The Interplay of Macro-Prudential Regulation and Microeconomic Financial Regulation in the European Union in 2011–2014

Abstract

Though macro-prudential policy is usually aimed at mitigating financial instability, in the European Union it mainly consisted of a discretionary use of old policy tools, such as micro prudential measures, which might have worsened an ongoing financial crisis. Two episodes will be examined: the 2011 special recapitalization of banks and the 2014 Asset Quality Review and stress tests. The metric for the EBA 2011 recapitalization was the ratio of capital to risk-weighted assets. In this exercise, unlike Basel II and III prescriptions, all government bonds had to be accounted for at their current valuation. This feature has not yet been included in any piece of EU legislation and was therefore highly discretionary. Given the falling prices of some European countries’ government bonds, peripheral countries’ banks were in need of more capital. Therefore, they may have reduced credit, especially to SME, or worsened credit conditions. The 2014 stress tests examined the solvency of banks with the same metric and parameters taken from a macroeconomic scenario that was a remake of the 2007–2008 financial crisis. This contrasted with the macroeconomic reality of the time in which a restrictive fiscal policy was affecting firms’ cash flows and hitting, in particular, peripheral countries.

Keywords:

• Credit
• European crisis
• financial
• macro-prudential
• regulation
• SME

JEL CLASSIFICATIONS:

• G28
• G21
• G01

Acknowledgments

The author thanks two anonymous referees and the editor of the journal for several useful comments. The usual disclaimer applies.

Correction Statement

This article has been corrected with minor changes. These changes do not impact the academic content of the article.

Notes

1 See Section Macro-Prudential regulation in 2011: A stress Test and a Pro-cyclical Capital Buffer in this article.

2 According to the definition of European Securities Markets Authority the objective of the International Accounting Standards (IAS) Regulation is the harmonisation of the financial information presented by issuers of securities in the European Union (EU). This increases transparency and comparability of financial statements and contributes to an efficient functioning of the European capital market and of the internal market.

3 The nexus between debt and financial risks has been studied by a number of heterodox economists such as Kalecki and Steindl. Steindl (1945, chapter 4) focusses on the issue of large vs. small firms writing that in case of adverse macroeconomic circumstances the potential losses for small firms are much higher because their ratio of net debt to equity is usually higher. For a discussion of this theme in relation to the European crisis, see Toporowski (2014).

4 This process was accelerated by the Single Supervisory Mechanism, which is the first step of the still unfinished European Banking Union. So, the obligation of reporting data according to the new rules of the CRR often became a constraint on banks that had to anticipate the strategy to accomplish those rules. After the recapitalization of 2011 capital raised by banks was much higher than that required to face shortfalls because most banks wished to be ready for the full implementation of the CRR. Hardy and Hesse (2013) write that even though in the 2011 European Banking Authority-led stress testing exercise the final estimated capital shortfall was modest the final result was the product of many banks pre-emptively increasing their capitalisation and raising more than €200 billion in capital by the conclusion of the recapitalisation exercise.

5 The filters were again suspended in 2020 during the COVID-19 crisis (European Union, European Parliament, and the Council 2020) amending Regulations (EU) No 575/2013 and (EU) 2019/876 as regards certain adjustments in response to the COVID-19 pandemic.

6 “It should be noted that while the computation of the potential losses and the removal of the prudential filters on the assets held in the available-for-sale portfolio is in line with the full implementation of the Basel III framework, a full marking-to-market requirement for all sovereign debt exposures, including the held-to-maturity portfolio and the loans-and- advances portfolio, is inconsistent with accounting and prudential treatment.” (Emphasis added) (ESRB 2015, 30).

7 I am indebted to a referee for pointing this out.

8 Regulation (EU) No 468/2014 of 16 April 2014 of the European Central Bank establishing the framework for cooperation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and with national designated authorities (SSM Framework Regulation) (ECB/2014/17).

9 There were criticisms about the choice of using the ratio of risk CET 1 to risk-weighted assets instead of the leverage ratio. Goldstein (2014) argued that as large French, German, and Dutch banks have low leverage ratios and low ratios of risk-weighted assets to total assets, they invariably look better under a test that uses risk-based measures rather than leverage ratios. He concluded that the ECB produced estimates of the aggregate capital shortfall and a country pattern of bank failures that were not believable.

10 The metric is called CISS and has been created by Holló, Kremer, and Lo Duca (2012).

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Notes on contributors

Domenica Tropeano

Domenica Tropeano is an associate professor in the Department of Economics and Law at the University of Macerata. Her main research interest is monetary policy in relation to the evolution of financial markets.