Supervisory Regime Research Articles

Solvency II post-Brexit: equivalence discussion in light of the UK solvency II review and the financial services and markets bill

PurposeFollowing the United Kingdom's (UK) withdrawal from the European Union (EU), there is uncertainty in the financial services industry on equivalence of regulatory regimes. This also affects the insurance industry. As of now, it is not clear if the UK’s supervisory regime (“Solvency UK”) will be classified as equivalent to the European Solvency II supervisory regime. After no equivalence decision was taken during the Brexit transition period and there are efforts by the UK in the form of the UK Solvency II Review and the Financial Services and Markets Bill to adapt Solvency II more to the characteristics of the national insurance market, the uncertainties are intensified. Although Solvency II non-equivalence would have a significant impact on insurance groups operating in both the UK and the EU, there has been no detailed analysis of whether these initiatives could have an impact on a future Solvency II equivalence decision. The purpose of this paper is to address and close this research gap with a literature review and a subsequent equivalence mapping and discussion.Design/methodology/approachBased on the literature review methodology, this paper draws on academic sources as well as publications from governments and regulators, articles from consultancies and subject matter experts and uses this literature to provide an overview of the current state of research on equivalence in the wider financial services industry, but specifically on Solvency II equivalence, the UK Solvency II Review and the Financial Services and Markets Bill. Based on this literature review, the paper also forms the basis for an innovative and forward-looking Solvency II equivalence mapping and discussion.FindingsSeveral articles state that differences between Solvency II and Solvency UK could harm a future Solvency II equivalence decision. The UK Solvency II Review and the Financial Services and Markets Bill are two initiatives that support the objective of aligning the Solvency II supervisory regime more closely with the circumstances of the UK insurance market. Although both initiatives contribute to the fact that Solvency UK differs in parts from Solvency II, based on the literature review and the subsequent equivalence mapping and discussion, there are currently no reforms that should harm future Solvency II equivalence decisions.Originality/valueThis paper provides a previously non-existent overview of equivalence in the wider financial services industry, but specifically on Solvency II equivalence, the UK Solvency II Review and the Financial Services and Markets Bill, and brings them together in an innovative equivalence discussion. It thus presents the current state of knowledge on Solvency II after Brexit and develops it further around a mapping against the equivalence criteria. As non-equivalence could have significant implications for insurance groups operating in both the UK and the EU, this paper is a useful and practical study that provides a previously non-existent equivalence mapping and discussion based on current initiatives and publications. It thus closes the research gap identified and reduces uncertainties in the insurance industry and can be used as a blueprint for detailed and forward-looking equivalence mappings and discussions for the wider financial services industry.

Third country central counterparty (CCP) supervision as a catalyst for more centralized EU CCP supervision?

ABSTRACT In early 2022, a UK CCP cancelled some $4 billion of transactions in the war-affected nickel market, triggering outrage from market participants that were in the money. The ‘nickel debacle’ illustrates that CCP risk management and loss absorption mechanisms may result in value redistribution among stakeholders. With CCP stakeholders located in multiple jurisdictions, crisis management decisions from a single-jurisdiction CCP supervisor may not pursue multi-jurisdictional financial stability or a fair balance of stakeholder interests across jurisdictions. Although the case for centralised supervision of EU CCPs thus appears strong, national concerns have persistently blocked increased centralisation. This article re-examines decentralised EU CCP supervision in light of the much-debated post-Brexit centralised EU supervisory regime for systemically important third country CCPs. Two new arguments emerge from this juxtaposition, revealing a dichotomy between the named supervisory regimes that appears hard to justify. First, a decentralised supervisory regime for EU CCPs is difficult to logically square with the policy arguments underpinning the post-Brexit EU supervisory system for systemically important third country CCPs. Secondly, the controversial location policy for ‘too systemically important’ third country CCPs could be more justifiable if the EU were to adopt centralised EU supervision of systemically important EU CCPs.

Глобальные системно значимые банки: все еще угроза для финансовой стабильности?

