09 December 2014

EBF assesment of a regulation on structural measures improving the resilience of EU credit institutions

The BSR appears redundant with other reforms. The objectives of the separation seen by the European Commission are actually already under the scrutiny of ongoing regulatory changes (CRDIV/CRR, BRRD, SSM/SRF, TLAC, etc.).

Separation is expected to increase funding costs for the trading entity. Such increase may even incentivise it to cease certain trading activities. EU separated trading entities would have difficulties surviving, as they would have to exit some unprofitable markets, and would be “forced” to exit other markets as they would not be able to offer competitive prices to their clients compared to third-country dedicated trading entities.

Separation is expected to increase funding costs for the core bank, because of separation on market making costs for European entities and duplicity of some compliance with many existing and coming regulations – for example the need for the CCI to acquire high quality liquid assets (HQLA) in the market to comply with the Liquidity Coverage ratio (LCR); or the prevalence of preferred depositors in the CCI resulting in equity and bond holders asking for a higher risk premia for holding bail-in able debt.

Those expected increases in funding costs will result in higher costs for the real economy for accessing the products and services offered by the trading entity, with important repercussion on hedging strategies and risk management costs:

• The BSR proposal would lead to a poor functioning of the secondary market and consequently an additional illiquidity premium for primary issues. Examples based on three reference values demonstrate that an increase of only 1 basis point in the yield of a bond would result in an additional average cost of funding for issuers located in the European Union (including sovereigns) of about EUR 0.75 billion yearly. For an increase of 5 basis points in bond yields the additional average cost of funding would be EUR 3.7 billion yearly. And for an increase of 10 basis points in bond yields the additional average cost of funding would be EUR 7.49 billion yearly.
• The core credit institution would only be able to provide corporates with standard risk management products. This will lead to higher costs for companies and institutional investors that, to a large degree, need to use non-standardised products to manage their business-related risks. The likely consequence is that corporates will end up not hedging their risk or taking extra risk due to the hedging mismatch stemming from not having adequate access and/or raised costs for non-cleared derivatives. This is particularly true for SMEs who will have less access to non-standardised products than large corporates.

The important role that universal banks currently play in facilitating the access for SMEs to an external investor base would be interrupted as separation requirements would make European universal banks less able to play this role due to competition from third-country dedicated trading entities. This could be to the disadvantage of smaller institutional investors and medium-sized companies in Europe that are currently being served by EU universal banks, as it is not sure that large and global trading entities would be interested in serving this client segment.

Full assesment

© EBF