European Systemic Risk Board Research Articles

Legal Aspects of Macroprudential Regulation within the EU and the EAEU

Introduction. The article examines the legal evolution of the regulation of the activities of the European Systemic Risk Board (hereinafter – ESRB) in the context of the formation of the organizational and legal mechanism of financial integration, and also assesses the reform of the legal acts in the context of building the Capital Markets Union. The paper reveals the results of comparative analysis of the legal foundations of the implementation of macroprudential policy in the EU and EAEU, identifying common and special features in the legal regulation of integration associations.Materials and methods. In the course of research, the following methods of scientific cognition were used: analysis, synthesis, abstraction, generalizations, analogies and others. The methodological basis of research consist of general scientific as well as special-legal methods, including method of dogmatic analysis (interpretation of legal norms, legal and technical constructions, etc.), formal, comparative legal methods.Results of the study. The analysis of the legal basis of the implementation of macroprudential supervision in the EU and the EAEU showed a significant extent of the financial integration in the EU, as testified by the presence of a supranational body, ESRB. However, at this moment there is stagnation in the development of legal regulation of ESRB activities. In the EAEU, in its turn, despite the existence of the legal foundation of regulation, macroprudential supervision is executed by the means of intergovernmental cooperation, and not supranational regulation.Discussion and conclusion. The study showed the existence of significant differences in the legal regulation of macroprudetial supervision in the EU and the EAEU as well as it was revealed that in the absence of comprehensive supranational regulation of the macroprudential supervision in the EAEU, there is potential for the development of a respective institution in the EAEU law.

Macroprudential policies and Brexit: A welfare analysis

AbstractBrexit will have implications on financial stability and the implementation of macroprudential policies. The United Kingdom (UK) will no longer be subject to the jurisdiction of the European Systemic Risk Board. This paper studies the welfare implications of this change of regime. By means of a dynamic stochastic general equilibrium model, I compare the pre‐Brexit scenario with the new one, in which the UK sets macroprudential policy independently. I find that, after Brexit, the UK is better off by setting its own macroprudential policy without taking into account Europe's welfare as a whole.

On the Macroprudential Policy Stance in an Emerging Economy

ABSTRACT Our paper examines the macroprudential policy stance for the Romanian economy by considering simultaneously, unlike other papers, how borrower (Loan-to-Value Instruments) and capital-based instruments (Countercyclical Capital buffers, or CCyB) can be used together. We propose a forward-looking rule with lagged expectations for the CCyB, which is aligned with the European Systemic Risk Board’s recommendation regarding the moment of decision and implementation. Our paper also contributes to the literature by proposing a shock structure that is able to replicate that financial cycles are more volatile than economic cycles. Our main finding is that policy makers should comprehensively assess the resulting effects when deciding about the macroprudential policy stance.

EU financial market regulation a decade from the financial-crisis-era reforms: crisis, uncertainty, and capacity

Abstract This article reflects on the effectiveness of European Union (EU) financial market regulation, a decade or so after the closure of the EU’s massive financial-crisis-era reform programme. To do so, it considers the first significant test of the financial-crisis-era reforms: the March 2020 period of acutely elevated financial stability risk as the COVID-19 pandemic intensified, global markets roiled, and the investment fund sector experienced large-scale disruption. It relates the EU’s broadly successful management of this period to, first, the resilience of the legislative choices made and refined over the financial crisis era as regards investment fund regulation and, secondly, to technocratic action, by the European Securities and Markets Authority (ESMA) and the European Systemic Risk Board (ESRB), that facilitated rule amplification, risk monitoring, supervisory coordination, and supervisory convergence and thereby supported the earlier legislative choices. Drawing on the March 2020 experience, the article goes on to consider the capacity of EU financial market regulation more generally to manage what are increasingly dynamic risks to financial market stability. It identifies a strengthening of the EU’s capacity in this regard, but also persistent and intractable risks to this capacity, including as regards legitimation.

The European Central Bank and financial stability: a quarter of a century of evolution and transformation (1998-2023)

This article examines the evolution of the mandate and tasks of the European Central Bank (ECB) in the field of financial stability since its establishment in 1998. Over this period, the significance of the ECB’s financial stability function has increased markedly, in parallel with the growth of macroprudential policy and driven by the institutional reforms stemming from the creation of the European Systemic Risk Board in 2010 and the start of the Single Supervisory Mechanism (SSM) in 2014. To carry out its tasks, the ECB has a Financial Stability Committee, which is made up of representatives of the central banks and banking supervisory authorities of the SSM area – including the Banco de España – , that acts as an internal forum for the ECB’s governing bodies to prepare issues relating to the analysis of risks and vulnerabilities and national macroprudential policies in the banking union. Lastly, an overview is provided of the main ECB publications and public interventions in this field.

