Mr. Lakewood

Basle Committee on Banking Supervision

JV: Question on the expansion of money - report says it is

L: You need to distinguish between the Basle Committee and the BIS which are two quite different bodies. They are frequently confused. JV: They are integrated. L: they are not integrated the BIS purely provides a meeting place for the Basle Committee, The BIS is not even on the Committee, they are not even in the room. They are not observers. The Basle committee is the heads of supervisors in the major countries, that includes four agencies from the U.S., the Japanese, Germans, etc. What the Core Principles are is a world-wide negotiated document to tell to set out a basic structure as to how it should be achieved. You are asking about the macro-economic effects of supervision or what is the macro- economic effects of banking lending. that is not something supervisors can fix. They are there to make suer there are some set of standards--some set of ethical standards. but if you are talking about whether banks have too much or too little to lend, they you are looking at the macro- economics and bank supervisors can't fix that, nor indeed can the BIS that's in the hands of Finance Ministers, central banks, national legislatures.

JV: then we will get to the macro-economic, I have followed the activities leading to the 24 core principles with IOSCO, the G-7, the need to have a greater mechanism to regulate the world--not the world economies but what the banks are doing, how they are doing it , how it implements the greater picture and what I am looking to fund out is the structure--I couldn't figure it out from the Annual Report, who reports to who and who supervises what?

Lakewood: You are talking about implementing the core principles. That is not dealt in the annual report, there are only several references in the Annual Report. There are a 160-170 countries that are called upon to implement the core principles., including the U.S. and I don't think the U.S. will want the Basle committee or the BIS to tell them how to implement the supervision. There are going to be a certain peer group pressure, pressure from the IMF/WB and from the rating agencies in the private sector--the direction of lending, maybe the IIF will play a role.

The difficulty about the Core principles is that they are not principles, or principles, not detailed procedures because, each country is different. you are looking at different countries, different legal system, different frameworks, different histories, different agencies--some central banks, some agencies. the world is a pretty complicated place when you get into the legal side of it. We don't feel confident to handle the legal side of it

and handle that deep level of detail. They are fairly specific but not detailed. some think that they are superficial in some areas. In accounting or law, if you try to get specific you come up with a barrier.

JV: When I interviewed Stanley Fisher at the IMF/WP Spring meeting, I asked him what modus operandi would be put in place in order to implement the Basle committee and he said you were still in the process of setting it up. I guess what I am trying to figure out is who is going to report to who. You have banking supervisors, IOSOC, insurance supervsiors --who will coordinate who?

Lakewood: I can only speak for the banking supervisors. The IIS - the IOSCO - recently produced something with structure - IIS has only produced a mission statement. Stanley Fischer is right when he says we haven't devised a process. First we need to fact-find and that's going on. We have a questionnaire being completed--a very detailed questionnaire and covers all of the Core Principles. Once we have them back, we can take stock as to where country stands and come up with some form of a time table. But of course--let's say you have a country which is pretty well up to speed like the United States. Maybe there is something in the Core Principles that needs to be done maybe it's a question of independence, or something that's tricky or maybe a legal change - we don't know what needed until we have done this study. We have to study the impediments. What is it that needs to be fixed and how difficult will it be to fix it. I think the IMF -- Stanley Fischer is going to be a player in this process because the IMF said they will use the Core Principles in their surveillance work. They will not I don't think will be very rigid in saying "This or that must be done.' but they are more likely to say, "This is not being done how do you propose to fix it?" and they will then discuss it will some of the countries. Don't underestimate how difficult this is going to be. To take a very simple example, just trying to build a professional supervisory agency is years of work. You can't build a supervisor by sending him on a couple of training courses even to Basle. You will need years of training and then you get the problem that if you develop a competent supervisor one of the consulting firms will pitch him an offer of twice the salary. So we are into a long, long process. This is just the first step for many countries. Many countries that have members of the Basle Committee or those close to the Basle Committee have actually implemented most of the Core Principles actually already. Most of the Asian countries are light ways away.

