Scholarly article on topic 'Institutional Change of the Supervisory System of the EU Financial Market'

Institutional Change of the Supervisory System of the EU Financial Market Academic research paper on "Economics and business"

CC BY-NC-ND
0
0
Share paper
OECD Field of science
Keywords
{"Supervision of financial markets" / "European System of Financial Supervision" / "Single Supervisory Mechanism" / "Single Resolution Mechanism" / "Euro area" / "Banking Union."}

Abstract of research paper on Economics and business, author of scientific article — Algis Junevičius, Mindaugas Puidokas

Abstract The global financial crisis caused public discussions on the efficiency of the supervisory institutions of the EU financial sector. This paper identified the changes of the EU financial supervisory system and evaluated the directions for improvement of the reform. The logical method is used for making a substantiated generalization of the collected facts and formulating transitional as well as final conclusions of the research. Seeking to evaluate the existing banking regulation in Lithuania and the EU, the method of systematic analysis is applied. The results of the study show that the recent integrated supervision models failed to quickly and efficiently respond to the financial crisis. Ordinary European System of Financial Supervision (ESFA) is insufficient to prevent splitting of the European financial market.

Academic research paper on topic "Institutional Change of the Supervisory System of the EU Financial Market"

Available online at www.sciencedirect.com

ScienceDirect

Procedía - Social and Behavioral Sciences 213 (2015) 55 - 60

20th International Scientific Conference Economics and Management - 2015 (ICEM-2015)

Institutional Change of the Supervisory System of the EU Financial

Market

Aigis Juneviciusa, Mindaugas Puidokas^*

abKaunas University of Technology, K. Donelaicio g. 73, Kaunas LT-44244, Lithuania

Abstract

The global financial crisis caused public discussions on the efficiency of the supervisory institutions of the EU financial sector. This paper identified the changes of the EU financial supervisory system and evaluated the directions for improvement of the reform. The logical method is used for making a substantiated generalization of the collected facts and formulating transitional as well as final conclusions of the research. Seeking to evaluate the existing banking regulation in Lithuania and the EU, the method of systematic analysis is applied. The results of the study show that the recent integrated supervision models failed to quickly and efficiently respond to the financial crisis. Ordinary European System of Financial Supervision (ESFA) is insufficient to prevent splitting of the European financial market.

© 2015 The Authors. Published by ElsevierLtd. This is an open access article under the CC BY-NC-ND license (http://creativecommons.Org/licenses/by-nc-nd/4.0/).

Peer-review under responsibility of Kaunas University of Technology, School of Economics and Business

Keywords: Supervision of financial markets; European System of Financial Supervision; Single Supervisory Mechanism; Single Resolution Mechanism; Euro area; Banking Union.

Introduction

The intervention of the European Union states in the rescue of the banking sector started in 2008/2009 alongside with the worldwide financial crisis on a dramatic scale. The support for the states was rendered in a variety of forms. Consequently, that made a negative effect on the public finances of the states which resulted in a moral hazard. The actions of that kind caused public discussions on the efficiency of the supervisory institutions of the financial sector on the macro and micro levels and disclosed the problems of that sector. Supervision is so far carried out based on

* Corresponding author. Tel.: +370-612-62-362 E-mail address: mindaugas.puidokas@ktu .lt and dr.mindaugas.puidokas@gmail.com

1877-0428 © 2015 The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Peer-review under responsibility of Kaunas University of Technology, School of Economics and Business doi:10.1016/j.sbspro.2015.11.403

different national rules without regard of the fact that the single market was established 23 years ago. It became clear that the existing supervisory measures were insufficient to avoid, to manage and to overcome crisis. The national supervisory models lag behind the modern reality, i.e. the integrated and interrelated European financial markets, where numerous financial enterprises operate on a cross-border scale. Unsuccessful regulation and supervision of financial markets should be regarded as one of the main causes of the worldwide financial crisis of 2008 (The Turner review, 2009; McCarty, Keith, Pole... 2010; Levine, 2010).

