ECB published a paper that investigates whether window dressing behavior affects additional capital requirements imposed on global systemically important banks (G-SIBs) according to the post-crisis financial regulatory framework. The G-SIB assessment is conducted once a year, with the calculation of G-SIB scores relying on year-end data. Thus, banks involved in the exercise could have an incentive to reduce activities affecting the G-SIB score in the last quarter of the year, with the intention to reduce additional capital buffer requirements arising from the G-SIB framework.
The paper describes the data used and the current institutional setup to calculate the G-SIB risk score; introduces the methodology to investigate whether banks have been incentivized to window-dress, and the potential role played by capital market activities. The findings of the paper suggest that banks participating in the G-SIB exercise are more likely to reduce activities affecting the additional buffer requirements for G-SIBs at the end of the year, relative to the other banks in the sample. Furthermore, the effects are stronger for banks that are relatively close to a threshold between two buckets associated with different additional buffer requirements (which may have stronger incentives to window dress) and for banks with a larger amount of repo market activities that can be terminated relatively easily at reporting dates. The former result supports the view that it is indeed the G-SIB framework that is incentivizing the reduction in activities affecting the G-SIB score at year-end, rather than other factors such as contributions to the Single Resolution Fund or bank levies in a number of countries that are also based on year-end balance sheet data.
Overall, the study illustrates that G-SIB scores tended to decline over the sample period, in line with intention of the G-SIB framework to reduce the systemic footprint of banks. However, the regulatory context might have incentivized some banks to window-dress. This may imply a distortion in the relative ranking of the systemic importance of banks and may have adverse effects on the functioning of capital markets and on the provision of financial services, as banks reduce certain activities toward the end of the year. Against this background, further investigation could be warranted to understand whether an alternative metric for the risk score calculation might help to avoid the unintended consequences of the G-SIB framework while guaranteeing a smooth decreasing trend in the systemic importance of banks. Such alternative metrics are already being explored for the leverage ratio framework and could be extended further throughout the regulatory framework.
Related Link: Working Paper (PDF)
Keywords: International, Europe, Banking, Window Dressing Behavior, Systemic Risk, Single Resolution Fund, G-SIBs, G-SIB Framework, ECB
Across 35 years in banking, Blake has gained deep insights into the inner working of this sector. Over the last two decades, Blake has been an Operating Committee member, leading teams and executing strategies in Credit and Enterprise Risk as well as Line of Business. His focus over this time has been primarily Commercial/Corporate with particular emphasis on CRE. Blake has spent most of his career with large and mid-size banks. Blake joined Moody’s Analytics in 2021 after leading the transformation of the credit approval and reporting process at a $25 billion bank.
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