ultimately reversed itself and declined to assess the monthly fee.

How reputational risk may be relevant

Financial institutions of all sizes have shared in the fall-out fairly or unfairly from a general decline in their industrys reputation among the public.

Moreover, the steady stream of litigation against financial institutions since the crisis has further harmed the reputations of specific firms among their customers.

Consider that in todays financial institution sector, a substantial portion of a banks enterprise value comes from intangible assets such as brand recognition and customer loyalty that may not appear on the balance sheet but are nevertheless critical to the banks success.

Also consider that at the end of 2012, deposits at commercial banks reached a record $10 trillion.

At the same time, the share of each deposit dollar that banks lent out hit a post-financial crisis low in the third quarter, which means that banks net interest margins have fallen sharply.

Across the industry, loan-to-deposit ratios are going down.In 2007, banks aggregate loan-to-deposit ratio was 91 percent. This ratio currently stands at 70 percent.In such a context, achieving higher earnings is a challenge.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 45

If bank profitability is going to improve in a context of low interest rates and higher compliance costs, lending income may remain low.

Profits will need to come from elsewhere.

One source of profits would be products that are not interest-rate dependent, but fee-dependent.

In other words, compressed net interest margins mean that many banks may look to new fee-generating products and trading activity to enhance profits.

The pressure to generate enhanced profits through high fees is palpable, and banks may choose to move aggressively down these paths.

But when a bank already suffers from a poor reputation either deservedly or as a knock-on effect of broader discontent with the financial industry it likely will face difficulties in introducing new fee-generating products or activities without inviting further criticism and damage to its reputation.

So an evaluation of the effects of the new product or activity on the banks reputation prior to launch is arguably necessary.

Reputational risk and supervision

The effects of the financial crisis, combined with the power of the Internet to broadly and quickly publicize information whether factually accurate or not should alert banks to how they are managing their reputations.

And supervisors have a duty to see that all risks are fully understood, even those risks that, like reputational risk, are unquantifiable or have not fully emerged.

I believe this is an area where supervision can add value.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 46

To the extent possible, supervision can unveil hidden loss exposures that may be building up through the accumulation of reputational risk elements.

If we were better able to identify and monitor such free-floating risk, and in so doing, to push bank boards of directors and senior management to pay more attention to reputational risk, we could help reduce the underpricing of these risks.

Many have argued, and I think its a compelling argument, that ineffective supervision and enforcement of existing laws and regulations contributed to the financial crisis.

By tolerating reduced transparency of risk in balance sheets and in complex institutional portfolios, as well as arbitrage around capital requirements and other prudential measures, supervision may have encouraged the underpricing of risk.

And the sudden correction of this underpricing of risk, in turn, accelerated the crisis.

The crisis punished investors who accepted more risk than they thought they had taken on, it punished consumers who overleveraged themselves, it punished Americans who lost their jobs and homes, and it contributed to the decline of once-vibrant neighborhoods and towns.

To mitigate the chances of such a crisis occurring again, supervisors need to redouble their efforts toward promoting greater transparency of risks and early confrontation of potential loss exposures.

We should view these efforts as a set of responsibilities for both banks and regulators that are aligned to assure the public and markets that risks can be fully understood and accurately estimated and priced.

In some ways, this perspective is not new territory for bank regulators.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 47

The Federal Reserve, for example, issued supervisory guidance in 1995 that identified the six primary risks that remain the focus of its supervisory program, and reputational risk is among them.

Having said that, it is still a risk that both banks and supervisors should learn how to identify ex ante rather than ex post.

So, while reputational risk is not a new concept by any means, it is an area that is ripe for additional work.

For example, the enterprise risk management framework of the Committee of Sponsoring Organizations of the Treadway Commission the so-called CO SO st and ard does not address reputational risk.

Likewise, the Basel capital frameworks exclude reputational risks from regulatory capital requirements.

Accordingly, the current approach to managing reputational risk is largely reactive rather than proactive.

Banks and examiners tend to focus their energies on handling the threats to their reputations that have already surfaced.

This is not risk management; it is crisis management a reactive approach aimed at limiting the damage.

Instead, we should think about a supervisory approach that incentivizes bank managers to sufficiently contemplate, quantify if necessary, and control the factors that affect the level of such risks before they fully emerge in an unmitigated form.

The way that the Federal Reserve supervises banking organizations may help identify risks sooner.

For all banking organizations, the supervisory program here does not simply rely on an annual onsite examination.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 48

The Federal Reserve supplements its regular examination activities with a program of continuous monitoring between examinations.

One of the key objectives of this program is to identify emerging risks and communicate with other regulators and the banks an updated risk assessment and supervisory strategy based on these risks.