JV: The supervisors - will they report to you and your committee for the banking system?

Lakewood: They will not report in a kind of legal sense to the extent we will be doing fact finding and assisting them -- with training and maybe giving them advice. They will be in contact with us. We are not the policeman or the cause, we are a kind of consulting body. We are going to hope to work with them. It's a cooperative process. If there is going to be a policeman in the court, its more likely to be the IMF or the World Bank who will take a more rigorous line. It could be the private sector like Moody's or some such body comes out and says that this country or that country has some major problems in applying the Core Principles, they may give it a lower credit rating.

JV: I think you hit what I was looking for as to who might take the lead. If the IMF were to take the lead in this, would their Articles have to be amended in order to do that?

Lakewood: That answer I don't know. I doubt it. I think within their Article IV and Article VIII consultations they have pretty wide discretion. You would have to ask Stanley Fisher or Lindgren or some of their experts.

JV: On page 168 of the Annual Report with regard to crisis intervention AND THE Core Principles - "Implementation will be a challenge. The withdrawal of rights of establishments for banks from jurisdiction with inadequate prudential standards." You will make the decision--we are talking national banks --the application, are we not, of the Core Principles to all banks throughout the world in order to get a feel as to a better feel for supervision and who is doing what?

Lakewood: I think you changed your question half-way through...JV: You're right I did. I'm sorry.

Lakewood: There will not be a black and white answer and this is not a black and white situation. It will always be possible to improve your supervision. The difficulty is that as I said, each country is different. It is not easy to move in. Let's say I am asked to go to the Netherlands and look at the supervision conducted by the Netherlands Bank JV. You mean the Netherlands National Bank? Lakewood: I am talking about the process of supervision in the Netherlands. JV: Of their national banks Lakewood: Of their banks in the Netherlands. When you say national banks, it would include foreign banks which operate in the Netherlands. Veon: Yes.

Lakewood: It also importantly includes their banks on a global basis. So, ABM Amro is a global bank but the Netherlands is the primary supervisory. It is very difficult. I can go in and say "that's interesting. They do it different from the U.S. or the British or the Germans." But it is difficult to say that they do it worse than the British or the Germans because you can't even score them on whether banks have failed or whether they have problems. If you did it like that you could probably argue that the U.S. has the worst supervision in the world. So it's all a matter of quality rather than quantity. It's an art not a science. All these things are not capable of scoring in a very precise manner. where the core Principles can be scored is in the legal situation. For example, the independent ....well it is not so easy to say whether an supervisory authority is independent. they may have the independence in law but the finance minister in some countries may put a lot of pressure on supervisory authorities particularly in the situation where banks are failing or a re-structuring is going on. Thailand is a typical case where they central bank has wanted to take strict strong action and has been warned off by the political side who have links with the private sector. Indonesia, even more so. We are still looking at a world where there are complicated links between the political and private side. Until you can get the corruption out of the system at the political level, you are always going to complicated influence on the bank supervisors which is coming in a round about way.

Veon: I was in banking for a short-time. I am no genius - what I am trying to figure out from and international standpoint, coming down, if it will be any different in trying to fix the problem. I think you hit it. It's corruption...

Lakewood: We are trying to hit it at a technological level. People keep saying to me, "that Capital Accord was very clever. You made a huge political decision and pretended it was technical. The Core principles are the same. They are technical but they are looking at a massive change in the kind of power structure in an economy. What is unique about the Core Principles is they are --basically they are a document in which all of the supervisors in the world support. they don't all agree with every single line in it and say 'We can't do this.' but they would like to be able to do it. so we are looking at a sort of Charter if you can call it at most. You are saying to the world that you want to have a strong banking system and operate effectively. We are saying this is how you can do it.

If you don't give us the powers that are set in here, particularly at the beginning of the document, then we can't do a proper job.

