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On the one hand, this means that there is need to assess the financial stability risks posed by individual banks and groups of banks. And there is need to look at the implications of proportionality for local competition.
On the other hand, the costs of regulation and supervision have to be considered. Small banks face greater difficulties in complying with complex regulation. This may put them at a disadvantage and therefore reduce diversity in the banking sector. However, a wide diversity of small and medium-sized banks makes the banking sector more stable. Thus proportionality may be necessary to foster such diversity.
It can generally be assumed that the failure of a small bank poses a smaller risk to the financial system than the failure of a big bank. So it might make sense to apply a different regulatory and supervisory regime to small individual banks.
However, when many small banks with the same business model form mutual liability arrangements via institutional protection schemes, qualified holdings or integrated cooperative structures, they might become systemically relevant – at least at national level.
In the event of a failure, all these small banks taken together could pose a big risk to the financial system. This is known as the “too many to fail” problem. It deserves particular attention – and probably a response that goes beyond the standard microprudential supervision.
As small banks are generally less risky, the costs and benefits of regulation and supervision may not be balanced for small banks in some areas. Applying to small banks the same approach that is applied to large banks would not be proportionate, as the costs, in particular of complex prudential rules, would be higher in comparison and the benefits would be smaller.
So there is a strong case for proportionality.
Looking at the European situation, the EU’s single rulebook already provides for such proportionality in many cases. For instance, reporting requirements for small banks are far less stringent than those for large banks: small banks have to report about 600 data points to supervisors, whereas larger banks have to report more than 40,000.
The question is whether more proportionality in banking regulation is needed?
Indeed, the discussion in Europe is currently focusing on changes in several additional areas which will enable banks to apply simpler rules and thus reduce compliance costs for smaller banks.
The critical question is: what do we want to achieve through the proportional regulation and supervision of small banks? Would it mean that these banks could hold less capital, less liquidity?
In Sabine Lautenschläger‘s opinion, proportionality means simpler rules for smaller banks. But it does not mean that the rules should be generally less stringent, or that banks can hold less capital or liquidity.
Finally, a crucial issue is where to draw the line between small and large banks.
Depending on the objectives of proportionality, the line might be drawn according to the volume of total assets; or it could be linked to the size of specific business activities. It might also depend on banks’ business models or on whether or not banks use internal models. And the size of a bank relative to the country’s total banking assets could also play a role.