- In the legislative reform of capital requirements for banks’ systemic risks, the financial sector has a clear goal: if an authority requires additional capital from banks, it needs to disclose its calculation method and the reasons justifying the additional requirement – and this disclosure must be better than it has been so far.
- The Finnish Parliament’s Commerce Committee outlined that when setting additional capital requirements based on systemic risks, the risks must be described in detail, their extent must be estimated, and the capital requirements must be derived from the risks in a transparent manner.
The obligation for authorities to provide more adequate justification for capital requirements will improve the transparency and predictability of decision-making. The calculation of systemic risk must indicate which risk is involved and how much capital is required to cover it.
In principle, without proper risk disclosure and transparent assessment, the decisions of the authorities could include the possibility of several capital requirements being calculated for the same risk. The regulation of systemic risks is based on the EU Capital Requirements Directive and Regulation (CRD V/CRR II), which clearly state that several capital requirements may not be imposed on the same risk. Finance Finland (FFI) is pleased to note that the Commerce Committee’s report aligns with EU regulation.
“It is important that the authorities have the tools at their disposal to increase capital requirements if safeguarding economic stability requires it. But since these requirements come not only with significant cost on banks, but also with spillover effect on the surrounding economy, the criteria for determining the requirements must be known precisely”, says Olli Salmi, Head of Banking Regulation at FFI.
The Commerce Committee does not propose any mechanistic rules for calculating the additional capital requirements. While accurate calculations are important, Salmi finds the committee’s position acceptable. FFI does not propose specific rules for calculation, either, but instead considers it important that the regulatory assessment and calculations are properly disclosed and transparent, thereby increasing the predictability and consistency of authorities’ decisions.
The calculation methodology is still relatively underdeveloped, internationally speaking, and the authorities have been worried that mechanistic rules would not account for the rapidly changing economic environment”, Salmi points out.
The Commerce Committee’s report is also in line with the ruling made by the European General Court last autumn. In accordance with the ruling, the banks subject to additional capital requirements must know the basis for the decision and be able to calculate and verify the requirements themselves, if necessary. Unless the calculations are carried out in the way now outlined by the Committee, it will be difficult to establish the legality of the decisions, and ex-post legal protection mechanisms cannot be used effectively.
The report of the Commerce Committee ensures regulatory coherence and the predictability and fairness of decision-making. This, in turn, creates better conditions for financing the economy.