The European Commission’s financial reform programme has made the EU financial services sector fundamentally more resilient, reducing the likelihood of bank failure and containing its effects should this occur - but it is essential that the right balance be found so that the financial sector is not prevented from carrying out its basic economic functions and supporting future economic growth.
There is a multiplicity of actual and prospective regulatory change within the banking sector all of which influence banks’ strategic decision-making, the products and services they offer and the price of those products and services, and which need to be taken into account in assessing this balance. This is as true of the role banks play in providing access to and supporting the functioning of financial markets, as it is of their role in providing traditional intermediary services.
Given its focus on bank capital requirements, this review is partial and fails to take into account the important impacts of, and interlinkages between, the other measures that are part of the CRDIV/CRR, notably liquidity and leverage requirements. Moreover, its scope does not extend to the BRRD, a new prudential framework that goes hand in hand with the CRDIV, providing authorities with a proactive toolkit, including capital measures, to manage recovery and resolution. Resolution tools enable authorities to minimise financial instability by ensuring the continuity of a bank’s critical functions and restoration of viable parts of the bank. The recently launched cumulative impact assessment exercise, part of the Commission’s CMU Action Plan, will thus be helpful in understanding the broader implications of the EU prudential regulation within the overall financial reform package.
Beyond the EU’s reform programme itself, there are several workstreams underway at international level likely to further increase capital requirements and significantly reduce the level of risk sensitivity of the prudential framework. It is crucial for the Commission to consider how these developments may impact European growth, as a lack of risk sensitivity leads to the inappropriate pricing of risk, creating a misallocation of capital across the economy, less diversification across firms’ portfolios, and potentially an increase in risk to the financial system as a whole.
Over the past years, banks have responded to regulatory reform by taking multiple restructuring actions, both of their organisations and product offering. We are concerned that regulatory changes driving these responses may represent an over-correction, beyond what could be considered as “necessary deleveraging”. Indeed, the decrease in lending to corporates and the structural and comparably small share of market-based financing in Europe are signs that choice for banking customers has been reducing and will continue to do so.
There is also evidence that many banks have exited or reduced market-making activities, implying that banks need to be more selective in offering their balance sheet capacity and end-users ultimately face a less diversified capital markets offering. Additionally, an increasing focus is being placed on the impacts of regulation on primary and secondary market liquidity and there are concerns that market liquidity could be further affected as monetary policy tightens. With the development of the CMU in the EU being one of the key priorities for EU policymakers, AFME and ISDA consider it is essential that the Commission examines how the prudential framework affects market liquidity and acts to preserve this important market function.
Having completed its reform agenda, the Commission now has a once-in-a-generation opportunity to reflect on the best approach to prudential regulation within the context of its objectives to support growth and develop European capital markets. Ideally, this should also be accompanied by the definition of a yardstick against which the success and impacts of the new prudential regulatory framework can be measured. In our view, this must involve finding the appropriate trade-off between the benefits of financial stability and a banking sector that is able to take controlled risks to provide credit to the economy. This balance could be jeopardised by unnecessary regulatory layering.
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