01 September 2011

Eurofi: Monitoring the impacts of financial reforms on the EU economy

According to the BIS and the EU Commission, the new regulatory frameworks – Basel III, Solvency II - should not impact growth in the long term. Nevertheless, Eurofi members remain concerned about their actual impact.

Indeed those reforms, beside the impact of higher costs of finance, should deeply modify financing mechanisms and reduce some financial institutions activities, possibly to the detriment of the economy in particular in Europe, the region where Solvency II will apply and lending is highly intermediated.

To quote an EU Central Bank executive: “Banks have several possibilities to adjust their capital ratios. For instance, they can raise capital, increase lending spreads, reduce dividends and/or downsize (risk-weighted) assets. In practice, it is likely that banks’ adjustment is going to be achieved through a combination of all these measures. There is empirical evidence, however, that in the short term and in crisis periods in particular, banks react to capital (and liquidity) constraints by de-leveraging and by tightening of credit conditions that can have a measurable impact on loan supply and thus on economic activity. Whatever methods banks choose to adjust their capital ratios, the overall effect is channelled to the macro-economy via various transmission channels.”

As these “effects” are difficult to anticipate and modelling assumptions always create arguments, a closed proactive monitoring of the actual consequences of the new prudential frameworks is both vital and urgent.

Moreover at a moment when economic growth is abating, recovery is very dependent on the capacity of the banking sector to provide financing. In such context, compelling banks to increase the regulatory capital may be pro-cyclical. Indeed, depending on market conditions, it would be difficult for banks to raise new equity, which would lead them to reduce their assets and the granting of new credits.

Policy makers must tread carefully to avoid constraining bank’s ability to lend to customers. An appropriate monitoring process capable to detect early any unintended consequence and achieve the possibly required regulatory adjustments should be set up. It is required to be up to the event of unintended significant consequences on the European economy, growth and employment. For both the ongoing monitoring and the regulatory adjustments process the European Systemic Risk Council is particularly well suited. This is essential to have the capacity possibly to review the implementation timetable depending on the pace of the recovery and adjust regulatory requirements over time to the real needs of reinforcing the solvency of the different financial activities. Lastly, this process should allow verifying the appropriateness and the impacts of certain measures.

Full paper

© EUROFI