The studies performed show that the EU institutions and Member States started an unprecedented reform of the performance of supervisory institutions. The presented landmarks of the reform of the banking system and integration of the European supervisory system aim at ensuring stability of global financial systems and returning trust in the markets (Larosiere, 2009; Liikanen, 2012; Masciandro, Pansini, Quityn, 2011; Miklaszewska, Mikolajczyk, Pawlowska, 2012). With regard to that, the aim of this paper is to assess the reform of the EU institutional system of financial supervision and the trends of its improvement. The authors identify institutional changes within the EU financial supervisory system after the financial crisis. A special attention is devoted to the establishment of the Banking Union characterized by a more integrated viewpoint and which can supplement the space of a single currency and internal market.

The research problem is formulated on the basis of the research questions: how the supervision and reorganization of the banking system should be carried out locally and globally?; what new supervisory mechanisms of financianl market must be created and how do they have to function?; To what degree are interference and control of the supervisory institutions appropriate, so that freedom of action is not violated and negative effect is avoided?

Practical implications of the paper confirmed that the recent integrated supervision models failed to quickly and efficiently respond to the financial crisis. Ordinary European System of Financial Supervision (ESFA) is insufficient to prevent splitting of the European financial market. Some mechanisms fail to fulfill their functions due to the intricacy of their internal structure and the size of the EU banking sector. The European Banking Union should make sufficient changes in this area.

The logical method is used for making a substantiated generalization of the collected facts and formulating transitional as well as final conclusions of the research. Seeking to evaluate the existing banking regulation in Lithuania and the EU, the method of systematic analysis is applied. Together with the logical method, the generalization method is used which helped to identify general and major features and characteristics of mechanisms analyzed in this paper.

1. The Institutional Model of European Financial Supervision

The EU Founding Treaty fails to contain a special chapter on the regulation of financial services. The greatest attention is devoted to harmonization of supervisory rules and requirements with the view of tightening and unifying the supervisory terms in the EU and internationally. For a long time, adoption of supervisory measures for financial markets was based on the so-called Lamfalussy process (2001). A new structure of committees was established aimed at simplification of the decision making process and promoting efficiency of financial markets supervision (Hix, 2006). Later, however, the reform of the process became inevitable. Regarding that fact, the European Commission authorized a group of experts headed by J.Larosiere, to analyze the situation and put forward possible schemes of financial supervision and regulation. In 2009 the report was publicized where 31 practical recommendations on how to improve the whole supervisory mechanism were put forward (Larosiere, 2009). That was how a new European system of financial supervision (ESFA) was established which started in 2011 (Regulations (EU) No 1092/2010, 1093/2010, 1094/2010, 1095/2010 of the European Parliament and of the Council, 2010). That was an important achievement in a further integration of a single market of financial services. ESFA is responsible for ensuring the EU system of financial supervision on two levels.

The supervision of macro-level risk restriction on the European level is carried out by the European Systemic Risk Board (Regulation (EU) No 1092/2010 of the European Parliament and of the Council, 2010). The Board's aim is to prevent systemic risk threatening the EU financial stability and to minimize its effect with regard to macro-economic changes. When the ESFA thinks that a critical situation might occur, it provides confidential warning to the Council as well as the evaluation of the system. The European system of financial supervision on a micro-level consists of the multilayer system of the appointed institutions. Different layers can be distinguished according to the

area of sectoral supervision and regulation (banking, insurance and securities markets) and according to the level of supervision and regulation (European and national). Three European institutions are responsible for the supervision of the micro-level risk, the institutions which replaced the former European supervision committees: the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA).

Supervision on macro-level

European board of systemic risk (EBSR)

Provides evaluation of the situation (ECOFIN)

Prevention of risk and

providing recommendations for

supervisors

The European System of Financial Supervision (ESFA)

The Joint Committee of European Financial Supervisory Institutions

European Banking Authority (EBA)

European Insurance and Occupational Pensions (EIOPA)

European Securities and Markets Authority (ESMA)

Fig. 1. Structure of the European financial supervisory institutions. Source: Skrzypek, 2010.

Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA). The research results, however, show that the recent integrated supervision models failed to quickly and efficiently respond to the financial crisis. Despite the fact that the supervision of banks is carried out on the EU level, the directives provide that it is to be further implemented on the national level. The ordinary European Supervisory System (ESFA) and coordination are insufficient to prevent disunity of the European financial markets. Some mechanisms fail to perform their functions due to the intricacy of their internal structure and the size of the EU banking sector.

2. The Future Changes of the EU Financial Supervision Model

The presented considerations on the situation in the Euro-zone put forward a number of important questions. How should the supervision and reorganization of the banking system be carried out locally and globally? What makes those processes successful? To what degree are interference and control of the supervisory institutions appropriate, so that freedom of action is not violated and negative effect is avoided? Those are the issues that the Banking Union or the so-called integrated financial system is seeking to address. That is one of the main changes to

be made in the EU supervisory model. Additional or double financial supervision will exceptionally cover only 19 member States of the Euro-zone. That conception is a response to the global financial crisis and is developed to ensure financial stability as well as to minimize the cost of the bank failures. Many authors suggest that the Banking Union should be based on full and detailed summary of the rules of financial services as well as on innovative structure of supervisory institutions. Since the subject is new, the authors' works are for the most part based on general approach achieved in the EU Council. The researchers review and identify structural and organizational schemes and measures of the establishment of the Banking Union (Zaleska, 2013; Lannoo, 2012; Breus, 2013; Gros and Shoenmaker, 2014; Beck (ed.), 2012).

The Banking Union is going to be based on a three-stage model consisting of three pillars: Single Supervisory Mechanism (SSM), Single Resolution Mechanism (SRM) and Deposit Guarantee Schemes (DGS). At the start the Member States agreed on the Single Supervisory Mechanism (Council Regulation (EU) No 1024/2013).

3 PILLARS OF EUROPEAN BANKING UNION

Single Supervisory Mechanism (SSM)

• The SSM is based on the transfer of banking supervision tasks in the Eurozone for European level (EU) institutions.

• ECB to directly supervise

120 significant banks, representing 85% of total euro area banking assets.

• ECB directly supervises only the most significant credit institutions. Their significance is assessed on the following criteria: size, the importance for the economy of the EU and for the cross-border activity.

• Less significant credit institutions will be supervised by competent national authorities.

•The EU member states, which currency is not euro, have the opportunity to participate in the SSM too.

• Fully operational on November 4, 2014

Single Resolution Mechanism (SRM)

• The Single Resolution Board is single authority responsible for resolution of euro area banks.

• Resolution to be financed by bank's shareholders and creditors (bail-in equal to at least 8% of total liabilities, pre-defined cascade of liability) and backed by Single Resolution Fund (5% of total liabilities max).

• Bail-in and resolution functions to apply from January 1st, 2016.

• Fund financed by bank levies raised at national level as from 2016 and gradually mutualized in the course of

8 years. Volume: EUR 55bn by 2024.

• Banks will have to pay ex ante and ex post contributions to the fund.

• The SRM entered into force on January 1st, 2015

Deposit Guarantee Scheme (DGS)

• Not envisaged at this stage.

• Instead: Harmonized deposit guarantee schemes as set out in

the Single Rule Book (Directive on DGS).

• EU savers are guaranteed that their deposits up to EUR 100.000

(per depositor / per bank) are protected at all times and everywhere in the EU.

• Financing requirements for DGS: target level for ex ante funds of 0.8% of covered deposits to be collected from banks over a 10-year period.

• DGS provides faster payment of deposits to depositors of failed financial institutions.

