leadership in financial services

Trinity Business School


Leadership in Financial Services

Guest lecture: Paul Woods

January 2017


Introduction• Background

� Joined Central Bank 2011, supported recovery initiatives during bailout, later moving to lead financial and non-financial risk management domains

� Prior experience leading in corporate and startup environments (telecoms, software)

� M.B.S DCU, M.Sc. Economic Policy, M.Sc. Distributed Systems from TCD

• Topics we’ll cover

� Central Banking

� Financial crises

� Future risks

� Leadership and values

• Inputs from great colleagues in Financial Stability and Monetary Policy

• The views do not formally represent the Central Bank, presentation given in personal capacity


A bird’s eye view of Central Bank stakeholders

Ireland from the International Space Station, sent to the author by Terry Virts, Commander and Astronaut


The importance of financial institutions• Intermediaries that perform critical role in any economy

� Banks – maturity transformation, loan deposits to facilitate (ideally) productive activity

� Insurance companies – facilitate transfer / pooling of risk, allowing efficient mitigation

� Other financial institutions act as important intermediaries between buyers and sellers

• Collectively financial institutions form a critical, but potentially dangerous distributed system

� Distributed systems lens as useful as economics lens when assessing risks

� Anywhere great power is bestowed, responsible values based leadership is crucial

• History highlights laissez-faire approach to regulatory oversight doesn’t work

� Divergent incentives for micro institutions versus greater good for macro economy

• Regulation and supervision ensures conformity with acceptable codes of behaviour

� Authorisations, supervision and ensuring codes of conduct regarding consumer protection


Star Wars as an analogy to financial services• Objective to maintain balance and ensure a stable financial system for all stakeholders

• System never designed with bad intent, but unintended consequences can arise

� Stakeholders may not recognise or intend contributing to magnitude of collective risk

� Institutions may have incentive to say, “there’s nothing to see here”

� Collectively institutions can form an ‘economic Death Star’

� Herd mentality can over inflate asset bubbles

• Financial crises have disastrous impact

� > Inequality, recovery options constrained by segment

� Loss employment, homes, emigration tears apart families

• Each stakeholder in financial system bears huge responsibility

� System’s roots must be nourished with strong leadership values and regulatory oversight


Risks confronting the systemInternal to Central Bank

Micro prudentialrisks

Macro prudentialrisks


Price stability• Primary objective of European System of Central Banks to maintain price stability

� Inflation is the rate at which general prices for goods and services rise

� High inflation causes a redistribution of wealth from lenders to borrowers

� Hyperinflation is an extraordinary high rate of inflation

� Deflation – incentive to postpone purchases, economy slows, cost of debt servicing rises

• Price stability a legal objective of central banks

� Often the target is set at 2%


Financial stability and crises

Short-term Decline in asset prices (property,

stocks), increase in unemployment

Banking sector losses and negative market sentiment

Higher Government debt

Legacy issues Muted credit growth, private and

public indebtedness

Weak banks and investor caution

Long-term growth prospects

• Impact of financial crises


• Boom/bust cycles in property

• Leverage and “this time is different”

• Globalisation and interconnected economies

Real Economy

• Increase in size and complexity

• Inadequate risk management

• Financial innovation and interconnectedness

Banking Sector• Reliance on market

discipline rather than intensive oversight

• Inadequate models• Overly expansionary

economic policies

Economic and Regulatory Policy

What causes a crisis• A number of interrelated factors

� Cost of Irish bank bailout – circa 64 billion euro (final costs will have to be calculated)


Macroprudential Policy

Policy Objective Type of toolMonetary policy Price stability Broad-based tool

Microprudentialpolicy

Stability of individual institutions

Targeted at specific institutions

Macroprudential policy

Financial stability Range of instruments which can be targeted at source of risk

• Policies that aim to reduce the possibility of a systemic crisis occurring

� Tools impacting how much banks can lend: loan-to-value, loan-to-income ratios

� Tools increasing bank resilience: Capital, sector specific buffers, sector specific limits


Financial crisis• Like watching a very slow motion crash simulation impacting all consumers and businesses

• Empathy: but real people impacted, limited crumple zones, airbags don’t deploy quickly

• Lesson: Importance of addressing risks ex ante, common good of macroprudential policy


The Irish Crisis

• Peak-to-trough fall (2007-2012): -50%• Peak no. of negative equity mortgages (2012):314,000

Housing Market

• Total losses (2009-2013): -€67bn• Peak non-performing loan ratio (2013Q4):27%• State investment in Irish banks (as at 2012): €63bn

Banking Sector

• Rise in unemployment rate (2007-2012): 10.4pp• Total fall in real GDP (2008-2010):-8.3%

Irish Economy


Mistakes were made in the past

All stakeholders must ensure mistakes never repeated

Our small team supervised Ireland’s most systemiccommercial banks with exposures a multiple of the

country’s GDP!!!

