Risk-lowering factors must also be taken into account when the supervisory authority evaluates whether a credit institution’s buffer requirement should be raised. This point of view is included in the Finnish government proposal on the national implementation of the EU banking package, which amends a number of essential directives and regulations. The Finnish government proposal involves significant problems, however: it gives authorities the power to raise the combined buffer requirement above the current maximum amount, which will throw a wrench in the wheels of the economy only starting to recover from the coronavirus crisis. The identification and quantification of risks in authorities’ decisions should also be subject to clearer requirements.
Finance Finland (FFI) does support the proposed legislative amendment that would require a clear statement of reasons from the authority setting buffer requirements. On the other hand, FFI holds that the legislator, in turn, should more firmly require that the decisions must be based on detailed calculations. At the moment, banks do not know what specific risk the systemic risk buffer is meant to protect against, or how large this risk is, or why the amount of reserved capital is what it is. The government proposal falls short in addressing these issues. The identification and quantification of risks should be made transparent in the decisions. This requirement must be further specified in secondary legislation.
“The decision to impose a capital requirement is based on risk calculation, which is a formulaic process. The calculation should be clearly stated in the decision. However, the government proposal is right in emphasising the consideration of risk-lowering factors, because these may change the result so that setting the capital requirement is not needed after all”, says FFI’s Head of Banking Regulation Olli Salmi.
Banks need to prepare for the worst
Banks’ capital requirements are meant to cover their risks in lending, inter alia, and thus increase stability. The requirements come at a cost, however, and may result in diminished lending. The correct level for capital requirements is usually reached through long and complicated international negotiations, and finding the right balance takes time.
For banks, predictability of the requirements is very important, so the capitalisation levels and their determination principles are specified in law. The government proposal would grant national authorities the power to raise credit institutions’ buffer requirements for systemic risks by several percentage points without going through the usual detailed process for setting capital requirements. It is important to precisely define the calculation of the requirements, because raising the capital requirements even by one percentage point would mean a reduction of tens of billions of euros in the banking sector’s lending capacity. This kind of drop would inevitably slow down economic growth.
“There’s no sense in giving the authorities more powers to raise capital requirements in the current economic environment, because banks always need to prepare for the worst – that is to say, the maximum amount that can be set”, Salmi points out.
FFI asserts that to secure economic growth, the combined amount of buffer requirements for systemic risks should be kept at the current level of 5 percent. The proposal’s maximum level of 8 percent of all risk-weighted assets is too high.
“Imposing additional capital requirements on banks – even opening it up as an option – is not the right solution in the current coronavirus-induced economic crisis. We need to get the economy back on the road to growth”, Salmi states.
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