Veon: It also says that in order to implement the core Principles that massive changes would have to be made in a country's law. Do you see that as a problem in getting this to be implemented?

Lakewood: Potentially yes. If there are really massive changes in the law. Veon: Some countries won't have as many things in their laws as there are in the Core Principles and other countries will have more....Lakewood: We are not in favor of a lot of supervisory practices being in the law. What we are in favor of is the supervisor having discretion to supervise and to set standards and numbers which he thinks are approporate. We don't think those things should actually be set in law because they might turn out to be wrong and then you would have change it. What we are looking at is contract law, property rights, bankruptcy law. I keep talking about Asia because it is in our thoughts but what you have seen that firms have failed and the banks have not been able to get a resoution or force the companies or the borrowers into bankruptcy. They just continue with great deb-- that's partly because of the Asian culture which says you cannot close people, you can't sack people. You are in a cultural situation there which is difficult to change. So you need stricter laws ont he contact side, sizeing collateral, enforcing contracts and things like this. Bankruptcy is important. If you look at Thailand, their finance minister is a very impressive man. they are biting the bullet and putting in all these things. Also, in order to provide some support, they ar4e bbasically diluting their ownership of their banks by allowing foreign capital in and theya re actually welcoming foreign capital and they are creating the conditions in which foreign capital is attracted inl. They are receiving a great deal of foreign capital. In order to do this, Thailand has to put in or determine to put in place a proper contract law which will be voted on by Parliament to get that legal structure in place.

JV:

Let me see if I can recap what I am trtying to undherstand which you have done an esxcellent job of explaing.

In order to try and prevent another Asian crisis your committee, is looking to--if I use the incorrect words, correct me--standardize the supervisory processes bing used on a global basis so that it is from the international down to the local in order to prevent something like Asia happening. In order to do so, there will need to be changes according to what is already in place in a country, also what will be needed are supervsiors who are properly trained and both of these will take a lot of time in order to implement.

Lake: The second half is definitely right. The first half we can back track a little . We can make a banking system less vulnerable with supervision with following best practice can make a banking system less vulnerable to shocks--whether they are currency shocks, macro-economic shocks, or whatever, bbut its not possible to provide a kind of answer to all problems by having better banking supervision. You've got to have reasonably stable macro-economic economic policies, and you can have a shock to a system through a natural disaster I means there is no way that banking supervision can prevent an earthquake or a war or correct damage from something like that so don't expect banking supervision to prevent any such event in the future.

I will also say taht the Core principles pre-dates the Asian Crisis and were in pre-draft last april and the crisis was mid-July and were being prdocued before that. So it is wrong to say the core principles are a reaction to the Asian crisis but a result of pressure on the Bbasle Committee to widen its mandate as it were and that pressure comes fromt he G-7 ministers, Lyon followed by Denver. They said, "you guys should be looking at the rest of the world." so we began to lok at the resut of the world which we did not until that time because we were a committee of ten countries and all that we had built a network with countries around the world, we didn't feel that it was our responsibility to fix supervisioon in every country--we could advise, help and share documents, but we were given a mandate.

JV: Thank you - you were instructed by the G-7 to look at methods to help the system. I have been trying to figure out in all of the international conferences I have gone to who is giving and who is taking the orders. I always think of the BIS onb top of the world--you have more gold than a lot of central banks. You just --this is the heart, core of all the central banks of the world--how does that work--who takes orders from who--is that something that is a possibility in understanding?

