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3 How Will the Ongoing Regulatory Reform in the EU Affect Lending?

3 How Will the Ongoing Regulatory Reform in the EU Affect Lending?

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Austria

Belgium

Bulgaria

Cyprus

Czech Republic

Denmark

Estonia

Finland

France

Germany

Greece

Hungary

Ireland

Italy

Latvia

Lithuania

Luxembourg

Malta

Netherlands

Poland

Portugal

Romania

Slovakia

Slovenia

Spain

Sweden

UK



−0.13

−0.24

0.03

−6.18

0.03

0.19

0.03

−0.03

0.22

0.19

0.30

0.03

7.62

0.03

0.30

0.03

0.30

−0.62

−0.35

0.67

0.03

−0.43

0.03

0.02

−0.43

−1.89

0.30



−2.75

−2.75

0.00

0.00

0.00

−2.75

0.00

0.00

1.47

0.00

1.47

2.75

−1.27

0.00

0.00

0.00

0.00

0.00

1.27

0.00

1.27

0.00

0.00

0.00

0.00

1.27

0.00



−0.60

−1.63

1.65

−2.00

0.81

1.11

0.08

0.19

1.22

−0.60

−0.49

1.62

−0.60

−1.52

−0.08

2.62

2.30

−1.17

−2.00

1.32

−0.70

0.02

−1.38

1.11

−0.90

1.02

−1.38



−0.08

−0.08

−0.08

0.82

−0.36

−0.08

−0.08

−0.43

−1.32

−0.08

−0.08

−0.08

−0.08

−0.08

−1.68

4.85

−0.08

−0.08

−1.32

−0.08

−0.08

1.17

−1.32

−0.08

1.17

−0.36

−0.08



−0.14

3.03

1.07

−0.14

−1.36

3.03

−1.36

−0.14

−0.14

−0.14

−0.50

−1.36

−0.14

1.82

−1.36

−0.14

−0.14

−1.36

−0.14

−0.14

−0.14

−0.14

−0.14

−0.14

−1.36

1.82

−0.14



0.40

−0.02

0.38

−1.01

0.38

−2.51

0.38

−0.62

−0.22

−0.89

0.38

−1.63

0.38

−1.63

1.39

1.39

0.38

−1.29

0.38

0.38

0.38

2.66

−0.64

1.37

0.38

−1.88

1.37



0.13

0.43

0.75

−3.86

−0.01

−1.53

0.14

−0.45

−0.45

3.27

−0.94

−0.30

−0.80

1.08

0.75

−0.01

−0.01

−1.06

0.19

−1.29

−0.01

0.29

2.80

−0.01

1.37

−0.01

−0.50



Problematic

institutions’

Entry

Capital

Activity

Auditing

Liquidity

Deposit

regulation adequacy regulation requirements requirements insurance regulation



Table 6.10  Post-crisis regulatory changes



−0.73

0.15

0.15

2.58

−0.73

−1.17

−0.73

−3.60

0.15

−0.51

−1.17

1.47

0.15

0.15

1.04

1.47

0.15

0.15

−0.73

0.15

0.15

0.15

0.15

−0.73

1.70

0.15



Supervision



6  Banking Regulation and Bank Lending in the EU 



243



244 



Post-Crisis Banking Regulation in the European Union



differed in terms of individual reforms. One could observe apparent harmonisation only in the case of capital regulations; that is, all countries

strengthened the role of credit, market and operational risk in computing

capital ratios. One could also observe a loosening of securities trading

and insurance activities restrictions. In the light of the analysis performed

in Sect. 6.2, one can expect that the observed loosening of activity regulation at the national level may create incentives for lending contraction.

The introduction of additional risk factors in the capital ratios may have

an ambiguous effect on the growth rates and quality of loans since, as

shown above, various components of capital regulations are conducive to

different lending behaviour.

The results of the exercises also allow us to draw some basic conclusions on the expected directions of the impact of EU level reforms on

lending. One of the main post-crisis regulatory acts, the CRD IV/CRR

package, imposes stringent capital and liquidity requirements. In the

light of the analysis preformed above, capital regulation has an ambiguous effect on credit provision, depending on the components of the

requirements. Since the newly introduced rules strengthened all three

components of capital requirements (the market, credit and operational

risk framework) one can expect their potentially significant impact on

lending. Note, however, that this effect will depend on the initial capital

positions of banks and the increase of financing cost triggered by the

new requirements. In the case of well capitalised credit institutions the

increased regulatory stringency might not alleviate substantially the loan

financing costs, hence its effect on lending might be moderate.

