Student meeting 28th April 2015
1. Introducing the Czech banking industry and
association
2. Political economy of banking (financial sector)
regulation – solving problems while creating new
ones
Who we are – about CBA
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37 member banks
Strategist, Expert, Partner, Opinion leader
Strong CSR element
Lobbyist representing the interest of the banking
sector …
• … talking to the supervisor, regulator, parliament,
NGOs, academic and research institutions, other
interested parties
• Extensive involvement in EU (EBF) activities,
maintaining dialogue with partner associations
• Extensive PR and image-making activities
Who we are – about CBA (2)
• Small secretariat (13 staff members in total)
• 21 working committees + scientific council …
involving 500 people from banks in total
• In average 2 to 3 expert meetings every day …
• Extensive and well performing communication
channels to and between banks
Who we are not … resp. prohibited by law to do …
• A place for coordination of business strategies …
• Collect statistical data, especially those relevant to business…
• A management entity exercising any power over member
banks …
• A single point of entry for comunication of third parties with
member banks
• A place for dispute resolution …
Structural characteristics
• There are 44 banks operating in the ČR under the ČNB license
• Of them, 35 were fully or majority owned by foreign entities
• More than 95 % of all assets are controlled by parent banks in developed
countries, in particular in the EU
• Four ‘large banks’ (each with assets over approx. EUR 8 billion) – Česká
spořitelna (Erste Group), Komerční banka (Société Générale Group), ČSOB
(KBC Group) and UniCredit Bank – manage close to 58% of all assets in the
banking sector …
• … their market share, however, is slowly declining over time due to
relatively strong competition from small and medium-sized banks
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The European banking sector in figures – selected countries
BANK REGULATORY CAPITAL TO RISK-WEIGHTED ASSETS, %
Performance indicators at sector level and
trends
• Strong capital (mostly high quality Tier 1 capital) and liquidity position
(over 18%)
• Profitability above EU average (ROE over years close to 20%)
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(The net interest rate income contributes almost 3 time as much as fees to the
financial and operating income of the banking industry)
• Assets to GDP at modest cca 125 %
• Loans: moderate growth despite recession 2008-2013
• NPLs: quantitatively not a big issue, however important source of risk in
banking sector
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Factors of stability
1. Prudent business model
– focus on traditional conservative commercial banking on the domestic market
and relatively little international activity
– very few ‘toxic assets, increasing share of domestic government bonds in
portfolio
– prudent risk management through the crisis (however, despite tightening
credit standards, the volume of loans is steadily raising)
2. Large deposit base, less dependence on the inter-bank market (third
lowest in the EU) or refinancing operations of the central bank
3. Most activities are undertaken in domestic currency implying lower
exposure to foreign exchange risk
4. Efficient cost management (cost to revenue ratio the third lowest within
the EU: 44% in ČR compared to 57% in EU - 2011)
• Essentially no need to deleverage
• Banks capable to sustain even extremely stressful scenarios simulated by
the central bank
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Selected factors of significance for the future shape
and condition of the Czech banking industry
1. Credit and operational risk
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Economic forecast for the ČR: economy sound but not
growing very fast
Persistent risk of spillover effects from EU/eurozone
2. Regulatory issues:
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Tsunami of regulation and significant institutional
initiatives
Banking industry in ČR capable to sustain the effects
3. Banking union?
4. Cyber risks?
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Political economy of banking (financial sector) regulation –
fighting the past wars
Topic 1 – is it fair to blame banks for the past crisis? Chronology of events,
factors …
Topic 2 – moral hazard and the issue of size
Topic 3 – the global regulatory tsunami – facts and impacts
Topic 4 – irresponsible consumers? Are we coming close (or past) the limits of
reasonable consumer protection? Consumer protection and free market.
Moral hazard.
Topic 5 – the specific Czech case – are we really so different?
Topic 6 – is Banking Union (in the EU) THE answer?
Topic 7 – the raid of non bank financial entities into – what was until recently –
banking business: new opportunities for regulatory arbitrage?
