4 Bank regulation and supervision, Basel Flashcards
The rationale for government intervention
1. Asymmetric information Customers lack the information and technical knowledge to properly assess the soundness safety , solidness and sustainability ) of a FI 2. Externalities Events that can cause the fail of a sound FI when another FI goes bankrupt contagion risk ). Furthermore , the social costs of the failure of a FI ( bank failure effect throughout the economy ) exceed the private costs private marginal costs borne by the shareholders and the employees of the company 3. Market power In the financial sector, economies of scale through merger and netork economis (for instance , in payment systems or stock exchanges ) may reduce competition . Competition policy aims to ensure effective competition by taking a strong line againts price fixing, market sharing cartels , abuse of dominant positions , and anti competitive mergers
Prudential Supervision
Aims to promote the stability of the financial system by ensuring the soundness of FI
As FI are becoming more complext supervisors are moving away from direct control to methods that
provide incentives for FI to behave prudently
Prudential Supervision Macroprudential supervision
Focuses on the financial system as a whole
Aims to
Promote the financial system’s resilience in absorbing risks
E nsure adequate levels of financial intermediation, and
C ontribute to sustainable economic growth
Prudential Supervision Microprudential supervision
Aims to
Ensure the solvency and financial soundness of each institution in the long run (and, thereby,
ensure the stability of the financial system)
E nsure the safety of the funds entrusted to the institutions
Conduct of business Supervision
Focuses on how FI deal with their customers and how FI behave in markets (FI activities)
Aims to
Ensure transparency of the information provided to customers by the supervised entities offering
banking products and services
Promotes the financial information and education of bank customers
En sure compliance with the regulatory framework for these products and services, thereby
contributing to the efficiency and stability of the financial system
Regulates, oversees and sanctions the conduct of supervised institutions offering retail banking
products and services
Regulatory system in the EU
The current regulatory system in the EU is based on the principle of home country control combined
with minimum standards and mutual recognition
Single Supervisory Mechanism (SSM) European System of Financial Supervision ( European Central Bank (ECB) National Supervisory Authorities (NSA)
S
ECTORAL
M ODEL
Separated
supervisors for
banking, insurance
and securities
Advantages
Facilitates the effective control of the supervised
entities
Allows for a high degree of specialization of the
supervisory authority in the corresponding
market segment
Reduced costs
Disadvantages
Hard to implemente due to current trend of
diversification of activities in all segments,
growing integration of markets and instruments
and the emergence of large financial
conglomerates
Possibility of conflicts among the several
objectives defined by segment
F
UNCTIONAL
M ODEL
Also known as the twin peaks model. Separated supervisors for each of the supervisory objectives (prudential and conduct of business supervision)
Advantages
Effective in a context of highly integrated markets
and in the presence of multi functional
operators, conglomerates and groups operating
in different areas/segments
Allows for uniform regulation for different
entities that perform the same activities
Disadvantages
It could lead to duplication or the lack of certain
controls when the areas of responsibility are not
correctly delimited
High costs
S
INGLE S UPERVISOR
M ODEL
Also known as the integrated model. There is a single supervisor for banking, insurance and securities (or one supervisor for prudential and conduct of business)
Advantages Economies of scale The supervisory authority has a unified, integrated and global vision of the reality of the financial system Reduces the possibility of regulatory arbitrage
Disadvantages
The decision process is very slow
Problems related to conflicting regulatory
objectives (tradeoff between competition and
stability)
ESFS European System of financial supervision p.17
ESFS was introduced in 2010 and it consists of
the European Systemic Risk Board (
3 European supervisory authorities ( namely
•
the European Banking Authority (
•
the European Securities and Markets Authority (
•
the European Insurance and Occupational Pensions
Authority (
National Supervisory Authorities (
The European Systemic Risk Board (
Responsible for the macroprudential oversight of the EU
financial system and the prevention and mitigation of
systemic risk
C overs banks, insurers, asset managers financial market
infrastructures and other financial institutions and markets
Monitors and assesses systemic risks and, where appropriate,