The exercises show that liquidity regulations did not impact lending

significantly over the sample period. Nevertheless one cannot draw the

same conclusion for the effects of CRD IV/CRR, since the package introduces two stringent liquidity ratios (LCR and NSFR), to which banks

did not have to conform until now.

The effect of the capital and liquidity regulations may differ during

the transitional phase of their introduction and in the long term. During

the transitional period, banks with weaker capital positions than required

have to issue additional equity, retain profits or reduce their risk weighted

assets. Also, to fulfil the liquidity standards, banks have to reduce their

maturity mismatches by acquiring highly liquid assets and long maturity



6  Banking Regulation and Bank Lending in the EU 



245



funding. Overall, banks will be confronted with higher funding costs and

lower interest income, and hence decreased profitability. They may compensate for this by increasing lending rates and lowering the interest paid

on deposits, which may be conducive to reduced credit demand (Berben,

Bierut, van den End, & Kakes, 2010). The impact of the increased funding costs on lending will depend on how banks distribute these costs

between the respective stakeholders.

Another channel through which the new capital regulation can influence lending in the transitional phase is reduced risk taking incentives.

The need to hold more capital against risky assets reduces the scope for

high-risk lending.

The long-term effects of capital and liquidity regulations are much less

certain than in the transitional phase. A substantial factor of the long-­

term impact will surely be the persistence of tendencies that occur during the transitional period: for instance, the mentioned widening of the

lending wedges due to increased funding costs (Berben et al., 2010). The

persistence of high funding costs is probable since banks will have to

maintain high capital and liquidity buffers. In the long term, though,

banks may adapt to the new condition by transforming their business

models or risk taking behaviour: for instance, by offering more fee-based

products. As a consequence the value of their risk weighted assets would

decrease and mitigate the capital requirements to be met. The long-term

benefit of the capital and liquidity buffers will be enhanced stability and

the minimisation of the costs of potential crises.

The results obtained above also shed some light on the direction of

influence of EU level banking activity regulation, for instance the discussed ring-fencing of banking activity and shadow banking regulation.

In the light of the results of the exercises, the restrictions on banking

activity may be to some extent beneficial. Nevertheless, these findings

cannot be transposed directly to the implications for potential ring-­

fencing of banking and non-banking activities. The complete separation

of the traditional and non-traditional activities is viewed as controversial

since banks may react to it by regulatory arbitrage.

Bank lending may be also affected by the new regulations concerning shadow banking; that is the Securities Financing Transactions

(Regulation 2015/2365) and the EC Proposal 2013/0306 on money



246 



Post-Crisis Banking Regulation in the European Union



market funds regulation, the framework for risk transfer instruments

EMIR, the framework for alternative investment fund managers directive (AIFMID), enhanced securitisation arrangements (MIFID), and the

UCITS framework. The new regulations may restrict the liquidity provision to the interbank markets by shadow banks and increase the costs of

bank financing in the short term. This effect may be pronounced, given

that the EU banking sector is substantially exposed to shadow banking

institutions’ financing. The long-term effect of the new regulations will

depend on the persistence of the alleviated costs and on the ability of

shadow banks to adapt to the new requirements. Also, the enhanced risk

management framework and transparency of transactions with shadow

banks should contribute to long-term stability benefits.

Two further regulatory acts, the BRRD and the DSGD, may have

a beneficial impact on lending. The results of the exercises above confirmed the positive impact of combined prudent supervision and deposit

insurance schemes on constraining NPL. One can therefore expect that

the increased supervisory power over sound and problematic institutions

within the SSM and SRM framework may contribute to a more prudent

lending behaviour.



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Summary and Conclusions



The post-crisis banking regulatory reforms in the European Union (EU)

have provoked an intense debate among academics, supervisors and representatives of the banking industry. Contrasting views emerged with

regards to the accuracy and the impact of the new solutions. The analysis

conducted in the book shows that the new regulations entail opportunities, as well as threats, for the EU banking sector.

The new regulations are a response to the recent financial crisis. They

amend many drawbacks of the incumbent frameworks. The liberalisation of the banking sectors and the change of banks’ business models

exacerbated the prevalent information asymmetry, the lack of market

discipline and the conflict of interests between bank stakeholders. The

crisis highlighted particularly the fallacies of the framework consisting

of regulatory arbitrage due to the unregulated shadow banking system,

insufficient regulation of systemically important institutions, the materialisation of endogenous and systemic risk, as well as deficient international coordination of regulation despite the increased international

interconnectedness of banks. These problems are substantially addressed

by the new regulations.