The global financial crisis of 2007–09, followed by sweeping overhaul of international banking regulation, urged financial regulators to apply a tailored supervisory regime to global systemically important banks (G-SIBs). This approach was caused by exacerbation of the G-SIBs’ systemic risks and their transmission during macro level instability. The size of G-SIBs, the extent of their market power, and the heterogeneity of their operating models resulted in their dual role in systemic stress: being a source of systemic risks for the macro level, G-SIBs are at the same time transmitters of crisis developments to the micro level, hence increasing their own exposure to risks. Under these circumstances, the objectives of the post-crisis recovery required a revision of regulatory priorities by shifting them from G-SIBs’ profitability to G-SIBs’ stress resilience through the application to them of more stringent capital adequacy standards and liquidity requirements, which ultimately contributed to G-SIBs’ insusceptibility to external shocks. At the same time, the G-SIBs’ role in exacerbation of systemic stress remains uncertain due to the unresolved issues of the G-SIBs’ systemic importance. Accordingly, the crisis and liquidity dilemmas remain unresolved. Given the high level of G-SIBs interconnectedness in the international financial area, their dysfunction can provoke a domino effect of insolvency and bankruptcies in the international banking sector. Based on 2011–21 statistics for all G-SIBs included in the annual lists of the Financial Stability Board (FSB), we found certain decline in G-SIBs’ systemic risks, which is attributable to further strengthening of their market discipline. This proves that international regulatory policy is on the right track. We also found that the stress resilience of G-SIBs, a product of the application of Basel III capital surcharge buffers and the total loss-absorbing capacity (TLAC) standard, significantly contributed to financial stability at a level sufficient not only for the integrity of G-SIBs’ performance during the COVID-19 pandemic, but also for minimization of the risk of collapse of the banking systems that prevented the transformation of the related shocks and instability into an economy-wide crisis. Nevertheless, the post-crisis regulatory reform failed to contain the systemic importance of G-SIBs, mostly due to the lack of supervisory tools and techniques in reduction of the negative effects of the G-SIBs’ international interconnectedness.

The new regulation of professional trustees in Switzerland

Abstract The Swiss federal legislator adopted a new federal act on financial institutions (FinIA).1 This legislation came into force on 1 January 2020. It subjects professional trustees and wealth managers to a new licensing and supervisory regime. This law affects not only Swiss institutions, but also foreign institutions operating in Switzerland, whether through a subsidiary, a branch or a representative office. We are approaching the end of the three-year transitional period (from 1 January 2020 to 31 December 2022) during which the institutions concerned must comply with the new legal requirements. This article analyses the scope of the new authorisation and supervision regime, the obligations of professional trustees under the new regulation, the new system of supervision of trustees, the specific rules applying to Swiss branches or representative offices of foreign trustees, the sanctions in case of infringement of obligations and the transitional provisions. This article is mainly addressed to trustees, but the new regulation also applies to professional wealth managers.

The Impact of bank-specific and macroeconomic variables on the profitability of banks from selected African countries

This was an empirical investigation of the impact of bank-specific and macroeconomic variables on the profitability of banks in selected countries in Africa, over the period 2009 to 2019. The study focused on 33 banks operating across 9 African countries, namely South Africa, Uganda, Kenya, Tunisia, Egypt, Namibia, Zambia, Nigeria and Ghana, as representative of the continent. The analyses of the various interrelations were done using the dynamic panel data modelling approach. The study used an unbalanced panel of commercial banks’ data in the selected countries to estimate the model with both the return on equity and the return on assets as proxies for profitability. Of the bank-specific variables, net interest margin, loan loss and cost to income ratios have a statistically significant negative relationship with profitability. The relationship between non-performing loans, capital adequacy and profitability is statistically not significant. There is however, a positive and statistically significant relationship between profitability and macroeconomic-specific variables. Overall the study shows mixed impacts of bank-specific and macroeconomic variables on the profitability of banks in the selected countries in Africa, although they are at a different level of regulatory and supervisory regimes, including the pace of technological developments and implementation.

Bank Audit Regulations and Reporting Quality

ABSTRACT This study examines whether bank audit regulations impact bank reporting quality. Using a multi-country panel of publicly traded banks, we find that regulations targeting auditor qualifications and independence improve bank reporting quality. In contrast, regulations that impose greater supervisory oversight of external auditors have little or even an adverse effect on bank reporting quality. Cross-sectional analysis further shows that the effects of bank audit regulations are concentrated among banks where supervisory regime is less independent. Our results hold after controlling for bank regulations pertinent to financial reporting and disclosure, the adoption of International Financial Reporting Standards, and time-varying country-level institutional characteristics. Overall, our findings suggest that audit regulations matter and their impact on bank reporting quality is sensitive to the type of audit regulation. JEL Classifications: G21; G38; M41; M42. Data Availability: The data used in this study are publicly available from the sources indicated in the text.

