Towards Single Resolution and Single Supervision of Systemically Important Financial Institutions in the European Union?

Abstract

The Global Financial Crisis proved that not only banks can cause systemic risk to the financial system and the wider economy. Indeed, systemic risk from nonbank financial undertakings proved to be a key vulnerability to the financial system. Such risks manifested when leveraged nonbank financial institutions provided bank-like activities, especially maturity and/or liquidity transformation. The increasingly blurred distinction between markets, financial institutions, services and products was, however, not matched by an integrated regulatory and supervisory approach.Instead, regulation remained sectorally organised, emphasizing on the banking sector. This created gaps in the coverage of regulation and supervision, leading to an inconsistent regulatory treatment of equivalent products and/or services. In turn this caused an unlevel playing field, provoking regulatory arbitrage behaviour leading to a migration of activities, and a build-up of systemic risk, in the less regulated or unregulated parts of the financial system.We propose a systemic approach, at the European level, to the monitoring of risks to financial stability posed by nonbank financial institutions. An EU institution, for example the European Systemic Risk Board, should be charged with identifying systemic risks in nonbank financial institutions. It should, subsequently, have the discretion to designate a nonbank financial firm as a Systemically Important Financial Institution (SIFI). Such designation would ensure that the level of regulatory and supervision commensurate with the risks to financial stability posed by a financial institution.Consequently, a European supervisor should have the possibility to impose enhanced prudential standards on designated firms. Additionally a single European resolution regime should be in place to ensure that vital functions of nonbank SIFIs remain operative even when they are failing or likely to fail, in order to guarantee the stability of the financial system.Such a regime would contribute to the elimination of supervisory and regulatory gaps, decrease regulatory arbitrage activities, and contribute to the stability of the financial system and a level-playing-field