© The Editor(s) (if applicable) and The Author(s) 2016

K. Sum, Post-Crisis Banking Regulation in the European Union,

DOI 10.1007/978-3-319-41378-5



251



252



Summary and Conclusions



The post-crisis regulatory reforms in the EU are based on the Basel III

framework. The main advantages of the new Basel Committee of Banking

Supervision (BCBS) guidelines are the strengthening of banks’ capital

positions and their resistance to shocks, the improvement of risk management, and the enhancement of transparency, governance and disclosure

in the banking industry. These goals are mainly achieved through the

enhanced derivatives risk management framework, decreased dependence

of the securitisation regulations on external rating-based models, as well

as improved risk modelling. Importantly the new framework mitigates

the procylicality of banking activities through the introduction of additional capital buffers. Although, one has to stress, that due to the pressure

of the banking industry some of the planned Basel III reforms have been

watered down in the final version of the framework and the timelines of

their implementation have been extended. A substantial drawback of the

new framework is the maintenance of the basic outline of Basel II with

regards to capital requirements against specific exposures. Particularly,

Basel III does not solve the problem of portfolio invariance. The imposition of additional capital requirements for concentrated portfolios has

been postponed until 2019, hence a substantial threat is that the incumbent rules may perpetuate systemic risk. Moreover, the framework still

leaves room for regulatory arbitrage due to the different treatment of the

trading and banking book positions and the possibility of shifting the risk

outside the banking sector to evade capital requirements. Controversial

aspects of Basel III refer also to the insufficiently addressed large exposures treatment and the issue of sovereign risk weighting. Potentially, this

could lead to risk concentration and improper sovereign risk pricing.

The new EU regulations build substantially on Basel III, but also

introduce EU-specific rules. As a response to the changing patterns of

EU banking integration they establish a supranational financial supervisory system consisting of the European Central Bank (ECB), European

Supervisory Authorities (ESA) and the European Systemic Risk Board

(ESRB). The new framework addresses the Too-Big-To-Fail problem by

strengthening the supervision over systemically important banks. It also

improves market transparency through the common reporting framework

for systemically important institutions. The new CRD IV/CRR package

strengthens the capital and liquidity positions of banks. An advantage



Summary and Conclusions



253



of the CRD IV/CRR package is that it also improves the previous versions of the directive, which contributed to the fragmentation of the EU

banking system and regulatory arbitrage. Since the Capital Requirements

Regulation (CRR) is directly binding on the respective member states it

limits the scope for national discretion. The banking sector stakeholders may also benefit from the Bank Recovery and Resolution Directive

(BRRD), which is aimed at restoring confidence in EU banks and preventing the need to bail out Too-Big-To-Fail institutions. Several acts

enhance the transparency of shadow banking regulation, which mitigates

a crucial problem—the opacity of the EU-banking sector funding. The

confidence in the banking sector is also boosted by the reformed Deposit

Guarantee Schemes Directive (DGSD) schemes. Substantial opportunities in terms of strengthening the EU banking systems’ stability also arise

due to the direct inclusion of bank governance elements in regulations

concerning the board of directors, shareholders’ rights, remuneration

policies and transparency requirements.

The new regulatory acts establish the basis for the creation of the banking union, one of the most ambitious and far reaching projects in the

history of the EU. The banking union provides substantial opportunities for bank stakeholders since it is aimed at resolving the immediate

problems relating to the sovereign debt crisis, as well as strengthening

the single market for financial services in the longer term. The movement

of the supervisory responsibility and potential financial assistance to the

supranational level is expected to reduce the fragmentation of financial

markets, counteract deposit flights and to restore confidence in the EU

banking sector through setting uniform standards for banking regulation

within the Single Supervisory Mechanism (SSM) and Single Resolution

Mechanism (SRM).

Nevertheless, the new EU regulations may also pose threats to credit

institutions’ stakeholders since they do not fully address the ailing banks’

problems. First of all, the EU rules diverge from the guidelines put forward in Basel III in terms of the crucial issue of the sovereign risk regulatory treatment. The attribution of zero risk weights to sovereign bonds in

capital requirements, as well as their exemptions from the large exposures

treatment may contribute to mispricing and concentration of sovereign

risk. Moreover, banks may incur substantial costs relating to the intro-



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