Regulating Liquidity Risks within “Institutional Protection Schemes”

Read full paper at:
http://www.scirp.org/journal/PaperInformation.aspx?PaperID=50168#.VDSjJVfHRK0

Author(s)  

Thomas Stern

Affiliation(s)

Austrian Financial Market Authorities (FMA), Vienna/Wien, Austria.

ABSTRACT

During an early phase of the financial crisis (2007), many financial institutions—in spite of adequate capital levels—faced heavy difficulties because they didn’t manage their liquidity profile in a prudent manner. Suddenly the crisis reminded the respective sector on the importance of liquidity to the proper functioning of financial markets. In front of the times of crisis, asset markets were broad and deep, funding was readily available at low cost. The quick change in market conditions showed how fast liquidity can dry up, and that illiquidity can endure for an extended period of time. The banks faced severe stress, which required actions by central banks to—one the one hand—keep alive both the functioning of capital and money markets and—on the other hand— support individual banks or banking groups, which lost their most important funding sources. The impact of a liquidity crisis broadly differs among jurisdiction, markets and concrete market participants. Empirically banks, which were very reliant on interbank funding and closely connected to other financial institutions, suffered during the crisis more than e.g. banks with a business model in favour of funding by retail deposits and holding sufficient Liquidity buffers. Especially in Austria and Germany, there is a phenomenon rising of so called “Institutional Protection Schemes” (in the following: “IPS”). The establishment of an IPS means the foundation of a “contractual or statutory liability arrangement which protects those institutions and in particular ensures their liquidity and solvency to avoid bankruptcy where necessary” (Article 113 para 7 CRR). Currently it seems that a huge part of Austrian banks (about 800 institutions in total) will apply for a membership in an IPS. Given that banks within the same IPS are strongly connected and the role of an IPS is to ensure the ongoing solvency and liquidity of its member institutions, such banking networks may create special needs for liquidity risk management and supervision. This paper deals with the question whether IPS’ are sufficiently regulated by CRR and CRD IV, focusing on the topic liquidity and liquidity risk. As mentioned, the basic notion of Basel III focuses on banking groups, not on banking networks and by no means on IPS. This raises the question whether the scope and content of the European regulations regarding liquidity risk deals with networks of banks, especially IPS, in an appropriate manner.

KEYWORDS

Liquidity, Liquidity Risk, Basel, IPS, Institutional Protection Schemes, Rabobank, CRR, Financial Regulation, Banks

Cite this paper

Stern, T. (2014). Regulating Liquidity Risks within “Institutional Protection Schemes”. Beijing Law Review, 5, 210-239. doi: 10.4236/blr.2014.53020. 

 

