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- Sustainable Architecture for Finance in Europe (SAFE) (23) (remove)
We provide an assessment of the Basel Committee on Banking Supervision (BCBS) proposal to restrict the internal ratings-based approach on bank risk and to introduce risk-weighted asset floors. If well enforced, risk-sensitive capital regulation results in a more efficient credit allocation compared to the standard approach. Thus, the internal ratings-based approach should be maintained. Further, the use of internal ratings-based output floors potentially results in unintended negative side effects. Input floors are likely a valuable tool to achieve risk-weighted assets comparability. Finally, the proposed measures have a potential detrimental impact for European banks as compared to others.
How demanding and consistent is the 2018 stress test design in comparison to previous exercises?
(2018)
Bank regulators have the discretion to discipline banks by executing enforcement actions to ensure that banks correct deficiencies regarding safe and sound banking principles. We highlight the trade-offs regarding the execution of enforcement actions for financial stability. Following this we provide an overview of the differences in the legal framework governing supervisors’ execution of enforcement actions in the Banking Union and the United States. After discussing work on the effect of enforcement action on bank behaviour and the real economy, we present data on the evolution of enforcement actions and monetary penalties by U.S. regulators. We conclude by noting the importance of supervisors to levy efficient monetary penalties and stressing that a division of competences among different regulators should not lead to a loss of efficiency regarding the execution of enforcement actions.
This in-depth analysis provides evidence on differences in the practice of supervising large banks in the UK and in the euro area. It identifies the diverging institutional architecture (partially supranationalised vs. national oversight) as a pivotal determinant for a higher effectiveness of supervisory decision making in the UK. The ECB is likely to take a more stringent stance in prudential supervision than UK authorities. The setting of risk weights and the design of macroprudential stress test scenarios document this hypothesis. This document was provided by the Economic Governance Support Unit at the request of the ECON Committee.
This document was requested by the European Parliament's Committee on Economic and Monetary Affairs. It was originally published on the European Parliament’s webpage: www.europarl.europa.eu/RegData/etudes/IDAN/2021/689443/IPOL_IDA(2021)689443_EN.pdf
This in-depth analysis proposes ways to retract from supervisory COVID-19 support measures without perils for financial stability. It simulates the likely impact of the corona crisis on euro area banks’ capital and predicts a significant capital shortfall. We recommend to end accounting practices that conceal loan losses and sustain capital relief measures. Our in-depth analysis also proposes how to address the impending capital shortfall in resolution/liquidation and a supranational recapitalisation.
Supranational supervision
(2022)
We exploit the establishment of a supranational supervisor in Europe (the Single Supervisory Mechanism) to learn how the organizational design of supervisory institutions impacts the enforcement of financial regulation. Banks under supranational supervision are required to increase regulatory capital for exposures to the same firm compared to banks under the local supervisor. Local supervisors provide preferential treatment to larger institutes. The central supervisor removes such biases, which results in an overall standardized behavior. While the central supervisor treats banks more equally, we document a loss in information in banks’ risk models associated with central supervision. The tighter supervision of larger banks results in a shift of particularly risky lending activities to smaller banks. We document lower sales and employment for firms receiving most of their funding from banks that receive a tighter supervisory treatment. Overall, the central supervisor treats banks more equally but has less information about them than the local supervisor.
We employ a unique dataset on members of an elite service club in Germany to investigate how elite networks affect the allocation of resources. Specifically, we investigate credit allocation decisions of banks to firms inside the network. Using a quasi-experimental research design, we document misallocation of bank credit inside the network, with state-owned banks engaging most actively in crony lending. The aggregate cost of credit misallocation amounts to 0.13 percent of annual GDP. Our findings, thus, resonate with existing theories of elite networks as rent extractive coalitions that stifle economic prosperity.
Using the negotiation process of the Basel Committee on Banking Supervision (BCBS), this paper studies the way regulators form their positions on regulatory issues in the process of international standard-setting and the consequences on the resultant harmonized framework. Leveraging on leaked voting records and corroborating them using machine learning techniques on publicly available speeches, we construct a unique dataset containing the positions of banks and national regulators on the regulatory initiatives of Basel II and III. We document that the probability of a regulator opposing a specific initiative increases by 30% if their domestic national champion opposes the new rule, particularly when the proposed rule disproportionately affects them. We find the effect is driven by regulators who had prior experience of working in large banks – lending support to the private-interest theories of regulation. Meanwhile smaller banks, even when they collectively have a higher share in the domestic market, do not have any impact on regulators’ stand – providing little support to public-interest theories of regulation. Finally, we show this decision-making process manifests into significant watering down of proposed rules, thereby limiting the potential gains from harmonization of international financial regulation.
In this study, we analyze the trading behavior of banks with lending relationships. We combine detailed German data on banks’ proprietary trading and market making with lending information from the credit register and then examine how banks trade stocks of their borrowers around important corporate events. We find that banks trade more frequently and also profitably ahead of events when they are the main lender (or relationship bank) for the borrower. Specifically, we show that relationship banks are more likely to build up positive (negative) trading positions in the two weeks before positive (negative) news events, and also that they unwind these positions shortly after the event. This trading pattern is more pronounced for unscheduled earnings events, M&A transactions, and after borrower obtain new bank loans. Our results suggest that lending relationships endow banks with important information, highlighting the potential for conflicts of interest in banking, which has been a prominent concern in the regulatory debate.
This briefing paper describes and evaluates the law and economics of institution(al) protection schemes. Throughout our analysis, we use Europe’s largest such scheme, that of German savings banks, as paradigm. We find strengths and weaknesses: Strong network-internal monitoring and early warning seems to be an important contributor to IPS network success. Similarly, the geographical quasi-cartel encourages banks to build a strong client base, including SME, in all regions. Third, the growth of the IPS member institutions may have benefitted from the strictly unlimited protection offered, in terms of euro amounts per account holder. The counterweighing weaknesses encompass the conditionality of the protection pledge and the underinvestment risk it entails, sometimes referred to as blackmailing the government, as well as the limited diversification potential of the deposit insurance within the network, and the near-incompatibility of the IPS model with the provisions of the BRRD, particularly relating to bail-in and resolution. Consequently, we suggest, as policy guidance, to treat large IPS networks similar to large banking groups, and put them as such under the direct supervision of the ECB within the SSM. Moreover, we suggest strengthening the seriousness of a deposit insurance that offers unlimited protection. Finally, to improve financial stability, we suggest embedding the IPS model into a multi-tier deposit re-insurance scheme, with a national and a European layer. This document was provided by the Economic Governance Support Unit at the request of the ECON Committee.
We employ a proprietary transaction-level dataset in Germany to examine how capital requirements affect the liquidity of corporate bonds. Using the 2011 European Banking Authority capital exercise that mandated certain banks to increase regulatory capital, we find that affected banks reduce their inventory holdings, pre-arrange more trades, and have smaller average trade size. While non-bank affiliated dealers increase their market-making activity, they are unable to bridge this gap - aggregate liquidity declines. Our results are stronger for banks with a higher capital shortfall, for non-investment grade bonds, and for bonds where the affected banks were the dominant market-maker.