Introductory statement

It is with great pleasure that I present the latest edition of the ECB Macroprudential Bulletin to you. It is the sixth issue in this semi-annual publication series, which was launched in 2016. The aim of the Bulletin is to bring greater transparency to the ECB’s ongoing work and thinking in the field of macroprudential policy. This issue of the Macroprudential Bulletin includes three articles on key macroprudential topics: the leverage ratio, the framework for global systemically important banks and the potential macroprudential tools for investment funds.

The first article analyses the leverage ratio and its links with the repo markets. The leverage ratio is a non-risk-based backstop measure used to prevent excessive on- and off-balance-sheet leverage building up, which was an underlying cause of the global financial crisis. In the context of evaluating the impact of post-crisis regulatory reforms, concerns have been raised that the leverage ratio – which includes repo assets – has had a negative impact on the functioning of repo markets by, for example, reducing banks’ willingness to provide repo services. As a consequence, a more lenient treatment, such as an exemption or a change in the netting with repo liabilities or against high-quality government bonds, has been proposed. This article looks into the implications of removing repo assets from the leverage ratio. The findings suggest that granting such an exemption may have adverse effects on the stability of the financial system, even when measures are introduced to compensate for the decline in capital required by the leverage ratio framework. Against the background of a pronounced increase in the median default probabilities for large, systemically relevant banks, an exemption of repo assets could considerably weaken the leverage ratio for some banks and may have adverse effects from a financial stability perspective. Consequently, such a change in treatment could lead to the re-emergence of risks related to the build-up of excessive leverage and over-reliance on short-term wholesale funding in financial markets. Overall, therefore, the analysis does not support a more lenient treatment of repo assets in the leverage ratio framework.

The second article focuses on the regulatory framework for global systemically important banks (G-SIBs), which was developed by the Basel Committee on Banking Supervision to address the negative externalities that a failure of these large banks could exert on the financial sector and the economy as a whole. The objective of the G-SIB framework is to reduce the probability of failure through higher capital requirements and to provide incentives for G‑SIBs to reduce their systemic importance. An indicator-based approach is used to identify these banks: five individual risk category scores are aggregated into an overall G-SIB score, which is then translated via capital buffer buckets into higher capital requirements. The G-SIB score is calculated using year-end data. This article presents evidence that some G-SIBs and other banks with reporting obligations tend to reduce their risk category scores at the end of a year, relative to other quarters. A possible explanation for this “window dressing” is that these banks aim to increase the probability of being allocated to a lower bucket with less stringent requirements. Window-dressing behaviour could have detrimental effects on financial stability as it may imply that banks’ overall systemic importance has been underestimated and, as a result, the relative ranking and higher loss absorbency requirement of G‑SIBs may be distorted. Additionally, the resulting reduction in the provision of certain services, which are captured by the indicators in the G-SIB framework at the end of a year, could adversely affect overall market functioning. The article suggests further investigating whether an alternative metric for calculating the risk score – based on averaging rather than year-end data – could help to avoid these unintended consequences of the G-SIB framework.

The last article aims to facilitate the discussion on potential macroprudential liquidity instruments for investment funds by providing a preliminary assessment of the effectiveness and efficiency of several instruments. The investment fund sector has expanded rapidly over the past decade: between 2008 and the end of 2016, total net assets of European investment funds more than doubled from €6.1 trillion to €14.1 trillion in Europe.^[1] At the same time, there are signs that funds increased their investments in riskier and less liquid assets, while offering short-term redemptions to investors. This development has given rise to financial stability concerns. For example, liquidity mismatches in the investment fund sector can create and amplify systemic risk through direct and indirect channels such as fire sales, direct spillovers to other financial institutions and impairment of credit intermediation. Against this background, the European Systemic Risk Board has identified the need to develop macroprudential instruments that address liquidity mismatches in funds as a key priority for the short to medium term. In addition, the Financial Stability Board has recommended that authorities should consider providing direction on fund managers’ use of liquidity management tools in exceptional circumstances. This article reviews various options for macroprudential liquidity tools, assesses their potential effectiveness and efficiency, and provides some suggestions in this regard. For example, it suggests that structural requirements, such as “redemption duration restrictions”, should be explored further. It also suggests that authorities should have the necessary powers and guidance to suspend redemptions to halt runs in exceptional circumstances.

As in previous issues, this Macroprudential Bulletin provides an overview of macroprudential policy measures which currently apply in euro area countries.

Finally, if you are interested in being notified of the latest publication of the Macroprudential Bulletin or wish to provide feedback, please send us an email at ecb.macroprudential.bulletin@ecb.europa.eu.

Luis de Guindos

Vice-President of the European Central Bank