Single Rulebook (CRD IV: Capital Requirements Directive)

Fig.2. Three pillars of the Banking Union. Source: adopted by Petersen, 2014

It came into effect on November 4, 2014. The Central European Bank directly supervises 128 banks of the Eurozone (out of 6000 in operation). Its performance is based on the national supervisory procedures and institutions. The mechanism is applied for systemic banks. The bank's importance will be evaluated based on the following

criteria: size, importance for European economy or for any other Member State involved and the importance for cross-border operation. With regard to that, the credit institution under the supervision of ECB must satisfy all of them. The total worth of its assets exceeds 30 billion EUR, or account for more than a fifth (20%) of GDP of the Member State. The ECB can on its own account consider that the institution is of special importance, on condition that it has established banking subsidiaries in more than one Member State and its cross-border assets or liabilities account for a big portion of all its assets or liabilities. Other banks which fail to meet those criteria remain under the supervision of national institutions; however, the ECB shall interfere in case it is necessary. The bank supervision mechanism provides that three biggest Lithuanian banks, i.e. SEB, DNB and Swedbank shall be directly supervised by the European Central Bank. The Bank of Lithuania shall only assist in performing supervision functions. The ECB shall qualify how the biggest banks of Lithuania ensure that the requirements for capital adequacy and liquidity are met and shall supervise the bank's internal control. The Bank of Lithuania shall further supervise smaller banks, but the CEB, however, shall have the right to take over their control.

Another essential pillar of the Banking Union is the Single Resolution Mechanism (SRM). It is to supplement the Single Supervision Mechanism (SSM) and is the second step in creating the Banking Union. SRM shall ensure that in case the banks face difficulties despite strict supervision, they can be efficiently reorganized at the smallest possible costs for the taxpayers and the real economy (Regulation of the European Parliament and of the Council, 2014). The funding of the reorganization is based on the complex multi-stage system or so-called "responsibilities cascade model". Its core is very simple: financing is to be provided by the markets, i.e., from the funds of the finance sector. The banking reorganization rules do not contain the provision that taxpayers are to bail out the failing banks, which led the countries to deep crisis. In the first place, loses shall be paid by the investors and depositors who are actually responsible for the operation of the banks.

The element which is absolutely necessary for proper SRM operation is the Single Resolution Fund (SRF). It should be directly funded by the ex ante contributions of the banks and its finances should be raised on the Union level, so that reorganization resources can be objectively distributed among all the Member States. The same funds financed by the ex ante contributions of the national banks shall be established in all the Member States of the Eurozone (National bank reorganization funds). That is the way to provide harmonious transition from the "bail outs" (difficulties are overcome at somebody else's expense) to "bail ins" (loses are paid by themselves), and bank supervision is supplemented by a strong and integrated system designed for the rescue of the failing banks. That mechanism is to start from 2016. However, in that context, there emerges a question on raising and using the funds in the SRF. The Fund will in the first place be related to the national rules regulating the usage of the funds on the national level and later their transfer to the supranational fund. Is it possible that there may be some contradictions between the national and European rules? It is also important to provide a sufficiently strict protection mechanism so that the funds of the Lithuanian national budget are not allocated to finance the SRF. That is especially applicable for that stage of the fund's establishment when the funds are insufficient to harness the crisis.

Conclusions

The results of the study show that the recent integrated supervision models failed to quickly and efficiently respond to the financial crisis. Ordinary European System of Financial Supervision (ESFA) is insufficient to prevent splitting of the European financial market. Some mechanisms fail to fulfill their functions due to the intricacy of their internal structure and the size of the EU banking sector. On the other hand, the study results show that the Banking Union (double financial supervision of the Euro-zone countries) will cause dramatic changes in that area. The new financial markets supervision model ensures a more integrated approach. The Banking Union is to supplement the area of the single currency and the internal market.

