This past week’s Economist highlights Europe’s continuing economic crisis and how deferred loss recognition by banks may translate into “pressure in the streets”. This article also notes that loans “to non-financial firms contracted in May by 4.1% in Italy, 5.0% in Portugal and 9.7% in Spain.”
Europe’s Zombie Banks
In the same week, the ECB’s Benoît Cœuré noted that “Reviving credit growth is one of the most pressing challenges for the euro area today” and that “… governments have to ensure that banks are properly capitalised and that their balance sheets are cleaned up.”
Reviving credit growth in the Euro area
Similarly, Harald Benink and Harry Huizinga from Tilburg University argue that bank losses should be acknowledged and imposed upon subordinated and common debt holders.
The urgent need to recapitalise Europe’s banks
The apparent success of bank recapitalisation in the US is one one of the supporting arguments.
Is forced re-capitalisation the way forward for Europe’s beleaguered economy?
Have US policy makers effectively addressed their structural banking sector issues and demonstrated the most appropriate policy response to the global financial crisis?
Re-capitalizing major banks is not sufficient to reestablish robust liquidity in the European credit risk transfer market. Restoring investors’ confidence and progressing reforms require enhanced transparency and standardization, notably on repo’s and securitizations.
Many policy makers recommendations listed in the forum topic “Shadow Banking Regulation in Europe” focus on enhancing disclosure and information-gathering by authorities. “While progress is being made, the exercise underscored the need for significant improvements in data availability and granularity to adequately capture the magnitude and nature of risks in the shadow banking system,” the FSB said.
For securitizations in Europe, here are the most important transparency initiatives currently sponsored in Europe by central banks and by the banking industry :
Considering policy recommendations on transparency, the following questions remain open for debate :
- Will more transparency also revive Europe’s secured lending and securitization markets?
- What additional infrastructure changes would strengthen market liquidity and robustness?
- Will transparency on market flows and counterparties help to restore investor confidence?
- What other initiatives would help reviving desirable credit risk transfers ?
Delivering effective regulation of the complex and diverse shadow banking sector is a real challenge for policy makers. They have also a very difficult job to mitigate systemic risk without harming activities which are desirable for the real economy. Because the shadow banking sector had a strong adaptive capacity, regulation should also be comprehensive, to reduce regulatory arbitrage.
Therefore, many consultation and policy documents were published in 2012. Here are some references to papers dealing with this topic :
The EU’s shadow banking response up to end 2011 focused mainly upon introducing a central counterparty to the over-the-counter derivatives market as well as requiring incremental capital for banks’ dealings with “shadow” banks.
The last FSB consultative document, published on November 18, sets out a number of recommendations across specific areas of concern, as identified in 2011. These focused on reducing risk spill-overs from shadow banking into the regular banking sector, mitigating systemic risks within the shadow banking sector, strengthening the money market funds framework, and dampening the systemic risks associated with securitization, repos and securities lending.
Considering all these recommendations
- What form of regulation will best reduce shadow banking’s systemic risks?
- How should different regulatory initiatives engage and better align with each other ?
- Will proposed regulations also encourage desirable credit risk transfer activities ?
- Should regulators move towards a functional regulation for all financial institutions, based on activities instead of regulatory status (bank, insurer,etc) ?