When we contemplate a supervisory approach that illuminates reputational risk, we might be able to more fully uncover the interconnection of risks that certain activities could impose on investors, creditors, counterparties, and taxpayers.

In this approach, we would first and foremost need to encourage banks to assess the potential riskiness of particular operations, investments, products, and decisions to their reputations and, ultimately, to their enterprise value.

As supervisors, one objective as we work with financial institutions to extract such information would be to try to develop ways of measuring the value of the risks that banks shift onto the financial safety net.

Reputation and financial inclusion

There is also a relationship between reputation and financial inclusion, by which I mean the extent to which consumers can participate in a financial marketplace that consists of competitive providers of credit, savings vehicles, and sources of enabling financial information.

As policymakers, we must address the perceived trustworthiness of those financial institutions that interact with the public and move the millions of Americans lingering in the margins of the financial marketplace into relationships that provide them with sustainable access to banking and credit, an understanding of how mortgages and credit work, and an understanding of how to create savings.

Data from the Federal Reserves Survey of Consumer Finances and the Federal Deposit Insurance Corporations survey of the unbanked and underbanked show that the percentage of families earning $15,000 perInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 49

year or less who reported that they have no bank account has been increasing steadily for the past five years, resulting in more than 28 percent of these families being unbanked as of 2011.

Families slightly further up the income distribution scale, earning between $15,000 and $30,000 per year, are also financially marginalized: 12 percent reported being unbanked and almost 26 percent reported being underbanked in 2011.

There are several potential reasons for these impediments to inclusion.

When we examine barriers that individual consumers face in becoming financially included, we uncover trustworthiness and reputation.

A Federal Reserve analysis of the most recent Survey of Consumer Finances suggests that the primary reason individuals do not have a transaction account is a simple dislike of dealing with financial institutions.

If that dislike emanates from the reputation of the particular bank, or the reputation of the banking industry as a whole, policymakers and financial institutions will not be able to enhance financial inclusion without addressing the reputational context.

Reputation and innovation

Id like to imagine how the publics sense of well-being might be enhanced by their interactions with financial institutions.

If we paid attention to the experiences of consumers as they interact with various segments of the financial marketplace, what could we learn?

If we see rigidities or imperfections in that interactive experience, what innovation might we imagine that would not only reduce reputational risk but create something new and potentially advantageous?

Technological innovation was the subject of a recent award ceremony inSan Francisco.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 50

The winners were companies with names like SoundCloud, GitHub, MakerBot, Techmeme, and Snapchat, all of which presumably do amazing things, although I dont understand exactly what.

But, evidently, the real buzz at the ceremony was over something much more mundane that I for one have no problem understanding.

That buzz was around a pedestrian item a new and improved coffee cup lid.

This lid, called FoamAroma, reportedly provides exactly the right set of openings to maximize aroma and recyclability, while minimizing the effects of coffee spurting out too fast.

The point here is that the innovator noticed something simple that others had not: many coffee shop employees dont drink their coffee from cups with plastic lids like their customers do, so there was a market need that had not been recognized and then addressed.

Here I am not just talking about the mixed miracle of mobile banking and mobile payments or being able to take a picture of a check with a smart phone and it appearing in my checking account.

Thats a topic that is amazing in its own right and worthy of a separate speech.

I am talking about encouraging banks to pay attention to the banking experiences of their customers and finding process improvements or service elements that may lead to something seemingly mundane but valuable nonetheless.

Some innovators see reputation itself as not just something to be managed, but as a product in and of itself.

With buyers and sellers repeatedly and constantly interacting on the Internet, there are reputation trails that are being created that, when compiled, give an alternative set of markers about how trustworthy aparticular buyer or seller may be.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 51

These reputation trails gathered when you evaluate a product youve bought online or when you deliver the product that youve promised create a picture of trust that some have argued has value that can be shaped.

Reputational risks and cybersecurity

Perhaps reputation will one day transform commerce.

But in the meantime, I would like to mention one set of reputational issues that the banking industry is confronting as we speak.

As is the case for reputation trails, it too involves the Internet, but this use of the Internet is not being done in the spirit of cooperation and enhancement of public trust.

This set of reputational issues comes in response to the recent substantial increase in cyberattacks, all of which have the potential to undermine the fundamental trust that the public puts into financial institutions.

Cyberattacks on banks are occurring with increasing frequency, and concerted cooperative work between government and financial institutions is underway.

Customers are increasingly being affected by the cybersecurity threats that banks face.

Recently, distributed denial-of-service attacks have caused temporary disruptions of some web services.

In September, the websites of several large banks were rendered inaccessible for several hours from attacks now attributed to possible foreign state-sponsored hackers.

