Principles of Financial Regulation

European Deposit Insurance Scheme (EDIS)

EDIS, depositors are guaranteed by European funds. This system was thought of increasing confidence in the banking system and preventing bank runs. Unfortunately, it was not put in place as some member states did not agree to share problems due to political opposition.

National Deposit Guarantee Schemes (NDGSs)

What we have is the National Deposit Guarantee Schemes similar to EDIS, implemented by each member state, instead of having a union scheme.

Single Supervisory Mechanism (SSM)

The system of banking supervision is made by the European Central Bank (ECB) and National Competent Authorities (NCAs). The main achievement of SSM was the transfer of specific tasks relating to the supervision of credit institutions to the ECB, which were previously of national competence.

The basis of SSM is Article 127 of the Treaty on the Functioning of the European Union (TFEU), which allows conferring specific tasks upon the ECB concerning policies related to the prudential supervision of credit institutions, with the exception of insurance undertakings.

Art 127 prohibits explicitly these subjects. Tasks of SSM are:

• Compliance with single rulebook and substantive law. One of the goals after the crisis was to increase harmonization through the union, to do it there was the creation of the rulebook. EBA
• In the banking sector, the authority is that implements standards that are soft laws, adopted by the commission. Then there are the EBA guidelines, the players in the market do not have to comply, there is a comply or explain effect, if you do not comply you have to explain why.

Objectives of SSM are 2:

1. Safety and soundness of credit institution (to avoid the spread of crisis as happened in 2008)
2. Stability of the financial system both by applying high standards of supervision by ECB and avoiding any discrimination against member states

Decision-making process. Single supervisory board:

We have the (main character inside ECB) it makes plans and executes supervisory tasks of ECB. The SB proposes a draft decision, then the governing council can object or not.

states participating in SSM; parliament could check if the SB operates correctly; can address with written questions to SB to explain why they decided; there are annual reports addressed to commission, parliament, or even to national parliaments of member states.

Supervisory tasks:

• Micro prudential tools:
• grants or withdraws of banking licenses: the reference authority that checks the compliance with the licensing requirements and on an on-going basis is the same, ECB
• authorization of acquisition of qualifies holdings
• conduct investigations and on site inspections
• carry out supervisory reviews
• impose corrective measures and sanctions
• Macro prudential tools:
• define higher requirements, set a buffer rate if national supervisor has not done so; every bank has to meet capital requirements that are fixed in regulation, but if a bank has riskier activity then ECB could decide that it has to increase standards.

Common procedures are important in the single supervision scheme. They constitute

An exception to the Significant Institutions/Less Significant Institutions divide: there are in fact some areas where the competences are spread between ECB and NCAs, without the division, they involve interaction. In particular in two areas:

1. Authorization and withdrawal of license
2. Acquisition of qualifying holdings

In these two areas, even if the final decision is made by the ECB, NCAs are still involved in an interaction that is fundamental in order to reach the decision.

Indirect supervision of LSIs. Day by day supervision is performed by NCAs, including adoption of supervisory decisions, with exceptions of common procedures (interaction with ECB).

ECB has power only of oversight, can give non-binding recommendations (soft law, guidelines), but when it is necessary they can take over supervision, e.g. a bank considered less significant should be supervised by NCAs but if the application of high supervision standards is required, then the ECB can have direct supervisory power.

Lesson 4

End of 1st

The nature and frequency of activity set out by individual Supervisory Examination Program (SEP) includes operational planning and day-to-day supervision defined in the SEP for each bank. This program sets the main supervisory tasks and activities for the following 12 months for each bank.

The significance criteria for supervision are as follows:

• The ECB exerts supervisory activity directly only to significant institutions, whereas NCAs do it with less significant banks.
• The division is based on criteria explained by Article 6 of the SSM regulation.

The criteria for determining significance are:

• Size of the bank: The total value of assets is considered significant if it exceeds 30 billion.
• Economic importance of the bank: The ratio of total assets to GDP of the member state exceeds 20%.

These criteria are based on the problems that the banking union tried to solve, such as banks considered "too big to fail" (TBTF). Therefore, an ex ante approach is needed to supervise their activity, as their failure could damage the whole system.

30 b assets (first criteria not met) then it could be important if its assets exceed 20% of GDB of participating member state, if the bank failed there could be huge damages to that member state.

Cross-border activity, important to identify that these kind of banks are important for system as a whole, if they fail there are problem with other states.

Direct public financial assistance, if a bank requests it, it should not be considered less significant, ECB says they need to supervise the bank.

3 most significant, in each member states, unless justified by particular circumstances, the 3 most significant banks are directly supervised by ECB.

Risk Map. In carrying the task of supervising banks, the guideline is to identify risk and in particular related to the single bank.

The risk map shows the risk impact and the probabilities of the single risks. The most important are the geopolitical uncertainties (Brexit, trade war China US), NPL (if a bank gives loans to companies and the company does not

Pay back the bank, it suffers a loss). In 2020 another risk inserted in the map will be the uncertainty brought by Coronavirus and lockdown.

SREP

The most important superiority activity of the ECB, which is SREP, that ends with a SREP decision; it is a review and evaluation process, task of the ongoing sup. that the ECB does SREP assessment with significant institutions. With The ECB has to verify model-business and profitability risk that every bank have because if a bank does not have a good business model it is probable it could fail, and it spreads to the system risk management-governance and has to be adequate as well, cause the bank otherwise cannot identify the risk is facing and manage it related risks,-capital basically the credit risk, if a bank gives money to a company it is different from giving money to a state, each carries different risk, for each debtor there is risk assessment and bank has to comply with some capital requirements liquidity funding,-risk to and facing liquid

liabilities (so in the Short Term) with LiquidAssets.The assessment ends with a SREP decision, that establishes for each bank what they have todo: banks may have to increase capital or improve liquidity measure, and of course everydecision is linked to the single bank that is supervised.(don’t worry if it is too specific, it will be explained)Slide is a bridge between the two parts of module:-phisiological life of bank, supervision-pathological life, when bank has problems.We can see in slide that ECB activity is related also to the resolution part, there is aninteraction between sup. carried by ECB and resolution carried by SRB. There are 4 parts:-ECB is responsible for recovery planning and assessment of recoverability. Recovery planscontain some info (governance arrangements, scenarios), each bank has to indicate some riskand consequent scenarios and