References

Beck, Th. (ed.) (2012). Banking Union for Europe. Risk and Challenges. Centre for Economic Policy Research (CEPR), London, UK. Retrieved

February 19, 2015 at http://www.voxeu.org/sites/default/files/file/Banking_Union.pdf Breus, F. (2013). European Banking Union. WIFOWorking Papers, No. 454. Retrieved February 19, 2015

at http://fritz.breuss.wifo.ac.at/Breuss_European_Banking_Union_WIF0_WP_454_Sept_2013.pdf

Council Regulation (EU) No 1024/2013 (2013). (It is conferring specific tasks on the European Central Bank concerning policies relating to the

prudential supervision of credit institutions). Official Journal of the European Union, L 287, 29.10.2013, 63-89. Gros, D.,Schoenmaker, D. (2014). European Deposit Insurauce and Resoliution in the Banking Union. Journal of Common Market Studies, 52, 529-546.

Hix, S. (2006).Europos S^jungos politine sistema, Vilnius: Eugrimas, 292-293.

Lamfalussy, A. (2001). The Regulation of European Securities Markets. The Committee of Wise Men. Final Report, Brussels. Retrieved

December 10, 2014 at http://ec.europa.eu/finance/securities/docs/lamfalussy/wisemen/final-report-wise-men_en.pdf Lannoo, K. (2012). The Roadmap to Banking Union: A call for consistency. Ceps commentary. Retrieved December 29, 2014 at file:///C:/Users/karolis/Downloads/KL%20Roadmap%20to%20banking%20union.pdf

Larosiere, J. (2009). The High-Level Group on Financial Supervision in the EU. Report, Brussel. Retrieved January 16, 2015 at

http://www.esrb.europa.eu/shared/pdf/de_larosiere_report_en.pdf7a855185299bf976712dc13c7644ccc8b Levine, R. (2010). The governance of financial regulation: reform lessons from the recent crisis. BIS Working Papers, No 329, p.1-24. Retrieved

March 19, 2015 at http://www.bis.org/publ/work329.pdf Liikanen, E. (2012). The High-Level Expert Group on reforming the structure of the EU Banking sector. Final Report, Brüssel. Retrieved

November 27, 2014 at http://ec.europa.eu/intemal_market/bankdocs/high-level_expert_group/report_en.pdf Masciandaro, D., Pansini, R. V., Quintyn. M. (2011). The Economic Crisis: Did Financial Supervision Matter?, IMF Working Paper WP/11/261, Washington.

McCarthy, N., Poole K. T., Romer T., Rosenthal, H. ( 2010). Political Fortunes: On Finance and its Regulation, Daedalus Fall, 139, 61-73. Miklaszewska, E., K. Mikolajczyk., M. Pawlowska. (2012). The consequences of postcrisis regulatory architecture for banks in Central Eastern

Europe. National Bank of Poland Working Papers, No. 131, Warszawa. Petersen, A.K. (2014). The Banking Union in a Nutshell. Global Capital Markets & Thematic Research. Allianz Global Investors. Retrieved

February 25, 2015 at http://www.allianzgi.com/en/Market-Insights/Pages/The-banking-union-in-a-nutshell.aspx Regulation (EU) No 806/2014 of the European Parliament and of the Council (2014). (It is establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010). Official Journal of the European Union. L 225 Volume 57. Retrieved February 15, 2015 at http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=0J:L:2014:225:FULL &from=EN. Regulation (EU) No 1092/2010 of the European Parliament and of the Council (2010). (Regulation on European Union macro-prudential

oversight of the financial system and establishing a European Systemic Risk Board). Official Journal of the European Union, L 331/1. Regulations (EU) No 1092/2010, 1093/2010, 1094/2010, 1095/2010 of the European Parliament and of the Council (2010). Official Journal of

the European Union, L 331/1, 15 of December. De Larosiere, J. (2009). Report: The High-Level Group on Financial Supervision in the EU. De Larosiere group, Brussels, 25 February. March

12, 2015 http://ec.europa.eu/internal_market/finances/docs/de_larosiere_report_en.pdf The Turner Review. (2009). A Regulatory Response to the Global Banking Crisis. In the Turner Review. Financial Services Authority, London.

Retrieved March 5, 2015 at http://www.fsa.gov.uk/pubs/other/turner_review.pdf Zaleska, M. (2013). Unia Bankowa. Difin. Warszawa.