One of the greatest threats facing not just banks but many businesses and government agencies is hacking and the possible theft of proprietary data and personal information about customers.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 52

This cybersecurity threat is increasing at a time when more and more bank customers depend on electronic and mobile banking.

Workers are using their own laptops and smart phones or working remotely from home computers, and this increases the entry points to the systems that need to be protected.

In addition, customers and vendors are linking their systems, enhancing efficiency, but also creating more opportunities for potential intrusions.

But even beyond the potential theft of data and disruption of service, cyberattacks can represent significant reputational risk because they have the potential to create dissatisfaction among many customers or, even more chilling, total loss of consumer confidence.

Cooperative work between government and industry is underway.

Through the Department of the Treasury, many of the affected institutions have requested and received technical assistance from the Department of Homeland Security, which has been helpful in mitigating the attacks.

Some institutions are researching new technologies for defense against cyberattacks through their Internet service providers or security vendors, and others are reviewing their incident response processes to better manage recovery time and communications among information technology, employees, vendors, media, and customers.

The Financial and Banking Information Infrastructure Committee, the Financial Services Information Sharing and Analysis Center, and the Financial Services Sector Coordinating Council are serving as the forum through which the financial services sector shares important information and develops critical infrastructure protection policies.

Through their coordination, affected institutions and law enforcement agencies can share threat information and mitigation techniques.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 53

In addition, a recent Executive Order issued by the President represents a continued commitment to enhancing the security and resiliency of the nations critical infrastructure to meet future threats.

Conclusion

In closing, these have been some of my reflections on reputation as it applies to the business of banks.

The concept of trust is relevant to how bankers engage in a business that is of benefit to the public and provides meaningful innovation to the core function of financial intermediation, as well as to how we as supervisors can engage in a process of observation that is forward-looking and of benefit to both the public and the institutions that we regulate.

Thank you for your attention today. I look forward to taking your questions.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 54Opinion of the European Insurance and Occupational Pensions Authority on Supervisory Response to aProlonged Low Interest RateEnvironment

Introduction and Legal Basis

This Opinion is issued under the provisions of Article 29(1) (a) of Regulation (EU) No1094/2010 of the European Parliament and of the Council of 24 November 2010 (hereafter the Regulation).

As established in this Article, EIOPA shall play an active role in building a common Union supervisory culture and consistent supervisory practices, as well as in ensuring uniform procedures and consistent approaches throughout the Union.

This Opinion is being issued in fulfilment of EIOPAs responsibilities to facilitate and coordinate supervisory actions under Article 18(1) and Article 31(e) of the Regulation.

The information gathering requirements in the Opinion are included under the provisions of Article 35 of the Regulation.

This Opinion is addressed to the national competent authorities represented in EIOPAs Board of Supervisors.

The Opinion includes an appendix setting out key tasks for EIOPA and National Supervisory Authorities.

Context

The Japanese experience in the 1990s and early 2000s demonstrates both the plausibility of a prolonged period of low interest rates, as well as the impact of such a scenario.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 55

Many Japanese life insurers had built up substantial books of guaranteed business from the 1980s and were vulnerable to a prolonged period of low interest rates.

The result was that between 1997 and 2001, seven Japanese firms failed and legislation was passed to allow insurers to alter guaranteed rates on policies where they face a high probability of bankruptcy.

EIOPA has been highlighting for some time the potential solvency risks arising from a prolonged period of low interest rates.

In 2011 EIOPA carried out a st ress t est includ in g a low yie ld scen ario t o assess the effects on the EU insurance sector of a prolonged period of low interest rates/yields.

Two scenarios involving different profiles for yields were tested.

The exercise concluded that 5% to 10% of the included companies would face severe problems, in the sense that their MCR ratio would fall below 100%.

In addition, an increased number of companies would observe that their capital position would deteriorate with MCR rates only slightly above the 100% mark, whereby they could become vulnerable to other potential external shocks.

It is also highlighted in the recently published EIOPA Risk Dashboard as a significant risk identified by national supervisory authorities.

The EIOPA Financial Stability Report for the second half of 2012 highlights the complex and uncertain financial and economic situation facing European insurers.

EIOPA has focused to date on insurers but the low interest rate environment is also having an impact on occupational pension funds.

EIOPA plans to explore this more fully during the course of 2013.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 56

On one hand, weak economic conditions across the European economy imply that monetary conditions in the EU are likely to remain adaptable to the prevailing economic environment.

This is reflected in the official interest rates in Europe that remain at low levels and on a downward trend.

On the other hand, European government bond yields continue to be divergent with some countries experiencing negative real yields at some maturities due to a flight to quality, while others are experiencing highly positive real yields across most maturities reflecting creditworthiness concerns and other uncertainties.

