BIS published a working paper that examines the financial stability implications of fragmentation in the global financial markets. The paper reviews the degree of fragmentation in various markets and classifies its possible causes. It then reviews whether fragmentation is necessarily detrimental to financial stability, suggesting that various trade-offs exist. The review suggests that reducing fragmentation and enhancing financial stability are, in general, highly likely to be complementary. Still, fragmentation is not necessarily harmful for financial stability. In specific cases, some degree of fragmentation can actually serve to enhance financial stability.
The paper identifies and reviews the possible causes of fragmentation—namely, natural barriers, market forces, policy actions and interventions other than financial regulatory actions, and financial regulation and its enforcement. The paper then proceeds to review the costs and benefits of fragmentation, mainly from a financial stability perspective, using examples from securities markets, international banking, and asset prices across countries. It concludes that whereas in some cases there appear to be no clear costs to financial stability, in other cases there might be some. The review also suggests there are clearly cases where (some type or degree of) fragmentation can serve to enhance financial stability. The next area covered is how regulation at the global level affects fragmentation. The last section of the paper builds on the analysis to review what actions may be called for. It argues for the need to develop a framework that can help identify cases where there are potential trade-offs.
Fragmentation may be bad for financial stability. However, fragmentation and financial stability themselves may also be subject to a trade-off. The paper makes the following proposals by way of a more formal approach to review and, possibly, undertake policy actions.
- The starting point is more thorough analysis. What needs to be assessed here is the overall social costs and benefits of fragmentation and this needs to be done across jurisdictions. The related question is whether the “bad” elements of fragmentation are prone to escalate to the level of systemic risk. A joint assessment of the causes and a possible trade-off could supply us with a menu of policy options.
- The second step is to select from that menu the options that can reduce fragmentation while improving financial stability. The aim is to identify improvements along the upward sloping part of the “iso-quant” financial-stability-fragmentation curve. All the drivers involved, not just regulation, would need to be assessed. Such a review may well conclude that the answer to many of the outstanding questions is to continue harmonizing regulation and implementation and enhancing information-sharing processes regarding possible policy actions and the like.
- Another, parallel step would be to encourage the private sector to provide (more of) its own solutions to complement public interventions. There are many examples of the private sector already using cooperative models to address fragmentation at the global level. For example, CLS Bank is playing a role in wholesale cross-border payments. Consideration is being given to developing more such private (interbank) settlement systems. Policymakers can only welcome that and other private sector approaches.
- A final step is to intervene using the right tools. There are a number of elements to this. One is to choose the most efficient instrument with which to intervene. For example, there can be differences between price- and quantity-related regulations in terms of effectiveness and benefits in the presence of uncertainty. There is also much to learn from private-sector solutions that can be built. Another element is to allow for some state contingency in applying the instrument chosen; for example, barriers to the allocation of liquidity and capital are clearly more costly in times of stress. Analyzing and then addressing these elements will help ensure that the public-sector intervenes not just when necessary, but also with the most effective tools.
Related Link: Working Paper
Keywords: International, Banking, Securities, Financial Stability, Financial Integration, Regulation and Supervision, Research, Market Fragmentation, Basel III, BIS
Previous ArticleHKMA Consults on Market Risk Capital Requirements for Banks
APRA issued a letter on the loss-absorbing capacity (LAC) requirements for domestic systemically important banks (D-SIBs) and published a discussion paper, along with the proposed the prudential standards on financial contingency planning (CPS 190) and resolution planning (CPS 900).
The European Commission (EC) launched a call for evidence, until March 18, 2022, as part of a comprehensive review of the macro-prudential rules for the banking sector under the Capital Requirements Regulation (CRR) and Directive (CRD IV).
The Financial Stability Board (FSB) published a report that sets out good practices for crisis management groups.
The Australian Prudential Regulation Authority (APRA) found that Heritage Bank Limited had incorrectly reported capital because of weaknesses in operational risk and compliance frameworks, although the bank did not breach minimum prudential capital ratios at any point and remains well-capitalized.
The Office of the Superintendent of Financial Institutions (OSFI) released the annual report for 2020-2021.
Through a letter addressed to the banking sector entities, the Office of the Superintendent of Financial Institutions (OSFI) announced deferral of the domestic implementation of the final Basel III reforms from the first to the second quarter of 2023.
EIOPA recently published a letter in which EC is informing the European Parliament and Council that it could not adopt the set of draft regulatory technical standards for disclosures under the Sustainable Finance Disclosure Regulation (SFDR) within the stipulated three-month period, given their length and technical detail.
The Financial Conduct Authority (FCA) published the third in a series of policy statements that set out rules to introduce the UK Investment Firm Prudential Regime (IFPR), which will take effect on January 01, 2022.
The Australian Prudential Regulation Authority (APRA) published, along with a summary of its response to the consultation feedback, an information paper that summarizes the finalized capital framework that is in line with the internationally agreed Basel III requirements for banks.
The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) issued a consultative report focusing on access to central counterparty (CCP) clearing and client-position portability.