• By all stakeholders

� Governance and risk management within commercial banks disastrously weak

� Group think, internal bank procedures often overridden, especially credit risk controls

� Banking supervision significantly under resourced, focus on process rather than outcomes

� Weak monitoring of macro risks domestically / globally


How does a central bank affect an economy?

Economy in recession

Lower interest rates, stimulus

Cost of borrowing falls

Firms and consumers borrow more

Firms hire more workers

Economic growth

Upward pressure on prices

• Process buys time but does not substitute for longer term sound fiscal leadership

� Non-standard measures not designed to be used over medium or long term


Monetary policy transmission channels

Banks’ and money market interest rates

Expectations of future interest rate & inflation/price developments

Asset prices & exchange rate

Supply of bank loans/credit

Savings and investment decisions

Aggregate demand and prices


ECB main refinancing rate

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

%

Main Refinancing Rate

Further reductions constrained


Low yield environment changes behaviour


ECB balance sheet

0

500

1000

1500

2000

2500

3000

3500

4000

€bn

• Quantitative easing

� Non-standard monetary policy also has bounds and implications for risk landscape


Bond spreads within Eurozone

0

2

4

6

8

10

12

14

%

Italian Spread Spanish Spread Irish Spread Greek Spread

“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” Mario Draghi, 2012


Fed balance sheet

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

$bn

• Policy Normalization Principles and Plans

� Stated goal to reduce balance sheet to pre 2008 levels over time

� Reduce holdings of long-term Treasurys and mortgage-backed securities by not replacing them upon maturity


Bank of Japan balance sheet

-

100,000

200,000

300,000

400,000

500,000

600,000

¥ bn

• Quantitative easing

� BOJ balance sheet represents much larger % of region GDP than ECB or Fed


Great Financial Crisis

500

700

900

1100

1300

1500

1700

1900

2100

2300

2500

S&P 500


Future risks to global financial stability

Inequality Brexit

Societal

Long-term macro implications of Brexit unclear, broader impact to global stability

Ageing populations, large scale involuntary migration, water crisisantibiotic resistance, pandemic …

Resource inequality & sustained unequal access to education drives mass unrest

Interstate Conflict Territorial disputes, military conflict, use of weapons mass destruction, fiscal cost of securing borders

Technology relatedFinancial institutions become tech companies. Potential for systemic cyber attack. Emerging risks – AI, P2P, DLT, > HST flash crashes …

Political Global power shifts, rise in populism, policies for protectionism, trade wars …

EconomicFiscal crises, asset bubbles, energy price shocks, derivative risk ‘black holes’, tax base evolution …

Terrorism Radical extremism and ability to disrupt society through large scale terrorist atrocities, ‘dog and flea’ economics – increasing burden

Other environmental Natural disasters, water crisis, extreme space weather event …

Global WarmingDisproportionate impact certain economies, segments, and institutions. Potential wholesale reassessment, stranded assets


A Central Bank must synchronise like an orchestra• Understand how micro and macro risks interlink

� Evaluate right mix of tools, ensure tools well ‘tuned’, optimize timing of intervention

� Smooth handoffs, such as transfer of cases from Financial Supervision to Resolution


Safeguarding stability, protecting consumers• Financial institutions play a critical role in any economy

� Incentives diverge, regulatory oversight must be embedded into system roots

� Timely action necessitated to reduce risk vulnerabilities

• Central Bank has broad portfolio of tools

� Each must overlap in a phalanx formation to prevent gaps

� Mon. Policy, macroprudential, microprudental, resolution …

• Responsible and accountable leadership is crucial

� Embedding risk management, strong governance, board / mgt. diversity

� Deep onus of care to protect consumers; customers, not chess pawns

• You are all nodes in the financial system

� Avoid the herd, learn financial skills, maintain your resilience


Supervision & Enforcement

Consumer Protection

Regulatory PolicyDevelopment

Payments, settlements& currency

Economic advice& Statistics

FinancialStability

PriceStability

Recovery& Resolution

A Central Bank trusted by the public,

respected by our peers

Central Bank’s role


Maybe you should join us, make an impact?

www.centralbank.ie/careers

leadership in financial services

Economy & Finance