Abstract
The global financial crisis proved that banks are not the sole source of systemic risk to the financial system and the wider economy. Indeed, systemic risk emanating from non-bank financial institutions proved to be a key vulnerability of the financial system. Such risks occurred, above all, when leveraged non-bank financial institutions performed bank-like activities such as maturity and/or liquidity transformation. However, the increasingly blurred distinction between markets, financial institutions, services and products is not matched in the European Union by an integrated regulatory and supervisory approach. Instead, regulation was and remains largely organised along sectoral lines, with an emphasis on the banking sector. As the global financial crisis shows, this creates a risk of gaps in the coverage of regulation and supervision, leading to inconsistent regulatory treatment of equivalent products and/or services. This in turn causes an unlevel playing field and increases the potential for regulatory arbitrage. In consequence, risky activities migrate to less regulated or unregulated parts of the financial system, leading to a largely unchecked build-up of systemic risk. Drawing inspiration from the reforms in the United States, we propose that the EU’s system of financial regulation be complemented by a robust body charged with identifying and monitoring non-bank financial institutions that are systemically important. This EU authority should have the discretion to designate a non-bank financial institution as a Non-Bank Systemically Important Financial Institution (non-bank SIFI). A logical choice would be to confer such powers on the European Systemic Risk Board. Designated non-bank SIFIs should be placed under direct prudential supervision by an EU body. This EU supervisor would have to establish, on an individual or categorical basis, appropriate enhanced prudential requirements tailored to the nature, risks and activities of the relevant non-bank SIFI. Additionally, a single European resolution regime should be in place to ensure that non-bank SIFIs can fail without destabilising the financial system. This would avoid a possible ‘Too-Big-To-Fail’ status, remove implicit government guarantees and subject the institution to market discipline. Our proposal aims to ensure that non-bank SIFIs are brought within a regulatory perimeter and supervisory scrutiny consistent with the risk they pose to financial stability. Such a regime would (i) help to eliminate (national) supervisory and regulatory gaps, (ii) reduce regulatory arbitrage activities, and (iii) contribute to the stability of the financial system and a level playing field.
Highlights
In 2001 Roger Lowenstein noted that the Fed’s initiative to organise a private bailout of hedge fund management firm Long-Term Capital Management (LTCM) was not done out of sympathy for LTCM nor to prevent losses to exposed financialTowards Single Supervision and Resolution of Systemically...institutions.1 Instead, the driving concern was ‘the broader notion of ‘‘systemic risk’’; if Long-Term failed, and if its creditors forced a hasty and disorderly liquidation, [the Fed] feared that it would harm the entire financial system, not just some of its big participants’.2 Still, with the last financial meltdown dating back to the 1930s, it was unclear whether ‘systemic risk’ presented a real threat
Our proposal aims to ensure that non-bank SIFIs are brought within a regulatory perimeter and supervisory scrutiny consistent with the risk they pose to financial stability
We propose that non-bank financial institutions which are systemically relevant should be subjected to European prudential regulation and to a European supervisor and a European resolution authority
Summary
In 2001 Roger Lowenstein noted that the Fed’s initiative to organise a private bailout of hedge fund management firm Long-Term Capital Management (LTCM) was not done out of sympathy for LTCM nor to prevent losses to exposed financial. This article seeks to contribute to the discussion on the development within the European Union of a regulatory regime which adequately addresses and mitigates the risk to financial stability posed by non-bank SIFIs. Section 2 highlights the relevance of the problem by reiterating lessons learned from the Global Financial Crisis, especially in respect of the systemic risk posed by non-bank financial institutions.
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