Is the current “fit and proper” regime appropriate for the Banking Union?

EU rules on fit and proper are a patchwork of high-level principles and national law. Deep cross-country differences affect both the assessment process and the criteria used. New Level 1 measures are required to impose common requirements on knowledge, experience, good repute, independence and conflicts of interest, and to unify procedural aspects across Member States. Meanwhile, the ECB should assign a public score to individual board members and disclose the motivations behind its fit and proper assessments. This document was provided by the Economic Governance Support Unit at the request of the ECON Committee

Pillar II in the New Basel Accord - The Challenge of Economic Capital

Pillar II complements the ‘black letter’ requirements of Pillar I and is intended to achieve two objectives: to ensure that banks have adequate capital to support all the risks in their business and to encourage them to use better techniques for monitoring and managing their risks. The second pillar specifically emphasises the need for a qualitative approach to supervising banks. It constitutes an integral part of the new capital accord and ranks equally alongside the minimum capital requirements and the call for market transparency. "Pillar II in the New Basel Accord: The Challenge of Economic Capital" tackles the regulatory framework, shows how to reconcile the various regulatory sources and focuses on the following sequence of questions: • What additional capital is required to support Pillar I risks where the Basel II models do not adequately reflect the unique circumstances of the particular bank? • What additional capital is required to support risks not captured under Pillar I at all? • What reduction in capital should be allowed to account for the fact that individual risks may be less than perfectly correlated? • What further adjustment should be made to counteract procyclical movements in regulatory capital resulting from the Pillar I calculation? • How should a banking group’s economic capital be allocated to its business units and legal entities? • How will supervisors from different countries interact when assessing Pillar II implementation in international banks? • How will hybrid capital help in preserving and maintaining the capital adequacy levels dictated by Pillar II

Il secondo pilastro di Basilea e la sfida del capitale economico

Il volume esamina alcune delle componenti primarie del processo di pianificazione patrimoniale, quali la determinazione e l’allocazione del capitale economico, concentrandosi ora sull’inquadramento normativo, ora sull’approfondimento delle metodologie di calcolo, ora sull’illustrazione degli aspetti di natura più propriamente strategica, gestionale e organizzativa. Ai diversi capitoli fanno seguito alcuni sintetici e incisivi Approfondimenti, a cura di esperti impegnati nell’implementazione della normativa sul Secondo Pilastro. Ne emerge una trattazione di tipo corale che agli esiti delle riflessioni accademiche affianca la concreta esperienza operativa delle banche, l’apporto di esperienze e di professionalità diversificate da parte delle associazioni di categoria e delle società di consulenza, la particolare ottica dei supervisori chiamati a emanare le norme e, allo stesso tempo, a valutare la compatibilità con gli obiettivi prudenziali delle metodologie e dei processi adottati dai soggetti vigilati

How demanding and consistent is the 2018 stress test design in comparison to previous exercises?

The 2018 EU-wide stress test requires banks to evaluate the impact on profits and capital of common macroeconomic scenarios for 2018-2020. The methodology set up by the EBA addresses four main sources of uncertainty: credit risk, market risk, financial risks on net interest income and operational risk. Credit risk is assessed on the basis of the new IFRS 9 accounting standard. Market risk includes a valuation of illiquid, hard-to-price level 2/3 financial instruments. Net interest income is assumed to suffer from an asymmetric increase in the rates earned on assets and paid on liabilities. Operating risk includes conduct risk and takes into account past loss events. This written advice highlights some weaknesses in the EBA methodology, which may lead to a different degree of conservativeness for some business models or countries. It also discusses ways to make future stress tests more realistic and reliable, by addressing resource gaps and improving governance

Non-performing loans in the European Union. State of the art and possible policy tools