The Legitimacy of the European Systemic Risk Board in Respect of its Performance, Roles and Contributions to the Financial Regulatory System

The Legitimacy of the European Systemic Risk Board in Respect of its Performance, Roles and Contributions to the Financial Regulatory System

Of Viruses, Economic Crises and Banks: The European Banking Union and the Response to Covid-19

This article provides an account of how the Covid-19 outbreak and its impact on the banking sector were tackled in the European Union. The Covid-19 crisis is the first economic crisis after the enactment of the regulatory reforms of the last decade and represents the first relevant test for the assessment of their effectiveness in particular in the Eurozone. The analysis focuses specifically on the new framework for Banking Supervision in the Euroarea, the Single Supervisory Mechanism within the Banking Union, and explains how ECB Banking Supervision reacted to the economic and financial shock generated by the Covid-19 outbreak until the end of 2020. In this context, the article discusses the ECB’s policy interventions within the wider European and international context where also significant initiatives from the central bank side of the ECB, the European Commission, the European Banking Authority, the European Systemic Risk Board, the EU co-legislators and the Basel Committee on Banking Supervision took place.1 The Article also analyses the potential limitations of the existing European framework for crisis management, should a further severe shock with new waves of infections and lockdowns require extraordinary policy interventions. The article is divided into 4 sections: section A sets the scene and briefly describes the unprecedented economic shock deriving from the outbreak of the virus followed by the various measures of containment and lockdown. Section B analyses the various policy initiatives taken by ECB Banking Supervision to tackle the crisis within the wider European and international context. Section C discusses the potential use of the European framework for crisis management in the banking sector, should a further severe economic shock with ample repercussions on the banking sector materialise. Section D concludes. European Banking Supervision, Covid-19, microprudential supervision, macroprudential supervision, distribution restrictions, usable capital, crisis management framework, precautionary recapitalisation, non-performing loans, asset management company

A Comparative Analysis of Macroprudential Policy across Euro Area Candidate Countries

Concerns to setting an appropriate overall macroprudential policy framework have taken shape at local, regional, and global level since the onset of the global financial crisis. At regional level, a particular case is that of the European Union, given the national-supranational relationship specific to this economic region. The article aims to identify the macroprudential policy condition of the Euro Area candidate countries, by using an index built on some criteria that describe on the one hand, the capacity of macroprudential policy governance and the “activism” of macroprudential authority, and, on the other hand, the degree of compliance with the European Systemic Risk Board (ESRB) recommendations for national macroprudential authorities, given that the countries under review are member states of the European Union. Our findings show that the Euro Area candidate countries have quite different macroprudential policy features, both in terms of its governance and in terms of the “convergence” towards ESRB recommendations. Although the analysis should be extended by adding other relevant criteria, we can assert that it offers an overview of the potential role of the national macroprudential policy as a shock-absorber instrument in the perspective of a future accession to the Euro Area.