Long term interest rates are of critical importance to life insurers, since these institutions typically have long-run obligations to policyholders that become more expensive in todays terms when market rates are low.

Consequently, the financial position of these firms typically deteriorates under such conditions, in particular where the duration of liabilities exceeds that of assets.

This problem is even more pronounced where guaranteed rates of return have been offered to policyholders.

A prolonged period of low interest rates may also have an adverse impact on non-life insurers pursuing a business model where investment returns are used to compensate for weak underwriting results.

In some cases, buoyant investment returns have facilitated intense price competition for market share with some firms operating with technical underwriting losses.

If underlying insurance business is being supported by investment returns this business model will be challenged by a prolonged low yield environment if no management action is taken to change the business model.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 57

Non-life insurers may also be affected in a situation where low yields do not provide sufficient returns to counteract the effects of inflation on longer tailed business.

This is a more difficult situation, since it requires inflation hedging over a long maturity.

The precise timing of when the effects of a prolonged low interest rate environment would manifest themselves on insurers balance sheets depends on the accounting methodology in use, as well as the business lines being written.

If market value is in use, the impact is very rapid since any decline in benchmark interest rates is reflected in the discount rate applied to liabilities.

This effect being amplified where the duration of liabilities is greater than that of assets.

The outcome is that available assets to cover solvency are eroded.

A relatively small number of EU jurisdictions utilise market value in insurance at present and they have already felt the impact of low interest rates.

If historic cost accounting is used then the impact on an insurers balance sheet appears more slowly since it emerges through lower profits or losses that are ultimately taken to the balance sheet.

The fact that the effects of low interest rates are slow to emerge in balance sheet terms does not mean the problem is not there and there is a real risk that firms could build up hidden problems.

This argues for the examination of a wider set of metrics when assessing the performance and condition of firms exposed to this risk.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 58

Examination of market value and historic cost accounting balance sheets can provide useful comparative information, while analysis of firms cashflows provides an insight into emerging imbalances.

In life insurance, guaranteed business is the most exposed to a prolonged period of low interest rates since there may be a yield spread compression.

In this case, as assets are (re)invested the achievable spread between returns on assets and guaranteed rates shrinks.

This reinvestment risk is the primary means by which the impact of low interest rates affects the financial position of firms in a historic cost accounting environment.

In terms of official solvency requirements, Solvency I is mainly based on historic cost accounting and is not a risk based framework.

As a result, the potential solvency impact under Solvency I is limited and may take some time to emerge in terms of solvency cover.

Nevertheless, some national supervisory authorities rate a prolonged low interest rate environment as an important risk for the insurance sector.

The implementation of Solvency II would see a move to market value and a risk based solvency requirement that would explicitly calculate the interest rate risk capital charge and would discount insurance liabilities using risk free rates as a basis.

In this context, it is important that insurers do not store up risks that may crystalize suddenly with the implementation of Solvency II.

Any delay in the full implementation of Solvency II should be used as a window for national supervisory authorities and insurers to deal with the issue.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 59

The impact of the current period of low interest rates has been felt in several European jurisdictions, where the national supervisory authorities have already taken a range of different measures to deal with the issue.

Internal research by EIOPA has highlighted the challenges faced by national supervisory authorities and individual insurers in responding to the risks posed by low interest rates.

In terms of guaranteed business, there are no immediate options available in relation to existing business which must be addressed through more medium term measures, such as increased reserving.

New business, on the other hand presents more options in terms of changes in product design to de-risk them or changes in the mix of business.

Firms have already started to respond by utilising these options.

Taking the above into consideration, EIOPA recommends the following supervisory responses:

Scoping the Challenges

National competent authorities, if they have not already done so, should actively assess for the insurance industry in their jurisdiction the potential scope and scale of the risks arising from low interest rates.

National competent authorities should then report to EIOPA their findings regarding potential scope and scale of risks.

EIOPA would coordinate a further exercise to assess the conditions that would be required for significant adverse solvency and/or systemic stability problems to arise, as well as to estimate when such problems would arise.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 60

National competent authorities should intensify the monitoring and supervision of insurance undertakings identified as having greater exposure to the risks posed by a low interest rate environment.

This should follow a clear escalation of supervisory activity dependent on the situation of the individual firm being considered.

Promoting Private Sector Solutions

Unsustainable business models in particular should face challenge from supervisors at an early stage and it is expected that insurance undertakings should be encouraged to resolve their own problems.

Even in those countries where the capital impact of low interest rates has already been recognized through market-consistent accounting, a threat to business models still exists.

Persistent low interest rates may damage the underlying value proposition of insurers, resulting in a downward pressure on sales and consequently pressures on expense ratios.

Additionally low interest rates may encourage other business model changes such as alterations in asset allocations in a search for yield, which may cre