Lakewood: Well we definitely take orders from everyone but we definitely do what we like. (JV: Very well said) I think at the end of the day the central banks -- through their governors--the G-10 governors and indeed the BIS shareholders in that structure is a pretty powerful body, you are right. But we are seeing--let me back track a bit--bank supervision was for about 15 or 20 years a kind of low-level te3chical matter where the central banks through the Basle committee did the technhical work. It is only with the Capital Accord that it became a kind of more high profile. but even then there weren't any competitiors to the Basle Committee for some years. In the last 2-3 years there have been a numer of .....cvompetitors coming pu. We have seen the iMF/world Bank get into supervision in a much bigger way, they have r3ecruited a lot of high powered people. Individually those people are strong but they dont' have a mechanism for makihng decisions. All they can do is be part of an IMF team and they have power in one or two countries but they don't have influence on a worldwide basis. The difficulty is that at the end of the day, it is an individual issue. What the IMF can or will do or the World Bank can or will do in their constitutencies is the real crux of the matter. What we are tyring to do is to make sure that the advice of the World Bank or IMF is consistent with the best practice and the lessions we have learned from dozen and dozen of events. don't underestimate the wealth of experince which the Basle committee because we have not only our 12 countries and the experiences they have had but we have a lot of international banking problems around the world.

JV: Who are some of the other agencies on the Basle committee--who sits in on your commission?

Lakewood: The Basle committee meetings are solo meetings of the G-10 alone and there is only bone observer and he is not in all of the meetings - the EU. The EU is only there when we are discussing issues which would have relevance for the E Legislation. We have over 18-20 years, since the first supervisors conference in 1979, we hafe been having every year a world conference. but as backing up that, we have developed a contact list of names ajnd addresses and phone numbers for ciruclation of documents, we have a bi-ennial report which is a contact document but more importantly we have built and encouraged regional gorups of supervsiors to collaborate so where IOSCO has come - from a big organiation and narrows to one or two key committess--they are a world organization--the Basle committee we have started from a very small nuquleas and we have spread out below it and in fact within our network, we have far more counttries than IOSCO. This is easy because its free. You have to pay to join IOSCO or IAIS.

When you talk about the role of the world Bank and the IMF, they are playing an increasing important role and as a result of the core Prinicples, it is written in the papwer, we have created two new gorups to monitor the implementation of the principles. One quite small with the IMF/World Bbank in that group with 18 countries plus those two and the European Union--that makes three observers as it were and a much wider groups which is anyone who wants to be part of the wider efforts.

Veon: At this point is it just trying to implement versus any kind of penalty for non-implementatiopn?

Lakewood: We are still fact-finding. The question of compliance is going to be difficult to establishy. It is going to be easy to say that you don't have the necessary bankruptcy law in place, you don't have possibly the necessary independence at that level. It will bbe difficult to say, "you don't have the right credit analysis or you don't have the right rules on concentration risk because countries will all have some form or they can pay for some form of rule together. The question is Is it an effective rule and is it being applied - this will be far more diffcult. Compliance is going to be difficult. If compliance is going to be difficult then penalties and punishments are even more dificult. At this pooint in time we are just trying to get the thing started and encourage countries to look at these and try and improve the structure they are working with. Further down the road, we will have to take that decision as to wqhat to do when people are plainly non-compling. And if its just incompetence we will try to help them but if its -- they are being aggressively non-compliant, then we will ahve to look again. Some countries like the US may decide to take specific measures. The US has been historically tough in the way it issues licenses to foreign banks--that's the way the penalize people. But I think we will ahve to face that one when welcome to it.

Veon: Robert Rubin told me for your information that the adaptation of the Basle Committee would not have to have the consent of Congress. I don't know why that is, I did not have a chance for a follow-up.

Lakewood: There is nothing [missed word or two] in it. They are just guidelines and recommendations. There is nothing in it that says "you must do this."

Veon:" You mentioned that there is nothing of a stronger nature for countires that are not compliant--that's on down the road.

Lakewood: You--staart defining what is non-compliant. I mean--the US--a lot of our papers --we put a paper out on internal controls recently. We would not regard that as a thing that would need legislation. it's a guidance for supervisors in how you should assess a bank. You go into a big and and what you need to know if those guys have contorl of there operations. These are the things you should look for. Not difficult to put it into a law and not necesary. Thank you.