Valuation Risk: A Holistic Accounting and Prudential Approach

Valuation Risk (VR) is the risk that an entity will experience a loss due to the inaccurate determination of the fair value of the financial instruments on its balance sheet. This risk is particularly significant for financial instruments with complex features, with limited-to-no liquidity, or with valuations that rely on internally developed models that may be seldom verified using actual trades. Bank VR has been drawing international supervisory attention recently. In February, the European Systemic Risk Board warned that the substantial amounts of instruments with complex features and limited liquidity that sit on banks’ balance sheets are a source of risk for the global financial system. In parallel, the European Central Bank has put trading risk and asset valuations among its supervisory priorities for 2020 and said it plans to execute investigations on banks with significant portfolios of complex instruments measured at fair value based on pricing models. Measured in terms of possible losses from fair value calculations and/or estimation errors on capital ratios, the potential impact of VR can be significant for banks with a combination of a high ratio of fair valued assets to total assets and a high leverage ratio. In such cases, even a relatively small error in determining fair values may significantly decrease the Tier 1 ratio. From a business perspective, banks with opaque and incomplete disclosure about the methods used to estimate the fair value (and the variation thereof) of complex financial instruments may find their stock prices penalized by financial analysts. The nature of VR differs from other banking risks. Market and credit risks, for example, are defined in terms of potential losses derived from the uncertainty about instrument prices over time. VR, however, measures uncertainty surrounding the difference between the reported fair value and the “true” tradeable price that a bank could obtain if it were to sell an asset or transfer a liability at a specific point in time (i.e., the valuation date). Prudential and accounting frameworks have designated a set of mitigation measures to deal with VR uncertainty, which are interrelated. We have conducted a comprehensive analysis of bank VR, encompassing governance, regulatory, and prudential dimensions and summarize it in the paper linked below. We describe the VR framework for a bank through a holistic approach, provide a detailed analysis of the relationships between the accounting and the prudential frameworks, and outline a methodological approach for the prudential treatment of VR. We conclude that: 1) Regulators will increasingly challenge banks over their fair value determination practices as part of a supervisory approach that looks for consistency and rigor across the whole valuation process. In this context, banks will face governance challenges on the clarity of the roles and responsibilities for different functions (namely, finance and risk.) 2) The requirements of the current prudential regulatory framework do not ensure that banks build a capital buffer large enough to address VR. Researchers and regulators should undertake additional studies to develop a sound and agreed upon methodology to identify and measure VR. 3) Regulators should require banks to provide more extensive disclosure about their exposure to VR. Increasing clarity and transparency around bank risks will enhance public trust and enable more accurate estimations of the risk embedded in banks’ balance sheets by observers and analysts. This would also be reflected in bank share prices.

The Response of the European Central Bank to the Current Pandemic Crisis: Monetary Policy and Prudential Banking Supervision Decisions

Immediately after the outbreak of the current pandemic crisis, the EU developed a (rather) consistent strategy, by taking measures in order to deal with health emergency needs, support economic activity and employment, preserve monetary and financial stability and prepare the ground for recovery; these contain a combination of government fiscal stimuli (with extensive resort to the principle of solidarity), emergency liquidity and monetary policy measures and measures relating to financial stability. After briefly reviewing all these measures from a systematic point of view, the present article further analyses the role of the European Central Bank (ECB) during the first phase of this crisis, both in its capacity as a monetary authority within the Eurosystem and in its capacity as prudential banking supervisory authority within the Single Supervisory Mechanism (SSM), with particular emphasis on the treatment of non-performing loans (NPLs). Its specific contribution to financial macro-prudential oversight within European Systemic Risk Board (ESRB) is also highlighted.

Italy

Macroprudential oversight in Italy combines local elements with the European framework. At a local level, financial stability is a shared responsibility between Banca d’Italia (BdI), which is the national central bank and the prudential authority for banks and other financial institutions, the markets authority, Commissione Nazionale per le Società e la Borsa (CONSOB), the insurance supervisor, Istituto per la Vigilanza Sulle Assicurazioni (IVASS), and the pension funds supervisor, Commissione di Vigilanza sui Fondi Pensione (COVIP).2 Each authority exercises its responsibility within a combination of sectoral and activity boundaries and the BdI plays a leading role in surveillance and coordination. Within the European framework, the BdI is both the national competent authority and the designated authority for the macroprudential tools considered under the Capital Requirements Regulation (CRR) and the Capital Requirements Directive IV (CRD IV), which are implemented and activated following the processes described in these regulatory texts and the guidelines provided by the European Central Bank (ECB) – within the competences assigned to it by the SSM Regulation - and the European Systemic Risk Board (ESRB). The ubiquitous role of the BdI on both fronts eases the challenges posed by the coexistence of these two frameworks.

The Response of the European Central Bank to the Current Pandemic Crisis: Monetary Policy and Prudential Banking Supervision Decisions

Immediately after the outbreak of the current pandemic crisis, the EU developed a (rather) consistent strategy, by taking measures in order to deal with health emergency needs, support economic activity and employment, preserve monetary and financial stability and prepare the ground for recovery; these contain a combination of government fiscal stimuli (with extensive resort to the principle of solidarity), emergency liquidity and monetary policy measures and measures relating to financial stability. After briefly reviewing all these measures from a systematic point of view, the present article further analyses the role of the European Central Bank (ECB) during the first phase of this crisis, both in its capacity as a monetary authority within the Eurosystem and in its capacity as prudential banking supervisory authority within the Single Supervisory Mechanism (SSM), with particular emphasis on the treatment of non-performing loans (NPLs). Its specific contribution to financial macro-prudential oversight within European Systemic Risk Board (ESRB) is also highlighted.