Bank earnings management using loan loss provisions: comparing the UK, France, South Africa and Egypt

PurposeThis paper aims to investigate bank earnings management using loan loss provision. The paper examines income smoothing, which is a type of earnings management. It compares the income smoothing behaviour of banks in the UK, France, South Africa and Egypt.Design/methodology/approachThe study uses the panel fixed effect regression methodology to analyse bank income smoothing.FindingsThe findings show that bank income smoothing is present in the UK and Egypt and absent in France and South Africa. Banks in Egypt used LLPs to smooth income before the global financial crisis. Meanwhile, bank income smoothing is pronounced in France during and after the financial crisis but was absent in the pre-crisis period. Also, bank income smoothing is reduced in countries that (1) have strict banking supervision, (2) adopt common law particularly the United Kingdom, and by countries that adopt civil law, particularly France and Egypt. Bank earnings management is greater in countries that (3) adopt a mixed legal system, particularly South Africa, and in countries that adopt International Financial Reporting Standards accounting standards.Research limitations/implicationsThe implication of the findings is that country differences may affect banks' incentive to smooth income using loan loss provision.Originality/valueThe novelty of this paper is that it explicitly analyses specific countries that have different supervisory regimes, different structure and accounting rules.

Income smoothing in European banks: The contrasting effects of monitoring mechanisms

This study provides evidence of the combined effect of various monitoring mechanisms on income smoothing through loan loss provisions using data on European banks across 25 countries and covering 2003 to 2015. We find that prudential supervision increases bank income smoothing, consistent with the idea that strict supervision increases banks’ incentives to signal business stability by managing earnings. However, the effect of prudential supervision is conditional on the intensity of market discipline and accounting enforcement, which reduce income smoothing only in strict supervisory regimes. The analysis also takes into account the effectiveness of prudential supervision, measured by considering the powers of national regulators and the results of financial health checks performed by European Union regulators. The results show that the effectiveness of prudential supervision influences how other monitoring mechanisms constrain bank income smoothing. Accounting enforcement reduces bank smoothing only in countries where prudential supervision is effective. Our findings suggest that strengthening investors’ governance and improving coordination between prudential supervisors and accounting enforcers can limit the paradoxical effect of strict supervision, which reduces bank transparency if not adequately combined with other monitoring mechanisms.

METHODOLOGICAL APPROACHES TO ESTABLISHING A LIFE ASSURANCE GUARANTEE SCHEME IN UKRAINE

Abstract. The article investigates the features of creation, implementation and functioning of life assurance guarantee schemes. Based on the analysis of Ukrainian experience with insurers’ failure during 2011—2019, as well as other mechanisms of policyholders’ protection (internal risk-management, reinsurance, risk-based prudential supervision, early interventions, policyholders’ priority in winding-up process), the article proves the necessity of insurance guarantee scheme (IGS) as the last-resort protection, especially in case of long term life assurance in Ukraine.The expected guarantee costs for Ukrainian insurance market are calculated in compliance with Solvency II capital requirements. The expected losses of the system in the event of failure as a proportion of remaining insurers’ gross premiums for various asset shortfalls are estimated. Considering high concentration in life insurance market of Ukraine, it is revealed that possible losses due to the insolvency of the first four life insurers in Ukraine (from Top-10) are crucial for both the market and the guarantee scheme, despite the fact that the total expected costs of IGS appear relatively small, making up 0.35—0.45% of life assurance gross premiums (in 2019). This is typical for small and concentrated insurance markets, especially if more than 96% premiums are collected by top ten insurers, which make up only half of the market. When established, policyholder protection funds should be designed carefully to minimise any drawbacks, particularly the moral hazard problem and the burden on soundly managed member companies. The key features of an effective IGS for Ukraine are offered. It has been proven that any IGS initiatives should be delayed in Ukraine until proportional regulation that reduce the risks of insurance companies is introduced and prudential supervisory regime Solvency II implemented. Keywords: life assurance, protection mechanisms, insurance guarantee scheme, insurer insolvency, policyholder protection. Formulas: 0; fig.: 3; tabl.: 2; bibl.: 10.