References

[1]	Affinito (2013). Affinito Massimiliano (2013). Central Bank Refinancing, Interbank Markets and the Hypothesis of Liquidity Hoarding: Evidence from a Euro-Area Banking System. ECB Working Paper Series, No. 1607.
[2]	BCBS (1988). International Convergence of Capital Measurement and Capital Standards. Basel: BIS.
[3]	BCBS (1992). A Framework for Measuring and Managing Liquidity. Basel: BIS.
[4]	BCBS (2000). Sound Practices for Managing Liquidity in Banking Organisations. Basel: BIS.
[5]	BCBS (2004). Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework. Basel: BIS.
[6]	BCBS (2008a). Liquidity Risk: Management and Supervisory Challenges. Basel: BIS.
[7]	BCBS (2008b). Principles for Sound Liquidity Risk Management and Supervision. Basel: BIS.
[8]	BCBS (2010). Basel III: International Framework for Liquidity Risk Measurement, Standards and Monitoring. Basel: BIS.
[9]	BCBS (2011). Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems—Revised Version June 2011. Basel: BIS.
[10]	BCBS (2013). Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools. Basel: BIS.
[11]	BCBS (2014). Consultative Document, Basel III: The Net Stable Funding Ratio. Basel: BIS.
[12]	Berrospide (2013). Bank Liquidity Hoarding and the Financial Crisis: An Empirical Evaluation, Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs. Washington DC: Federal Reserve Board.
[13]	Bervas, A. (2009). Market Liquidity and Its Corporation into Risk Management, Banque de France, Financial Stability Review No. 8.
[14]	Bindseil, U. (2013). No. 1610: Central Bank Collateral, Asset Fire Sales, Regulation and Liquidity. ECB Working Paper Series.
[15]	Blume, M. (2007). 22a BWG, Dellinger, Bankwesengesetz—BWG Kommentar, Wien.
[16]	Blundell-Wignall, A., & Atkinson, P. (2010). Thinking beyond Basel III: Necessary Solutions for Capital and Liquidity. OECD Journal: Financial Market Trends, 2010, 1-23.
[17]	CEBS (2008). CEBS’s Recommendations on Liquidity Risk Management. London.
[18]	CEBS (2009). Guidelines on Liquidity Buffers & Survival Periods. London.
[19]	CEBS (2010a). CEBS Guidelines on Liquidity Cost Benefit Allocation. London.
[20]	CEBS (2010b). CEBS Guidelines on Stress Testing. London.
[21]	COM (2011). European Commission, Proposal for a Regulation of the European Parliament and of the Council on Prudential Requirements for Credit Institutions and Investment Firms (Text with EEA Relevance)/COM/2011/0452 Final-COD/ 2011/0202.
[22]	CRD II Directive 2009/111/EC of the European Parliament and the Council of 16 September 2009 Amending Directives 2006/48/EC, 2006/49/EC and 2007/64/EC as Regards Banks Affiliated to Central Institutions, Certain Own Funds Items, Large Exposures, Supervisory Arrangements, and Crisis Management.
[23]	CRD IV Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on Access to the Activity of Credit Institutions and the Prudential Supervision of Credit Institutions and Investment Firms, Amending Directive 2002/ 87/EC and Repealing Directives 2006/48/EC and 2006/49/EC.
[24]	Dellinger, M., Burger, F., & Puhm, S. (2011). 23 BWG, Dellinger, Bankwesengesetz—BWG Kommentar, Wien.
[25]	EBA (2013a). Report on Appropriate Uniform Definitions of Extremely High Quality Liquid Assets (Extremely HQLA) and High Quality Liquid Assets (HQLA) and on Operational Requirements for Liquid Assets under Article 509(3) and (5). London: CRR.
[26]	EBA (2013b). Discussion Paper—Draft Methodology for Assessment of Liquidity and Funding Risk under SREP (EBA/DP/ 2013/04). London.
[27]	Espinosa-Vega, M. (2009). IMF: Prevent Institutions Becoming Too Connected to Fail, Survey Magazine: IMF Research. Washington DC.
[28]	G-20 (2010). The Seoul Summi Document—Framework for Strong, Sustainable and Balanced Growth. Seoul.
[29]	Harris, E. S. (2013). Ben Bernanke’s Fed: The Federal Reserve after Greenspan. Boston, MA: Harvard Business Press.
[30]	Harvard Law School (2013). The Harvard Law School Forum on Corporate Governance and Financial Regulation. Basel Committee Revises Basel III Liquidity Coverage Ratio, HBS.
[31]	Hicks, J. R. (1936). Value and Capital—An Inquiry into Some Fundamental Principles of Economic Theory. Oxford: Oxford University Press.
[32]	IMF (2013). Addressing Interconnectedness: Concepts and Prudential Tools. IMF Working Paper, WP/13/199.
[33]	Jergitsch, Motter, & Siegl (2010). 27 BWG, Dellinger, Bankwesengesetz—BWG Kommentar, Wien.
[34]	Keynes, J. M. (1936). The General Theory of Employment, Interest and Money. London.
[35]	Larson, J. (2011). The Basel Accords. Iowa City, IO: University of Iowa College of Law Center for International Finance and Development.
[36]	Matz, L., & Neu, P. (2007). Liquidity Risk Measurement and Management: A Practitioner’s Guide to Global Best Practices. Singapore City: J Wiley.
[37]	Nikolaou, K. (2009). Liquidity (Risk) Concepts—Definitions and Interactions. ECB Working Paper Series No. 1008.
[38]	Nowak, R. A. (2011). How Effective Is Global Financial Regulation? The Basel Accords’ Role in Mitigating Banking Crises. Durham, NC: Duke University.
[39]	O’Grady, S. (2008). Credit Crunch: “It’s Just the End of the Beginning”. London: The Independent.
[40]	OECD (1971). OECD Economic Outlook, Ausgaben 9-16. Saint Paul, MN: University of Minnesota.
[41]	PRA: Prudential Regulation Authority—Bank of England (2014). Applying for a CRR Permission. London.
[42]	Shin, H. S. (2008). Reflections on Modern Bank Runs: A Case Study of Northern Rock. Princeton, NJ: Princeton University.
[43]	Stern, T. (2013). Zur Bedeutung institutsbezogener Sicherungssysteme, ZFR 2013, 206, Wien.                                       eww141008lx