04 February 2020

BIS: Financial Stability Institute: Convergence in the prudential regulation of banks - what is missing?

This paper leverages off the FSB’s report and identifies specific sources of regulatory divergence in the banking sector. The findings are based upon a synthesis of earlier publications of the Financial Stability Institute that identified the methods that authorities use to implement international standards and to develop policies in areas for which no sufficiently prescriptive guidance exists.

Regulatory-driven market fragmentation poses challenges for the proper functioning of the global financial system. Unwarranted divergence in prudential requirements may distort competition and discourage banks from undertaking cross border activities. If this occurs, it may reduce the efficiency of the financial system, hinder international capital flows and impede global risk-sharing among a broader array of market participants.

Some aspects of divergent prudential frameworks are not necessarily detrimental to financial stability and other policy objectives. Domestic economic and market conditions may require regulation to be adjusted in order to achieve a specific policy goal. In some cases, authorities impose higher standards than the applicable international norms with the aim of addressing country-specific concerns. In other cases, authorities may impose different prudential standards on banks that are deemed not to be internationally active, with a view to tailoring the rules to fit the risk profiles of banks operating in their respective jurisdictions.

Full, timely and consistent implementation of the standards, at least to international active banks, is a necessary condition to minimise unwarranted divergence. The BCBS regularly reviews the implementation of agreed standards in member jurisdictions. In addition, it has already issued guidance on specific elements of the prudential regime where significant discrepancies exist.

Yet domestic regulations that are assessed as compliant with Basel standards may still lead to different prudential outcomes across jurisdictions. There are at least three key drivers for such deviations:

• heterogeneous practices in the measurement of certain assets that depend heavily on assumptions;
• variations in the scope of the implementation of Pillar 1; and
• divergent approaches in the application of Pillar 2.

All three factors combined can generate significant variation in prudential regimes that is unlikely to be fully justified by financial stability considerations. 

Scope may exist to mitigate unwarranted sources of divergence, particularly where excessive discrepancies remain. On the first source of variation – asset measurement practices that drive the calculation of regulatory capital – the design of consistently applied prudential backstops, particularly for the measurement of NPEs and Level 2/3 assets, can reduce unwarranted variability across jurisdictions. On the second and third sources of discrepancies – differences in the national implementation of some elements of Pillar 1 and Pillar 2 requirements – there is scope to investigate whether all differences are justified on the basis of national specificities or whether additional guidance may mitigate unwarranted regulatory fragmentation. 

Full publication on BIS

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