REMIT: ten years and counting

Trading in energy derivatives is subjected to a fragmented regulatory framework which is largely designed for capital markets. Since 2011, a tailor made regime for the energy sector is in place; REMIT. Market participants need to find their way in this diverse set of obligations and prohibitions. This article describes the regulatory paradigm to which market participants need to adhere and the practical impact on trading in energy derivatives. Data reporting obligations, position limits and the prohibition on insider trading, market manipulation and the disclosure of inside information are discussed in more detail. The article concludes that REMIT fills in a regulatory gap, but its existence is not necessarily inevitable to capture energy derivative trading under a supervisory regime which is adapted to the specifics of energy markets.

Republic of Korea

Oversight of the Korean financial system is broadly effective. Korea’s Financial Services Commission (FSC) and Financial Supervisory Service (FSS) have in place regulatory and supervisory regimes in line with international standards with only a few remaining gaps. The authorities have addressed most of the recommendations of the previous FSAP and made good progress in benchmarking their frameworks with the Basel Core Principles (BCP), the Insurance Core Principles (ICP) and the International Organization of Securities Commissions (IOSCO) Objectives and Principles for Securities Supervision (IOP).

Features of Application of Modern Concepts of Bank Regulation and Supervision in Russia

Even in times of crisis, the key to stability of the modern banking system remains largely the concepts of banking regulation and supervision used by supervisors. In the context of globalization and external challenges, the Central Bank of Russia is adapting foreign concepts of regulation and supervision to the realities of the Russian financial system in order to ensure sustainable socio-economic development of the country. That is why the article is devoted to the analysis of the effectiveness of modern concepts of banking regulation and supervision. The article lists and characterizes the most common concepts in the use of banking regulation and supervision, as well as provides an author’s view of modern alternative approaches to the organization of banking regulation and supervision, which can allow the Central Bank of Russia to improve the applied supervisory regime.

Why the Italian Banking System that ‘Cruised Over’ the Global Financial Crisis, Found Itself Roiled by the Sovereign Debt Crisis: Reviewing and Highlighting the Key Issues

Why the Italian Banking System that ‘Cruised Over’ the Global Financial Crisis, Found Itself Roiled by the Sovereign Debt Crisis: Reviewing and Highlighting the Key Issues

Was sind grenzüberschreitende Pensionskassengeschäfte?

This article deals with the crossborder business of pension funds, resp Institutions for Occupational Retirement Provision (IORPs) according to the IORP-II Directive. In case of a cross-border business of IORPs, the IOPR-II Directive provides for a special supervisory regime. However, from a legal point of view it is unclear what circumstances trigger a cross-border case and the respective legal consequences (notification procedure etc). This question will be analysed on the basis of an occupational pension scheme where the IORP and the employee reside resp work in Austria, but the employer resides in another Member State. In this scenario, the question arises whether this constitutes a cross-border business according to the IORP-II Directive resp the Austrian Pension Fund Act which implements the directive. It is argued that the decisive test for this problem is the applicable “social and labour law” - within the meaning of the directive - for the pension scheme. A cross-border case is triggered only if - according to international labour law - the “social and labour law” of another country than the home state of the IORP is applicable. Since in the case analysed in this article, where employees work in Austria for a foreign employer that contracts with an Austrian IORP, the Austrian “social and labour law” is applicable, the Austrian IORP does not operate cross-border.

Do bankruptcy profiles of Islamic banks differ across organizational structure? evidence from Malaysia

Malaysian Islamic banks operate in different organizational structures, namely domestic, locally foreign incorporated, and development financial institutions which may have an influence on their stability. This research evaluates the bankruptcy profiles of 19 selected Malaysian Islamic banks from 2010 to 2017 and analyses the insolvency risk associated with the three different organizational structures. Using the Altman’s Z-Score Model (2000), a stability test was conducted. Finding s /Originality: the paper finds that, on average, the development financial institutions were the most stable banks, followed by foreign Islamic banks. It also finds that bigger domestic Islamic banks were situated in the safe zone as they had high Z-score values. Furthermore, asset quality ratio contributed to higher Z-score values. An appropriate asset-liability management therefore helps ensure the stability of Islamic banks in Malaysia. An effective macroprudential supervisory regime must also be in place to increase the resilience of the financial system.