Topic 1 (crisis and banks)
Prologue
• A crisis is a more or less drastic correction of imbalances, created in
previous times …
• In most cases, a crisis is generated by an overheating of the economy,
apparent through „bubbles“ on various markets
• Unsustainable deviations are misinterpreted as trends
• But, at the end of the day, the disciplining role (power) of the market can
hardly be avoided …
• Although crises may be of a diverse nature (monetary, banking, debt), they
have all one thing in common: risks are being underestimated, old truth is
being (intentionally) overlooked, prudential behaviour weakened
The roots of crisis are always found in „good times“, when the world
looks pretty and sweet
It has been no different last time and banks should rightly be
allocated part of the responsibility for it (but not all of the
responsibility)
1.1. But let's take it from the beginning – the recent episode …
macroeconomic developments and policies
• A prolonged period of low inflation, implying low profit returns on
investment
↓
- Mistakes of central bankers, overlooking the bubbles (and the message
these bubbles were sending to policy makers), a misinterpretation of the
long period of low inflation …
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Investors in search for higher risk
Creativity in new and complex investment products, offering higher
returns (and distributing – hiding – (excessive) risks
In an environment of unshakable trust in an ever growing global economy,
driven by new global players (mostly the BRICs) showing an unlimited
hunger for growth
The psychology of investors „if they can make it, we have to make it as
well, if they succeeded, we will as well“
Expectation of small investors, depositors, shareholders: all of them willing
to „be there, get their own part of the cake“ – lesson of human psychology:
would anyone resist to become rich, if risks seem to have evaporated from
the landscape?
1.2. The financial (banking) causes:
• Enormous diversification of financial intermediary, an extremely robust
surge of the non-banking intermediary (partially in response to ever
increasing limitation imposed by regulators
• Development of a „shadow“ (or parallel) banking, various special purpose
vehicles (SPVs), investment banks (detached from primary deposits and
with huge leverage ratios), investment funds, hedge funds
• A failure to properly manage risk in the credit process: the mortgage
provider would, for instance, sell, within the six months, the instrument to
a third party: thus, his motives to assess the creditworthiness of clients
went severely weakened
• Expectations and instructions of bank shareholders to managements –
pressure on profits, shortening of investment horizons
The financial (banking) causes ctd:
• Regulation got relaxed (example: the Glass-Steagall Act terminated)
• Supervisors felt asleep, overlooked syndromes of forthcoming trouble –
assets bubbles etc)
• Leading to almost no assessment of creditworthiness of clients, lending
even more than 100% value of the property, progressive interest rates
(lower at the start to attract clients) with instalments often, at the
beginning, even below the due interest payment etc
• Value appraisals got systemically overshot (everyone down the chain
interested in achieving the higher price possible)
• Rating agencies: got on board as well …
Please note: the risk has not disappeared, it merely got hidden (became
thus even more like a time bomb)
1.3. Role of institutions (governments, regulators,
supervisors): far from being innocent
• Community Reinvestment Act (1977, J. Carter): support access
to housing
• Fannie Mae and Freddie Mac (government sponsored
enterprises, purpose: access to housing for low income
people)
• Commodity Futures Modernisation Act (2000): derivates
exempted from regulatory requirements and supervision and
minimum reserve requirements
• 2002: FED terminates supervision of mortgage companies
• 2004: Securities and Exchange Commission grants an
exemption from the required debt-to-net capital ratio to
Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Sterns,
Morgan Stanley (the allowed leverage ratio increased from 12
to 40)
Epilogue to Topic 1: And than, the party was over …
• When Lehman collapsed, no one new precisely,
where the risk would emerge from and how it would
hit the financial accounts of market players
• Confidence amongst market participants was gone …
• And so was liquidity from the market …
• Consequently, the ability (and willingness) to lend
money to corporates was gone as well …
• Producing second round negative effects on financial
institutions
Chronology of events: how is the crisis passing
through the economy
• Mortgage sector → financial intermediary
• Financial intermediary → real economy
• Real economy → a) financial intermediary (secondary effects)
→ b) public finance + debt crisis
• Debt crisis
→ a) financial intermediary
→ b) real economy → financial intermediary
Questions:
• Is there an escape to this vicious circle at all?
• How to socialize the future costs of consolidation of financial entities?
