Featured Product

    ISDA Urges EU to Revise CRR to Address Procyclicality Amid Stress

    April 27, 2020

    ISDA published a statement urging European authorities toward a more effective course of action to deal with the procyclicality that causes market risk capital requirements to balloon during a period of stress. To ease the impact of recent market volatility, ECB has temporarily reduced the qualitative market risk multiplier, which is not directly linked to the number of back-testing exceptions that are causing the problem. ISDA, however, states that a more effective course of action would be to revise the Capital Requirements Regulation in EU to bring it in line with the Basel Committee standards by giving national competent authorities the flexibility to take appropriate action when exceptions are not caused by deficiencies in the model. This would allow national authorities to intervene where necessary to temporarily suspend the automatic effects of the multiplier until the extreme effects of the COVID-19 pandemic are over.

    Regulators have typically tried to avoid putting in place measures that are explicitly procyclical, but the recent bout of COVID-related volatility is resulting in a significant increase in trading book capital requirements that could impede the ability of banks to deploy capital in support of the economy. The issue centers on the elevated number of value-at-risk (VaR) back-testing exceptions that banks are experiencing, caused by severe market volatility due to the pandemic. Under the current regime introduced as part of Basel 2.5, banks are required to add a multiplier to their capital calculations if actual or hypothetical P&L over the course of a single trading day exceeds VaR estimates more than four times in a year—with the multiplier increasing as the number of exceptions continues to climb. However, this measure has proved to be highly procyclical. The multiplier is meant to compensate for model deficiencies, but extreme volatility in recent weeks has put VaR models under pressure, resulting in a higher number of exceptions. This means banks are having to apply multipliers because of market volatility rather than shortcomings in their models, causing market risk capital requirements to balloon during a period of stress.

    All of this is happening at a time when regulators are taking measures to encourage banks to use excess capital and liquidity to continue to provide intermediation services and support the economy. The procyclical nature of the VaR multiplier could end up having the opposite effect, putting pressure on capital requirements. Regulators in CanadaSwitzerland, and the UK have recognized this issue and have taken action to smooth the volatility-induced procyclical effect of the multiplier. For example, Swiss regulators have opted to freeze the multiplier used by banks as of February 1 until July 1. ECB has also looked to address the problem and announced that it is temporarily reducing the "qualitative market risk multiplier," a measure set by supervisors that is intended to address weaknesses in a bank’s risk management, controls, and governance framework. While this action is welcome, ISDA would urge the European authorities to go further. The qualitative multiplier indirectly linked to the number of back-testing exceptions causing the problem. It is also individual to each bank, meaning the potential level of relief could differ between firms and be limited in some cases.

    Therefore, ISDA believes that a more effective course of action would be to revise the Capital Requirements Regulation in EU to bring it in line with the Basel Committee standards by giving national competent authorities the flexibility to take appropriate action when exceptions are not caused by deficiencies in the model. This would allow national authorities to intervene where necessary to temporarily suspend the automatic effects of the multiplier until the extreme effects of the COVID-19 outbreak are over. It is important that banks have sufficient capital to weather the current crisis and the more than EUR 2 trillion in tier 1 capital that internationally active banks have added to their balance sheets since 2011 means they are more resilient to stress. However, the procyclical market risk capital measures give banks less leeway to act as intermediaries, hindering firms from accessing the financing and risk management services they need.

     

    Related Link: Statement

    Keywords: International, Europe, EU, Banking, COVID-19, Value-at-Risk, CRR, Procyclicality, Basel, Market Risk, Regulatory Capital, Backtesting Exception, ISDA

    Featured Experts
    Related Articles
    News

    EC to Defer Application of SFDR Standards Till July 2022

    The European Commission (EC) announced plans to defer the application of 13 regulatory technical standards under the Sustainable Finance Disclosure Regulation (2019/2088) by six months, from January 01, 2022 to July 01, 2022.

    July 23, 2021 WebPage Regulatory News
    News

    BoE Consults on Approach to Setting MREL, Publishes Bail-In Guidance

    The Bank of England (BoE) published a consultation paper on approach to setting minimum requirement for own funds and eligible liabilities (MREL), an operational guide on executing bail-in, and a statement from the Deputy Governor Dave Ramsden.

    July 22, 2021 WebPage Regulatory News
    News

    EBA Seeks Views on Proportionality Assessment Methodology

    The European Banking Authority (EBA) is seeking preliminary input on standardization of the proportionality assessment methodology for credit institutions and investment firms.

    July 22, 2021 WebPage Regulatory News
    News

    US Agencies Propose Changes to Call Reports and Instructions

    Certain regulatory authorities in the US are extending period for completion of the review of certain residential mortgage provisions and for publication of notice disclosing the determination of this review until December 20, 2021.

    July 22, 2021 WebPage Regulatory News
    News

    PRA Finalizes Rulebook Definition of Higher Paid Material Risk-Taker

    The Prudential Regulation Authority (PRA) published the policy statement PS18/21, which introduces an amendment in the definition of "higher paid material risk taker" in the Remuneration Part of the PRA Rulebook.

    July 21, 2021 WebPage Regulatory News
    News

    EBA Examines Asset Encumbrance in Banking Sector

    The European Banking Authority (EBA) published its annual report on asset encumbrance in banking sector.

    July 21, 2021 WebPage Regulatory News
    News

    EBA Publishes Methodological Guide to Mystery Shopping

    The European Banking Authority (EBA) published a methodological guide to mystery shopping.

    July 21, 2021 WebPage Regulatory News
    News

    APRA Issues Update on Capital Reform Policy Settings for Banks

    The Australian Prudential Regulation Authority (APRA) released a letter to authorized deposit-taking institutions to provide an update on key policy settings for the capital framework reforms, which will come into effect from January 01, 2023.

    July 21, 2021 WebPage Regulatory News
    News

    CPMI-IOSCO Assess Continuity Planning of Market Infrastructures

    The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) published a report that assesses the business continuity planning activities of financial market infrastructures or FMIs.

    July 21, 2021 WebPage Regulatory News
    News

    ESMA Responds to Proposal Related to Sustainability Standards Board

    The European Securities and Markets Authority (ESMA) has responded to the IFRS consultation on targeted amendments to the IFRS Foundation constitution to accommodate an International Sustainability Standards Board (ISSB) to set IFRS Sustainability Standards.

    July 21, 2021 WebPage Regulatory News
    RESULTS 1 - 10 OF 7283