With the onset of the global financial crisis in 2007, a number of government interventions were required to ensure that the financial system did not implode.This required the use of taxpayer funds to prop up ailing banks.The knee-jerk reaction of politicians and regulators was to ensure that this never happens again.
Considering the costs of the financial crisis, the need for reform in banking regulation is widely acknowledged.From 2008, the EU Commission under Commissioner Barnier required the EU legislative machine to go into overdrive to draft and refine a plethora of banking regulation to set up the EU Banking Union.
As part of the setting up of the EU Banking Union, the Single Supervisory Mechanism kicked in on November 4, 2014 when the ECB took over the role of supervising European banks with the objective of preventing future bank failures. The Single Resolution Mechanism – the second pillar of the Banking Union – came into force on August 19, 2014. This second pillar, through the Single Resolution Board and Single Resolution Fund, would ensure that if a bank does fail, there is a clear way to resolve it limiting the use of taxpayer money. The third and last pillar of the Banking Union is the European Depositor Insurance Scheme, a European scheme to complement national schemes which would protect depositor’s funds, should the bank requiring resolution not have sufficient money to pay back the depositors.
The fast-paced implementation of EU banking regulation and the fundamental principle of a single EU rule book may not always have allowed for the implementation of the principle of proportionality to be followed to the full extent possible.
What is the principle of proportionality?
A significant body of work in this field was undertaken by the European Banking Authority’s banking stakeholder group. The group highlights in its December 2015 report ‘Proportionality in Bank Regulation’, that the cumulative effects of every individual regulation and the complexity of these regulations may themselves be increasing the costs of the regulation more than the actual benefits that they were intended to transfer to the market.This is more acute for smaller banks with lower risk business models.
The European banking regulators are today more receptive to the principle of proportionality when compared to the years following the financial crisis
The US legislative system recognises the principle of proportionality in its banking regulation framework, where a two-tier banking regulatory system is implemented. This regulatory system categorises smaller community banks offering traditional services – which therefore carry less risk – as one tier (banks with less than $50 billion in assets under the Dodd-Frank Act) allowing them to offer less risky products to the market.
The larger investment banks fall into a second category which would require greater regulation and supervision.The above may be an interesting approach for the European banking sector. However, one must admit that the European banking market is more diversified and would not permit the clear distinction between Main Street and Wall Street banks as in the US.
The EU Commission, during a consultation process launched as part of its Capital Markets Union in October 2015 (‘Call for Evidence: EU Regulatory Framework for Financial Services’), sought input from stakeholders on how the principle of proportionality could effectively be implemented in EU banking regulation.
Following feedback from stakeholders, the EU Commission in November of 2016, launched the revised CRR and CRD IV regulations presenting the principle of a small institution which requires less frequent reporting and disclosure requirements.
The European banking regulators are today more receptive to the principle of proportionality when compared to the years following the financial crisis. However, savings and retail banks call for the principle to be taken further into consideration in order to reduce the regulatory burden and additional costs involved. This will allow Europe’s locally focused banks to continue to serve the real economy by providing more loans to household and SMEs, and therefore increase growth and jobs.
This paradigm shift is an opportunity for a small member state like Malta when holding the presidency of the European Council to place the principle of proportionality higher on the EU agenda.
The revisions of CRR and CRD IV are seen as an opportunity which should not be missed, to introduce more proportionality in the regulatory framework applicable to the European banking sector.
Mark Scicluna Bartoli is the head of EU & Institutional Affairs at Bank of Valletta and is also responsible for Bank of Valletta’s Brussels EU Representative Office.