issues warnings and recommendations
The European Banking Authority (
Its main task is to contribute to the creation of the European
Single Rulebook in banking whose objective is to provide a
single set of harmonised prudential rules for financial
institutions throughout the EU
Plays also an important role in promoting convergence of
supervisory practices and is mandated to assess risks and
vulnerabilities in the EU banking sector
The European Securities and Markets Authority (
Has direct supervisory powers in two areas Credit Rating
Agencies and Trade Repositories (centrally collect and
maintain the records of derivatives, of securities financing
transactions and on transparency of securities financing
transactions)
The European Insurance and Occupational Pensions Authority
(
Its main task is to promote a sound regulatory framework for and
consistent supervision of insurance and occupational pensions
sectors in Europe
This protects the rights of policyholders, pension scheme
members and beneficiaries It also creates public confidence in
the EU’s insurance and occupational pensions sectors
Adoption of the Basel Framework
The banking supervision rules applied in the EU are based on the set of standards for the prudential
regulation of credit institutions developed by the Basel Committee on Banking Supervision (
Is the primary global standard setter for the prudential regulation of banks and provides a forum
for regular cooperation on banking supervisory matters
W as established by the central bank Governors of the G 10 countries at the end of 1974
Its 45 members comprise central banks and bank supervisors from 28 jurisdictions
It has no supervisory power
Its mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose
of enhancing financial stability
•
E xchanging information on developments in the banking sector and financial markets, to help identify
current or emerging risks for the global financial system
•
Sharing supervisory issues, approaches and techniques to promote common understanding and to
improve cross border cooperation
•
A ddressing regulatory and supervisory gaps that pose risks to financial stability
•
M onitoring the implementation of BCBS standards in member countries and beyond with the purpose
of ensuring their timely, consistent and effective implementation
Basel 1
In 1988 the BCBS publishes a set of recommendations known as Basel I
In order to contribute to the soundness of the international banking system and reduce competitive
imbalances between banks and national banking systems, it established minimum capital requirements
Minimum proportion of capital (corresponding to a percentage of the total amount of risk weighted
positions) that the financial institution must permanently guarantee to minimize the possibility of
insolvency and bankruptcy in the banking system
bank has to hold at least 8% of their risk weighted assets
Basel 1 critics
The Accord concentrated on credit risk alone Other types of risk, such as interest rate risk, liquidity
risk, currency risk and operating risk, were ignored
Risk weights did not adequately differentiate between the risk level of the bank assets (e g AAA
company and non OECD country bank)
Assumes that all corporate borrowers have equal risk of default (e g company AAA and company B)
There was no reward for banks that reduced portfolio risk because there was no acknowledgment of
risk diversification in the calculations of capital requirements
Basel 2
Capital requirements should be more risk sensitive so that equity or capital levels keep pace with changes
in institutions’ risk profile, including operational risk
Probability of negative impacts on results or on capital, arising from failures in the analysis, processing
or settlement of operations, internal and external fraud, the activity being affected due to the use of
resources under the outsourcing regime, the existence of resources insufficient or inadequate human
resources or the inoperability of the infrastructure
The capital adequacy regime should not be limited to the setting of minimum regulatory ratios
The role of supervisory authorities and market discipline are equally relevant
The dissemination of best practices in the financial system should be encouraged, developing a set of
incentives that reward the capacity of institutions to measure and manage risk
3 pillars :
- Minimum capital requirements
- supervisory review process
- market discipline
Basel 3
After the subprime financial crisis, the BCBS publish the Basel III Accord
“Basel III A global regulatory Framework for more resilient banks and banking systems”systems”(June
2011
“Basel III International Framework for liquidity risk measurement, standards and monitoring
(December 2010
This agreement increases the capital requirements of banks in order to improve their quality and
expand their capacity to absorb losses and withstand periods of low liquidity levels
