ESRB General Board meeting in Frankfurt

The General Board of the European Systemic Risk Board (ESRB) held its eighth regular meeting today.

The current situation

Financial market sentiment has improved in recent months, though downside risks to growth continue to add to concerns about the macro-financial environment in the European Union.

Indicators of systemic risk have also improved. A number of banks have successfully issued tier 2 capital and accessed primary unsecured markets, marking an improvement in investors’ appetite for bank credit risk, falling bond spreads, and easing liquidity conditions.

The bank-sovereign interlinkages, together with geographical market fragmentation, remain a matter of concern for public finances, bank soundness and financial stability at large. A consistent implementation of the agreements on the banking union, including the speedy adoption of the Council regulations concerning the establishment of a single supervisory mechanism and the presentation of proposals on a single European resolution mechanism, will help to assuage these risks.

Looking to the medium term, the General Board discussed four potential risks to financial stability in the EU. First, it raised the potential risks of under-provisioning and related forbearance. These include the perceived uncertainty around the quality of banks’ assets and capital levels, increasing the cost of market funding and possibly delaying necessary restructuring. Second, the General Board observed that the mandatory requirement of central clearing for standardised over-the-counter derivatives may give rise to new, too-big-to-fail institutions, as the importance of central counterparties (CCPs) is likely to grow. Third, the General Board highlighted the need to investigate possible implications of a low interest rate environment on the ability of long-term investors, including insurance companies and pension funds, to generate adequate returns. Fourth, the General Board also noted the possible risks posed by the overvaluation of some housing markets, which may merit further work.

To tackle these risks from a macro-prudential perspective, the General Board also draws attention to the need to:

  • ensure that banks provision against expected losses in a timely fashion, with supervisory authorities – at the European and national level – called upon to examine and monitor the quality of bank assets. In this context, there is a need for better and more consistent data to help supervisors ensure that forbearance is accompanied by appropriate provisioning and to foster greater market transparency;
  • ensure that CCPs have appropriate risk management and risk absorption capacity, mitigate the possible pro-cyclical impact of their margining policies, and support early introduction of an EU resolution regime for CCPs;
  • monitor closely the effects of low interest rates on the medium-term soundness of insurance companies and pension funds;
  • build a better understanding of developments across the European Union in real estate markets where prices continue to be elevated or rising, and explore ways to mitigate the build-up of imbalances and strengthen the financial system’s resilience in the event of a downturn.

Today, the ESRB General Board published the second issue of the risk dashboard.

Structural developments

The General Board considered two structural developments.

A – Asset encumbrance. Over the past few years, banks’ funding structures have undergone significant change as a consequence of the financial crisis. A most notable development has been the rising importance of secured funding.

Investors have become increasingly aware of the risks of an excessive level of encumbrance, implying subordination of other creditors, with consequences for potential pay-outs in the context of resolution. Future access to unsecured markets and correct pricing of risks may as a consequence become more difficult. In addition, encumbrance tends to be pro-cyclical, with collateralisation requirements rising during stress periods.

B – Money market funds in Europe. The Financial Stability Board and the International Organization of Securities Commissions have recently advocated a range of regulatory reforms for money market funds (MMFs). The aim is to reduce their vulnerability to customer runs, avoid regulatory arbitrage and mitigate the potential for systemic spillovers. In the United States, the Financial Stability Oversight Council has recently published a consultative paper with the same aim. In Europe, the European Commission has carried out a consultation in the framework of the so-called “UCITS VI” review of legislation on investment funds, opening the way for possible measures to reform the legislation on MMFs. The ESRB supports a regulatory reform in the EU, building on the work of ESMA and ideally as part of a global standard.

ESRB activities

The ESRB has published a response to a consultation by the European Commission on a possible framework for the regulation of the production and use of indices serving as benchmarks in financial and other contracts. Finally, the ESRB is publishing today a response to a consultation by the European Commission on a possible recovery and resolution framework for financial institutions other than banks