European Parliament published a study on a new regime on sovereign concentration charges for banks’ sovereign exposures. The paper makes a concrete proposal for a Sovereign Concentration Charges Regulation (SCCR), including calibration and careful transitional arrangements to avoid any disorderly market impact.
Achieving the aim of Europe’s banking union project, to break the vicious circle between banks and sovereigns, requires new policy initiatives. The most direct bank-sovereign linkages are national deposit insurance and concentrated domestic sovereign exposures. Thus, simultaneously, with a European Deposit Insurance Scheme (EDIS) as proposed by the EC in 2015, the EU should introduce regulatory disincentives against highly concentrated sovereign exposures of euro area banks. The SCCR and EDIS together could realistically receive political approval in 2018 and be fully implemented within a decade. This paper outlines a workable design for the SCCR as the new EU legislation to be adopted as a complement of EDIS. The SCCR would add sovereign exposures above a certain threshold (defined as a ratio to tier 1 capital), weighted by a coefficient (sovereign concentration charge) that increases with the exposure ratio, to risk-weighted assets in the capital ratio’s denominator. The charges for concentrated sovereign exposures to different euro-area countries would add up. Sovereign exposures under 33% of tier 1 capital would be entirely exempt. The marginal capital charges on concentrated exposures would be mild for exposures of up to 100% of tier 1 capital and will rise more steeply above that level. Should this calibration turn out to have an insufficient impact, it could be strengthened at a later stage.
The proposed transitional arrangements are also designed to ensure a smooth path toward the new regime, even if market conditions become less favorable. The transitional arrangements include extensive consultation with market participants, a gradual phase-in over a long period, and exemption from the concentration charges of all debt issued before the SCCR’s entry into force. While banks’ behavioral response to the new regime is impossible to predict with certainty, it is expected that most banks will respond to the introduction of the SCCR by diversifying their sovereign exposures away from their current home bias, but leaving them largely unchanged in euro-area aggregate. If so, the reform will neither materially impact banks’ prudential ratios nor entail any material costs. The adoption of the proposed SCCR, along with a full EDIS—ideally complemented by other reforms to increase risk-sharing and enhance market discipline in the banking policy framework—would significantly reduce bank-sovereign linkages and thus strengthen the Banking Union, foster greater EU financial integration, and increase financial stability for each member state and for the EU as a whole.
Related Link: Study on Sovereign Concentration Charges (PDF)
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