An early warning system for predicting systemic banking crises in the Eurozone: A logit regression approach

Eurosystem macroprudential policies require shared action between national authorities and the European Central Bank (ECB). This has created the need for a common basis for macroprudential analysis and as result the Macroprudential Database (MPDB) was created by the ECB and the European Systemic Risk Board (ESRB) in 2015 in order to support the central bank's functions and ESRB's needs. This paper examines a multivariate binary logit Early Warning Model (EWM) for systemic banking crises with the aim to evaluate the predictive validity of the risk indicators included in the MPDB, as well as further variables not employed in previous relevant studies. The main finding is that most of the risk indicators employed from MPDB are important for forecasting from 4 to 1 years before the onset of a systemic banking crisis. Specific banking variables that capture industry concentration, assets, funding, and liquidity, are more important, on average, than macroeconomic variables. Important financial stress indicators such as CLIFS and SovCISS and economic expectations are also significant. The model is robust to various specifications and has a better performance when post-crisis observations are not included.

Macroprudential Policy in a Heterogeneous Environment-An Application of Agent-Based Approach in Systemic Risk Modelling.

Assessment of welfare effects of macroprudential policy seems the most important application of the Dynamic Stochastic General Equilibrium (DSGE) framework of macro-modelling. In particular, the DSGE-3D model, with three layers of default (3D), was developed and used by the European Systemic Risk Board and European Central Bank as a reference tool to formally model the financial cycle as well as to analyze effects of macroprudential policies. Despite the extreme importance of incorporating financial constraints in Real Business Cycle (RBC) models, the resulting DSGE-3D construct still embraces the representative agent idea, making serious analyses of diversity of economic entities impossible. In this paper, we present an alternative to DSGE modelling that seriously departs from the assumption of the representativeness of agents. Within an Agent Based Modelling (ABM) framework, we build an environment suitable for performing counterfactual simulations of the impact of macroprudential policy on the economy, financial system and society. We contribute to the existing literature by presenting an ABM model with broad insight into heterogeneity of agents. We show the stabilizing effects of macroprudential policies in the case of economic or financial distress.

The European Systemic Risk Board – governance and early experience

ABSTRACT The European Systemic Risk Board is charged with the macroprudential oversight of the financial system in the European Union. We compare and contrast the ESRB with the U.S. National Transportation Safety Board, which some scholars proposed as a role model for systemic risk management. There are parallels and some differences between these organisations. Neither institution has direct regulatory power, which could paradoxically be beneficial as it may help preserve their independence and objectivity in the long run. We also review the ESRB’s activities after it started in 2010 and assess the effect of its first public recommendation.

France

Macroprudential policy in France is the joint responsibility with several European institutions. With the operationalization of the EU Capital Requirement Directive and Capital Requirement Regulation (CRD/CRR), the French authorities have implemented, several capital buffers, as well as the liquidity coverage ratio (LCR), based on this framework. In France, Haut conseil de stabilité financière (HCSF) is the macroprudential authority established in accordance with recommendation European Systemic Risk Board (ESRB)/2011/13 and the designated authority established in accordance with Article 136 of CRD and is in charge of activating several measures in the CRD/CRR framework as well has direct responsibilities over several tools outside this framework, for example borrower-based tools.

Inaction in Macro-prudential Supervision: Assessing the EU’s Response

Abstract In the macro-prudential literature, ‘inaction bias’ describes the supposed tendency of macro-prudential actors to favour inaction over action when considering the use of macro-prudential tools. While inaction bias is a topic of much interest in macro-prudential policy circles, it has received scant attention from legal scholarship. The aim of this article is to contribute to filling this gap by studying inaction in an EU macro-prudential context and by evaluating the institutional arrangements that were put in place in order to address so-called inaction bias. Several actors at the EU level have a role to play in macro-prudential supervision, especially the European Systemic Risk Board and the European Central Bank (ECB). This paper will assess their capabilities and their capacity to turn these into actions. The role of the ECB will be of particular interest since it was vested with real powers to address possible inaction bias among states participating in the Banking Union. Among other things, I will examine whether the ECB’s macro-prudential powers are the cure to the problems that are said to underpin inaction bias at the national level.

Lack of international risk management in BREXIT?