This note provides an updated picture on NPLs in the European Union, showing that – although the NPL ratio has been steadily decreasing, significant differences remain across Member States. It then discusses the two main factors driving NPLs in the long term: the macroeconomic cycle and the banks’ lending practices, arguing that policy makers should continue to encourage the development of sound internal credit ratings. Finally, four main levers are discussed, that can be used to curb high NPL stocks. Internal recovery processes, which should be improved by investing in better IT architectures and specialised professional skills. NPL sales, which may prove attractive (and reduce the supervisors’ own reputational risks), but also to destroy value for bank shareholders, debtholders and the public purse. Asset management companies (AMCs), which may prevent banks from disorderly liquidating NPLs, force badly-managed banks to feel the pain of past mistakes and gradually recover loans while being funded at an acceptable cost. Calendar provisioning regimes like the one recently proposed by the SSM, which may force banks to quickly write down non performing exposures, but may suffer from several drawbacks and should be enacted through a fully-fledged, accountable political process. In designing ways to tackle non-performing exposures, one should never forget that NPLs, while being associated with modest profits and poor loan supply, do not cause them but, like them, follow from poor real growth, ineffective management and faulty governance schemes

The next SSM term: supervisory challenges ahead

We look at the challenges facing the Single Supervisory Mechanism in the coming years, and discuss vulnerabilities in the euro area’s banking system, as well as possible improvements in the SSM’s internal practices. Among the former are low profitability, the increased role of the shadow banking system and weak governance. The latter include an overly complex regulatory framework, limits on staffing that lead to excessive usage of consultants, the need for more transparency and accountability. The SSM should help banks achieve more sustainable returns by making supervisory requirements less complex. It should monitor shadow banks, ensuring that traditional lenders are isolated from possible shocks. As for governance, the SSM ought to engage in a multi-year action plan aimed at improving ethics, technical qualifications, checks and balances. Regulatory complexity must be reduced by further harmonising national rules. Constraints on the SSM’s budget and human resources should be loosened, but the use of external consultants ought to be limited to special cases. Accountability and transparency can be enhanced, e.g., through greater disclosure on resources and objectives, SREP and other internal methodologies, and on decisions taken by the SSM’s Administrative Board of Review. The European Court of Auditors should be entitled to assess the soundness of the SSM’s processes, without interfering with individual supervisory decisions

Review of the 2017 SREP results - Banking Union Scrutiny

This report looks at the methodology used by the ECB to carry out its supervisory evaluation of banks (“SREP”), as well as at theaggregate results disclosed by the supervisors and the figures released over time by individual banks. Our review suggests that greater disclosure may improve uniformity in how the SREP is implemented across institutions, as well as consistency between SREP analyses and supervisory priorities. Disclosure towards banks could be enhanced by using a standard, detailed template in the communication of the SREP findings (including “horizontal” benchmarking analyses and differences between supervisory computations and the banks’ own estimates). The release of SREP results to the public, while strengthening market discipline, may trigger undesirable reactions by customers and market counterparties; for banks with listed financial instruments, however, the additional capital requirements following from the SREP meet the definition of inside information provided in the Market Abuse Regulation, and should therefore be publicly disclosed. Finally, higher transparency standards are called for when it comes to the methodologies and metrics used by supervisors to assess specific areas within the SREP

What future for BASEL II?

The financial crisis that severely hit the international banking industry during the last few years has clearly highlighted a number of problems and weaknesses associated with the prudential regulatory framework centred on risk-weighted capital adequacy requirements. These very weaknesses gave rise to the new proposals by the Basel Committee to revise the capital adequacy framework known as "Basel 3"

Prestiti bancari, rating interni e modelli VaR: quale autonomiadi pricing per le unità operative?

Il lavoro passa in rassegna le implicazioni dei moderni modelli VaR per il rischio di credito in termini di pricing e di autonomie operativ

Supervisors as Information Producers: Do Stress Tests Reduce Bank Opaqueness?

In this paper we examine the 2011 European stress test exercise to assess whether and how it affected bank stock prices. Our event study analysis shows that the test’s results were considered relevant by investors. The market did not simply look at the detailed historical data which was released after the tests, but also attached considerable importance to variables measuring each bank’s vulnerability to the simulated downturn scenario. The latter include proxies for liquidity risk and model risk. Information on sovereign debt holdings, while affecting market reaction on a univariate basis, is not statistically significant in a multivariate setting. We also find that the market is not able to anticipate the test results and this is consistent with the idea of greater bank opaqueness prior to the disclosure of the stress test results. Overall, our analysis shows that stress tests produce valuable information for market participants and can play a role in mitigating bank opacity