Systemic risk is a complex problem of the current global financial markets. It has grown along with the shift towards globalisation and became apparent during the recent financial crisis. The fact that the failure of an institution or parts of the financial system in a specific context can endanger the whole global financial system has given rise to government support and the consequent question of moral hazard. Some literature on the subject in a more limited context was available already before 2007 but more research has been conducted since the crisis. Systemic risk on a global scale is a new threat and will require changes in the global financial architecture.

 

In this context, the EBF is committed to collaborate with policy makers in the development of solutions with a view to prevent a new surge of financial instability and to mitigate the build-up of systemic risk across the financial sector.

 

Financial system is an ever changing network and consequently the EBF considers that every market participant contributes to systemic risk. This is true for both small and large firms as demonstrated during the recent crisis. Therefore, efforts should be led to the identification of sources and processes of systemic risk. The size of an institution is an incomplete, and therefore, unsatisfactory proxy on systemic importance and does not provide meaningful information as regards to systemic risk. Further analysis is imperative before implementing provisions based, directly or implicitly, on the size of financial institutions.
 

As a matter of principle, the use of lists of Systemically Important Financial Institutions (SIFI) is not the right solution to address the root problems. Conversely, the EBF thinks that a continuous approach to systemic risk, in which all institutions as part of the network are deemed systemic to varying degrees, would be preferable.

 

Systemic risk is dynamic in nature. The recent crisis has shown how weaknesses in risk management and business models can make a formerly mild instrument spark off a general turmoil. Therefore, there is need for dynamic monitoring mechanism in order to better anticipate where the next systemic risk accumulation is building up.

 

For this purpose, dynamic macro-prudential surveillance is the cornerstone of systemic risk identification. Its indications should then be incorporated in the supervisory review and evaluation process conducted by micro-prudential supervisors. The Basel Accord provides a suitable framework to do so within the scope of the second pillar, which offers invaluable information to supervisors and the opportunity to identify systemic risk symptoms.

It is important to note that systemic risk prevention is not only a matter of individual banks surveillance. The quality of supervision, the regulatory framework and the crisis management framework of each jurisdiction separately as well as the effectiveness of the EU wide framework should also be part of the assessment.

 

The defence against systemic instability should be armed around the crisis management framework in a three-staged approach, starting with a vigilance process of macro-prudential.

 

Monitoring coupled with the closer oversight by the consolidating supervisors. An early intervention phase would trigger mechanisms aimed to maintain institutions as a going concern. Finally, under the new resolution regime, the resolution authority would ensure that shareholders bear any losses incurred and creditors, if necessary, as a last resort will also be required to participate to some extent. This will limit moral hazard and the too-big-to-fail problem, and shield taxpayers from intervening.
 

Recently, some countries, such as Belgium, Switzerland and the US, have launched their own proposals in this area, some of them inclusive of hard prudential measures. The EBF would expect that policy makers duly coordinate their initiatives to tackle the risks of a systemic nature with consistent global standards.

 

In the opinion of the EBF, capital surcharge should not be considered as an option in the systemic risk discussion owing to the poor set of proxies posed for choosing the institutions inflicted by this as well as very little firm evidence existing on what constitutes an adequate surcharge. These measures do not address the root problem and may bring other undesirable consequences. Moreover, they have been extensively used in the context of the Basel III final package.

 

Prudential actions should be based on sound examination of the origins of systemic risk and be led by a continuous monitoring and identification process. The banking industry broadly acknowledges the practical difficulties in the investigation of systemic risk sources due to scarce data and analytical complexity. However, systemic risk prevention is worth a genuine effort to develop a plausible rigorous solution. In this vein, EBF stands ready to collaborate with policy makers with a view to defining a well-balanced framework that:

 

• Takes account of the true sources of systemic risk.

• Allows for a continuous update and is forward-looking by nature.

• Avails effective actions to reduce the risk of contagion, giving supervisors clear
mandates homogeneously framed in all jurisdictions.

• Allocates prudential requirements commensurate to the systemic risk involved,
without imposing additional capital surcharges.

 

The final regulatory and supervisory framework should be geared to enhance the detection and management of systemic risk, as well as to reduce the risk of contagion.

Full position paper