BREXIT is a historical step for the UK and the EU27 which could bring a strong Pound deprecation, an increase in risk premiums for British bonds and a transitory rise of financial market volatility plus a long-term reduction of economic growth in the UK; but also risks for the EU27. New BREXIT aspects are considered in an enhanced Branson model. Macroprudential supervision is a crucial policy challenge for EU28 in the context of BREXIT and the European Systemic Risk Board thus should have a critical role in 2019 and the following years. The ESRB should timely analyze the potential risk of BREXIT and consider adequate policy options to reduce or eliminate risks. Contract continuity as well as cooperation in prudential supervision between the EU27 and the UK stand for BREXIT-related problems that could create financial market stability – as is the BREXIT-induced UK deregulation pressure. EU prudential supervision post-BREXIT faces problems since a very large part of EU27 wholesale banking markets in the UK and thus not regulated by the EU after March 29, 2019. The EU Commission’s competence for EU trade policy as well as international investment treaties gives the EU the opportunity to offer the UK not only a – limited – Free Trade Agreement but an international investment treaty as well, including options for global cooperation. Several policy innovations are proposed which could help to limit risk associated with instability.

Exposition, Climax, Denouement: Life-Cycle Evaluation of the Recent Financial Crisis in the EU by Linking the ESRB Financial Crisis Database to the European Commission's Macroeconomic Imbalance Procedure Scoreboard

The paper investigates the life-cycle of the 2008-2009 financial crisis by linking the Macroeconomic Imbalance Procedure (MIP) Scoreboard of the European Commission to the crisis database of the European Systemic Risk Board (ESRB). The novelty of the analysis is that early warning capacity of MIP indicators is empirically tested in case of various crisis events case by case (i) Currency/Balance-of-Payment/Capital flow events, (ii) Sovereign crisis events, (iii) Banking crisis events and (iv) Significant asset price corrections in EU Member States. Furthermore, we contribute to the literature by studying the predicting power of the MIP Scoreboard in the identification of the overheating in the economy in advance of crises (preventive arm of the MIP). We found that the predictive power of the MIP Scoreboard may be twice as high to capture sovereign and Currency/Balance-of-Payment/Capital flow type of crisis events than its power to capture a banking crisis or serious asset price corrections. We confirm the results of earlier empirical studies that some MIP indicators perform relatively well (current account and net international position) in all specifications. A simple composite indicator based on the threshold breaches of MIP Scoreboard Indicators, performed in most cases as good as the best individual indicator, and hence could be considered as an input to a simple, rule based and accountable decision making. JEL Classification: C40, G01, E44, E61, G28

Financial Engineering Coupled with Regulatory Incentives: Is There a Strong Market Case for Sovereign Bond-Backed Securities (SBBSs) in the Euro-Area? A Brief Analysis of the European Commission's Proposal for a Regulation on SBBSs

The aim of this paper is to present and briefly analyse the provisions of the recent (24 May 2018) European Commission’s proposal for a Regulation of the European Parliament and the Council, whose objective is to lay down a general framework for sovereign bond-backed securities (SBBSs). It is structured in six (6) Sections: (1) Section A, entitled “A general overview”, briefly summarises the work of the European Systemic Risk Board (ESRB) on sovereign bond-backed securities, which forms the basis for the latest regulatory initiative (Sub-section 1), and then presents the main considerations underlying the proposed Regulation (Sub-section 2). (2) Section B addresses the proposed Regulation’s subject matter and scope, as well as the proposed limitations on the use of the designation ‘SBBS’ (Sub-sections 1-2, respectively). (3) The (relatively lengthier) Section C analyses Articles 4-8 of the proposed Regulation concerning: • the eligibility and composition of the underlying portfolio of SBBS issues, the maturity of the underlying assets and the tranching of issues (Sub-section 1), as well as • the issuance of SBBSs by special purpose entities (SPEs), the obligations of these entities and the management of SBBSs (Sub-section 2). (4) The notification, transparency and information requirements laid down in Articles 10-12 of the proposed Regulation are presented in Section D (Sub-sections 1-3, respectively). (5) Section E, on the so-called “product oversight”, deals with the proposed Regulation’s provisions (Articles 13-20) concerning the supervision of SPEs and the related cooperation arrangements between competent authorities and the European Securities and Markets Authority (ESMA), the sanctioning regime, as well as the macro-prudential oversight of the SBBS market by the ESRB (Sub-sections 1-3, respectively). (6) Finally, Section F is devoted to the presentation of the proposed Regulation’s rules (Articles 21-26) governing the amendments to existing legal acts which constitute sources of EU financial law, the evaluation clause and the application of the “comitology procedure” (Sub-sections 1-3, respectively). The study ends with the concluding remarks. The cut-off date for information contained in this study is 26 August 2018.