Topic 2
Moral hazard and the issue of size
(Moral hazard occurs when one
person takes more risks because
someone else bears the burden of
those risks)
Banking assets to GDP represent 150% in the USA
Assets of commercial banks in EU and in USA
(thousands of billions USD)
Selected group of European banks: structure of portfolio
(= all banks traded on stock exchanges)
Total 32 banks
of which: 10 larger
36 %
36 %
of which: 10 smaller
9%
75 %
There are in total cca 8000 banks in EU: the difference in the above indicator would be
even greater since even the 10 smaller banks belong to the 0,5 % of the larger EU banks
Remember the term Moral Hazard –
we will use it again in a moment
Topic 3
The global regulatory tsunami – facts
and impacts
Key regulatory initiatives
Financial
Transaction /
Activity Tax
SIFI
Bank
Recovery and
Resolution
Deposit
Guarantee
and Investor
Compensation
Schemes
Corporate
Governance
and
Remuneration
Policies
CRD IV/
Basel III
Revision of
MiFID and
Market Abuse
Directive
Consumer
Protection
The European Banking Federation (of which we are members) is currently
following 150 different regulatory initiatives
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Examples
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CRDIV
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Own funds, liauidity risk management, large exposures, pillar 2, financial conglomerates, macro-prudentail supervision,
securitisation,
SIFI
DGS
MiFID (financial instruments)
FTT
Sectoral taxes
CDS (credit default swaps)
Derivatives regulation
Crisis resolution and recovery
Mortgage directive
Consumer credit directive
EMIR (market infrstructure)
Payment services
Accounting standards
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IFRS
Reporting standards
Audit rules
Consumer protection
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Capital adequacy
Liquidity requirements
Leverage ratio
corporate governance
Compensation schemes
Financial inclusion
Switching
Tying
AML
PRIPS (packaged retail investment products)
SEPA
Interest rate benchmarks
New institutions
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EBA
ESMA
EIOPA
ECB
European resolution authority
ESM
EC
ESBR European board for systemic risk)
Background
 Response to the crisis
 AIM - strengthen the resilience of the banking sector → reduce
the probability and severity of future financial crises and remove
current regulation shortcomings
 RISKS:
 Adoption of measures that would not be taken in a more stable
period.
 Adoption under time pressure raises doubts about the proper
calibration, timing and globally consistent implementation.
 Limiting the banks ability to grant credits to individuals and/or
companies and/or governments → negative impact on real
economy.
Our Czech opinion
 Not absolutely against new regulation initiatives - but
more regulation may not equal to better regulation.
(Even strong) regulation is ineffective without proper
supervision.
 Level playing field - to avoid regulatory arbitrage.
 No complex impact study of all initiatives.
 Regulatory changes will reduce the profitability of
both assets and capital; the consequences thereof will
fall upon not only shareholders but also clients, and
thus, in the broader context, upon the entire economy.
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Qualitative impact analysis – April 2015
Effect on financial situation
Effect on capacity
Topic 4 – irresponsible consumers?
Are we coming close (or past) the limits of
reasonable consumer protection?
Consumer protection and free market.
Moral hazard.
Examples
• Deposit insurance
• Haircuts of consumer debt
• Creating funds to help repay debt
• Consumer insolvency
Items for discussion:
• Administrative controls of interest rates?
Topic 5 – the specific Czech case
Are we really so different?
Deposit/Loan ratio
Total private debt/GDP
Conclusion to Topic 5
• Indeed, we ARE different
• In our case, the regulatory tsunami is a cure of a
very healthy patient
• One size does not fit all (even by far not)
• Compliance costs vs global competitive position
of the Czech banking industry
Topic 6 – is Banking Union (in the EU) THE answer?
Banking Union
Single EU
supervisor
Single EU
deposit
guarantee
scheme
Common
resolution
authority
and fund
Single
rule book
120 banks are directly supervised by the ECB
Benefits and risks
• less regulatory arbitrage
• less compliance costs
• single set of rules – better competitive environment
• simplified management of activities at group
level
• supervision immune to political pressure
• potential risk to local (remote, small) market, especially where
entity is a DiSIF
• distant supervision may not be sensitive to local specifics
• local authorities short of one key instrument to protect stablity of
local market
Topic 7
The raid of non bank financial entities into –
what was until recently – banking business:
new opportunities for regulatory arbitrage?