Drivers of solvency risk – Are microfinance institutions different?

Based on a dataset covering 2938 banks and 1078 microfinance institutions (MFIs) operating in 106 countries this paper compares drivers of MFI and bank solvency risk. Measuring solvency risk by the non-performing loans (NPL) ratio we find that several factors driving the bank NPL ratio play a more subdued role for MFIs. By contrast, MFI Z-scores, notably those of MFI banks, credit unions and other MFIs, are driven by largely the same factors as bank Z-scores. The difference in results can be linked to the special characteristics of credit technologies pursued by MFIs. Given that the Z-score is the broader risk measure we conclude from our results that larger and deposit taking MFIs should be subject to the same regulatory and supervisory regimes as banks.

State Formation Under International Supervision and the Construction of Hierarchies in National Membership: A Balkan Story

While territorial integrity is largely described as the norm in post-1945 Western Europe, this article shows that it is not one in twentieth century history. This article examines the post-World War I formation of the Kingdom of Yugoslavia at the Paris Peace Conference and the internationally supervised formation of the post-Yugoslav states in the 1990s. It argues that each time multinational entities dissolved and new states were formed in the name of self-determination, territorial rescaling had direct consequences for the status and rights of domestic populations leading to ethnic and citizenship stratifications further supported by international supervisory regimes.

Republic of Armenia

This detailed assessment of observance has been conducted against the standard issued by the Basel Committee on Banking Supervision in 2012. The report also highlights that the Central Bank of Armenia has made significant progress in its approach to banking supervision with adoption of the risk-based program (RBS) framework and addressing gaps in the regulatory framework identified in the 2012 Basel Core Principles assessment. Improvements have been made in the regulatory regime regarding requirements for risk management, stress testing, corporate governance, country risk and consolidated supervision. Although the supervisory regime has recently transitioned from a rules-based to an RBS, there is a need for continued refinement of the program for more granular assessments of firms’ capital needs. The process for conducting risk assessments of each firm has identified a need for building a stronger and more structured (system-wide) understanding of the level and magnitude of risk and the risk management capabilities across banking firms.

Restoring Regulatory Credibility and Preventing “Repo Runs”: A Cautionary Tale

In the aftermath of the global financial crisis (‘GFC’), policy-makers and regulators have been engaged in Herculean efforts to restore their tarnished reputations. These efforts have involved jettisoning much of their flawed ideological baggage of old, rooted in a belief about the self-correcting nature of markets and the ability of financial institutions to police themselves, and, in turn, building new, more muscular regulatory and supervisory regimes. This ongoing process is explored through the lens of a high-profile facet of shadow banking, namely the regulation of sale and repurchase agreements (so-called ‘repos’). Here, regulators have set out to address a key vulnerability associated with the maturity mismatch between the short-term liabilities of the repo borrower and its longer-term assets, which has the potential to trigger a so-called ‘repo run’. Through a review of a series of highly problematic reform options, the discussion indicates that there is a danger that regulators will repeat the mistakes of the past by substituting their misplaced faith, pre-GFC, in the self-correcting power of markets, with a misguided conviction, post-crisis, in their capacities to build regulatory regimes which can contain the risks associated with modern-day financial markets. It is suggested that such over-confidence is liable to lull us into a false sense of security about how robust these regimes really are, and to cause regulators to shirk some of the more difficult questions which remain to be addressed.

Earnings quality and external governance on banks: empirical evidence in the European context

This paper examines the relationship between external governance exerted by the national supervision and bank earnings quality, specifically earnings persistence and cash flow predictability. To test the predictions, multivariate regressions are carried out on a panel dataset of 4,443 bank-year observations from the European Union across the 2005-2014 timeframe. Results show that higher supervisory power, independence and greater stringency of capital regulation are associated to higher persistence of reported earnings. Additionally, banks under strict supervisory regimes, independent authorities and stricter capital regulation exhibit earnings that are better predictors of future cash flows. This paper has policy implications for the ongoing European debate concerning advantages and disadvantages of the new Single Supervisory Mechanisms, with specific reference to the influence of the national authorities' characteristics on bank transparency. The findings suggest indeed to adequately consider the effects of national supervisory styles on accounting quality.