ECB published Issue 6 of the Macroprudential Bulletin. The Bulletin provides an overview of the macro-prudential policy measures that apply in euro area countries as of August 01, 2018 and highlights that most of these measures will be fully phased in from January 01, 2019. Additionally, this issue includes three articles on key macro-prudential topics: the leverage ratio, the framework for global systemically important banks (G-SIBs), and the potential macro-prudential tools for investment funds.
The first article analyzes the leverage ratio and its links with the repo markets. This article looks into the implications of removing repo assets from the leverage ratio. The findings suggest that granting such an exemption may have adverse effects on the stability of the financial system, even when measures are introduced to compensate for the decline in capital required by the leverage ratio framework. Against the background of a pronounced increase in the median default probabilities for large, systemically relevant banks, an exemption of repo assets could considerably weaken the leverage ratio for some banks and may have adverse effects from a financial stability perspective. Consequently, such a change in treatment could lead to the re-emergence of risks related to the build-up of excessive leverage and over-reliance on short-term wholesale funding in financial markets. Overall, therefore, the analysis does not support a more lenient treatment of repo assets in the leverage ratio framework.
The second article focuses on the regulatory framework for G-SIBs, which BCBS developed to address the negative externalities that a failure of these large banks could exert on the financial sector and the economy. This article presents evidence that some G-SIBs and other banks with reporting obligations tend to reduce their risk category scores at the end of a year, relative to other quarters. A possible explanation for this “window dressing” is that these banks aim to increase the probability of being allocated to a lower bucket with less stringent requirements. Window-dressing behavior could have detrimental effects on financial stability, as it may imply that banks’ overall systemic importance has been underestimated and, as a result, the relative ranking and higher loss absorbency requirement of G‑SIBs may be distorted. Additionally, the resulting reduction in the provision of certain services, which are captured by the indicators in the G-SIB framework at the end of a year, could adversely affect overall market functioning. The article suggests further investigating whether an alternative metric for calculating the risk score—based on averaging rather than year-end data—can help to avoid these unintended consequences of the G-SIB framework.
The third and last article aims to facilitate the discussion on potential macro-prudential liquidity instruments for investment funds by providing a preliminary assessment of the effectiveness and efficiency of several instruments. ESRB has identified the need to develop macro-prudential instruments that address liquidity mismatches in funds as a key priority for the short to medium term. FSB has also recommended that authorities should consider providing direction on fund managers’ use of liquidity management tools in exceptional circumstances. This article reviews various options for macro-prudential liquidity tools, assesses their potential effectiveness and efficiency, and provides some suggestions in this regard. One of the suggestions is that structural requirements, such as “redemption duration restrictions,, should be explored further. The article also suggests that authorities should have the necessary powers and guidance to suspend redemptions to halt runs in exceptional circumstances.
Related Link: Macroprudential Bulletin
Keywords: Europe, EU, Banking, Leverage Ratio, Repo, G-SIB Framework, Liquidity Tools, Macroprudential Bulletin, 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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