Pablo Hernández de Cos, the Governor of BDE, spoke at the Second Financial Stability Conference, which was jointly organized by the BDE and the Center for Monetary and Financial Studies (CEMFI) in Madrid. He discussed the macro-prudential institutional framework in Spain, with focus on two issues: the macro-prudential policy objectives and the choice among the different tools at the disposal of the macro-prudential authority to best achieve these objectives in different circumstances.
The BDE Governor highlighted that systemic risk is multidimensional and this is why having different macro-prudential tools at the disposal of the macro-prudential authority is crucial. However, it is not always obvious how to discriminate among the different macro-prudential tools, given the potential interactions between them. One example he gave for this is the decision to activate the countercyclical capital buffer (CCyB) as opposed to activating a sectoral CCyB. It is perfectly feasible that some credit segments show exuberant behavior in the economy without any evidence of the credit cycle being in an expansionary phase. The CCyB activation to address a situation of this type does not seem advisable. To achieve the objective of exclusively moderating the growth of the exuberant portfolios, it would be necessary to act on the relative costs of financing, making these more expensive in relative terms, through the activation of a countercyclical capital buffer to be applied exclusively on those credit segments. However, the coexistence between both tools can be complex, especially if a transition from one or several sectoral buffers to the total buffer must be made. Accordingly, its use should be confined to very specific circumstances.
Another example he gave involves the use of capital instruments vs borrower-based tools. In his perspective, making all prudential supervision rely on the amount of capital that entities need is too reductionist. He believes that both types of tools should perhaps be used simultaneously, depending on the circumstances, but always based on a rigorous and detailed analysis. On the use of borrower-based tools vs capital instruments, it seems reasonable that, if credit is showing high and sustained growth over time but without credit standards being relaxed, the ideal would be to increase entities’ resilience using capital instruments. However, even if credit were to show moderate growth, if the conditions for granting these loans are being relaxed (thus increasing the volume of credit at risk of default), it would probably be more efficient to use the borrower-based tools to guarantee sound credit underwriting standards. He said it is not enough to supervise and control a specific characteristic of the loan; rather, a comprehensive approach must be adopted in which the different dimensions are addressed.
At present, however, credit underwriting standards are not contemplated in European legislation, although some authorities, including BDE, are empowered to set them. The BDE Governor believes that consideration should be given to including them in future revisions of the European regulation. In his view, this would offer at least three advantages by allowing harmonization of the different dimensions of the credit standards, enabling different jurisdictions to request reciprocity of the measures adopted, and allowing ECB to top up the measures, reducing the potential inaction bias of national authorities.
The third good example, according to him, in understanding the interactions among different macro-prudential instruments is related to the surcharge on systemic entities (globally systemic or domestically systemic banks), which is the main capital tool to address the cross-sectional dimension of systemic risk. On top of how to calibrate this buffer, further study is needed on how it interacts with CCyB. This is especially important in countries where credit from systemic banks represents a high proportion of total credit and, in addition, when these banks have a significant international presence. The other instrument in the macro-prudential policy-maker’s toolkit to address non-cyclical risks is the systemic risk buffer. He welcomed the European initiative to allow its application to sectoral credit portfolios, thus providing it with more flexibility. He concluded that when deciding to activate any tool, it is necessary to convince stakeholders with arguments and evidence that, even if there are apparent short-term costs, the medium and long-term benefits are clearly greater.
Finally, he stressed that the bulk of macro-prudential tools affect banks exclusively. While banks continue to account for most financial intermediation, they are losing relevance and could do so even more in the future. This can give rise to regulatory arbitrage and undermine the effectiveness of macro-prudential tools. He added that one of the tests for the Spanish macro-prudential institutional setting will be whether it is able to achieve enough coordination across authorities to maximize the effectiveness of the macro-prudential toolkit. It should be considered that global financial integration can also have similar effects to the domestic development of the non-bank financial sector, with banking and non-banking entities operating in different jurisdictions. Especially in this last area, major steps have been taken (with reciprocity agreements), but there is still ample room for improvement.
Related Link: Speech
Keywords: Europe, Spain, Banking, CCyB, Systemic Risk, Macro-Prudential Policy, Borrower-Based Measure, Sectoral CCyB, Systemic Risk Buffer, BDE
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.
Previous ArticleFED Revises and Extends Form FR Y-9C for Three Years
The finalization of the two sustainability disclosure standards—IFRS S1 and IFRS S2—is expected to be a significant step forward in the harmonization of sustainability disclosures worldwide.
Decentralized finance (DeFi) is expected to increase in prominence, finding traction in use cases such as lending, trading, and investing, without the intermediation of traditional financial institutions.
The Basel Committee on Banking Supervision (BCBS) published reports that assessed the overall implementation of the net stable funding ratio (NSFR) and the large exposures rules in the U.S.
At the global level, supervisory efforts are increasingly focused on addressing climate risks via better quality data and innovative use of technologies such as generative artificial intelligence (AI) and blockchain.
The finalization of the IFRS sustainability disclosure standards in late June 2023 has brought to the forefront the themes of the harmonization of sustainability disclosures
The European Banking Authority (EBA) recently issued several regulatory publications impacting the banking sector.
The Basel Committee on Banking Supervision (BCBS) launched a consultation on revisions to the core principles for effective banking supervision, with the comment period ending on October 06, 2023.
The U.S. banking agencies (FDIC, FED, and OCC) recently proposed rules implementing the final Basel III reforms, also known as the Basel III Endgame.
The Financial Stability Board (FSB) recently published the second annual progress report on the July 2021 roadmap to address climate-related financial risks.
The recognition of climate change as a systemic risk to the global economy has further intensified regulatory and supervisory focus on monitoring of the environmental, social, and governance (ESG) risks.