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With IstEin you can easily follow the international financial regulation process (About us).
- IstEin Financial Regulation Review No. 173 (21 July - 03 August 2016)
- IstEin Financial Regulation Review No. 172 (07 - 20 July 2016)
- IstEin Financial Regulation Review No. 171 (16 June - 06 July 2016)
- IstEin Financial Regulation Review No. 170 (02 - 15 June 2016)
- IstEin Financial Regulation Review No. 169 (19 May - 01 June 2016)
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High levels of correlation among financial assets as well as extreme losses are typical during crises periods. In such situations, quantitative asset allocation models are often not robust to deal with estimation errors and lead to identify underperforming investment strategies. It is an open question if in such periods, it would be better to hold diversified portfolios, such as the equally weighted, rather than investing in few selected assets. In this paper, authors show that alternative strategies developed by constraining the level of diversification of the portfolio, by means of a regularization constraint on the sparse lq-norm of portfolio weights, can better deal with the trade-off between risk diversification and estimation error.
Concentration risk is an important feature of many banking sectors, especially in emerging and small economies. Under the Basel Framework, Pillar 1 capital requirements for credit risk do not cover concentration risk, and those calculated under the Internal Ratings Based (IRB) approach explicitly exclude it. Banks are expected to compensate for this by autonomously estimating and setting aside appropriate capital buffers, which supervisors are required to assess and possibly challenge within the Pillar 2 process. Inadequate reflection of this risk can lead to insufficient capital levels even when the capital ratios seem high. Authors propose a flexible technique, based on a combination of “full” credit portfolio modeling and asymptotic results, to calculate capital requirements for name and sector concentration risk in banks’ portfolios. The proposed approach lends itself to be used in bilateral surveillance, as a potential area for technical assistance on banking supervision, and as a policy tool to gauge the degree of concentration risk in different banking systems.
The European Commission (EC) released a report on the remuneration rules for credit institutions and investment firms.
It finds that the remuneration rules are generally effective in curbing excessive risk-taking behaviour and short-termism. These were precisely the reasons why the rules were introduced in the aftermath of the financial crisis.
However, drawing in particular on work done by the European Banking Authority, two public consultations and an external study, the report concludes that, in certain cases, some of the rules may be too costly and burdensome to apply, compared to their prudential benefits.
See also: press release, Commission Staff Working Document on detailed assessment of remuneration rules and Commission Staff Working Document on evaluation of deferral and pay-out in instruments rules
Consultation paper on the proposal for the implementing technical standards under the insurance distribution directive
The European Insurance and Occupational Pensions Authority (EIOPA) published a consultation paper on draft Implementing Technical Standards (ITS) standardising the presentation format of the Insurance Product Information Document (IPID). The IPID will be provided to the customer prior to the conclusion of a non-life insurance contract in accordance with the provisions of the Insurance Distribution Directive (IDD).
The purpose of the IPID is to ensure that key information about non-life insurance products is presented to the customer in a standardised format they can use to understand the product offered, and compare between different products.
Consultation will close on 24 October 2016.
See also: press release
The Association for Financial Markets in Europe (AFME) published model clauses for the contractual recognition of bail-in for the purposes of satisfying the requirements of Article 55 of the EU Bank Recovery and Resolution Directive (BRRD). The model clauses seek to support cross-border effectiveness of resolution and assist banks with complying with the requirements of Article 55 BRRD by providing model wording for inclusion in debt instruments and other contracts.
The scope of Article 55 is very broad and requires banks to include contractual recognition clauses in contracts giving rise to all liabilities governed by non-EEA law, save where these are expressly excluded from bail-in under the BRRD. The requirement gives rise to significant challenges, for example where banks are unable to unilaterally amend contracts, such as in relation to trade finance and membership of financial markets infrastructure.
See also: press release
The Global Financial Crisis (GFC) exposed clear gaps in the pre-crisis regulatory and supervisory framework in most of financial systems worldwide, but not in all financial systems. Optimal design of supervisory and regulatory arrangements in the post-crisis perspective requires identifying elements that failed in helping predicting current slowdown, and those that directly or indirectly affected vulnerability of financial markets. Both tasks appear to be as challenging as twelve labors of Hercules: demanding, covering wide aspects of financial and macroeconomic environment, requiring cooperation of many key agents in all markets; hence truly virtually impossible.
Prominent policy makers assert that managerial short-termism was at the root of the subprime mortgage crisis of 2007-2009. Prior scholarly research, however, largely rejects this assertion. Using a more comprehensive measure of CEO incentives for short-termism, authors uncover evidence that short-termism indeed played a role in the crisis. Authors find that shorter vesting schedules for CEO equity holdings are positively related to firm exposure to subprime mortgage assets, as well as a higher probability of financial distress and lower risk-adjusted stock returns during the crisis. Furthermore, shorter vesting schedules are positively associated with fines and settlements for subprime-related fraud.
This paper offers a historical perspective on the evolution of central banks as lenders of last resort (LOLR). Countries differ in the statutory powers of the LOLR, which is the outcome of a political bargain. Collateralized LOLR lending as envisioned by Bagehot (1873) requires five key legal and institutional preconditions, all of which required political agreement. LOLR mechanisms evolved to include more than collateralized lending. LOLRs established prior to World War II, with few exceptions, followed policies that can be broadly characterized as implementing “Bagehot’s Principles”: seeking to preserve systemic financial stability rather than preventing the failure of particular banks, and limiting the amount of risk absorbed by the LOLR as much as possible when providing financial assistance. After World War II, and especially after the 1970s, generous deposit insurance and ad hoc bank bailouts became the norm. The focus of bank safety net policy changed from targeting systemic stability to preventing depositor loss and the failure of banks. Statutory powers of central banks do not change much over time, or correlate with country characteristics, instead reflecting idiosyncratic political histories.
Authors develop an equilibrium model of real and financial market integration in which real firms and financial investors independently decide on their investment into different locations (countries). Authors show that, in the presence financial frictions, firms' real investment choices become strategic complements, leading to multiple, self-fulfilling equilibria. This fragility may lead to a global crash in which severe underinvestment into countries with under-developed financial markets spills over to countries connected to them by real investment linkages. Authors show that such global crashes are particularly severe when frictions are sufficiently symmetric across countries. By contrast, with enough asymmetry, the economy is likely to end up in a local crash equilibrium in which countries with low real investment barriers suffer the most.
Press releases announcing and explaining monetary policy decisions play a critical role in the communication strategy of central banks. Because of their market-moving potential, it is particularly important how they are drafted. Often, central banks start from the previous statement and update the earlier text with only small changes. This way, it is straightforward to compare statements and see how the central bank’s thinking has evolved. This paper studies to what extent such similarity in central bank statements matters for the reception of their content in financial markets. Using the case of the Bank of Canada (the G7 central bank that had to rely the least on unconventional monetary policy following the global financial crisis and has therefore broadly continued standard monetary policy communications), the paper shows that press releases with larger differences in wording lead to higher volatility in financial markets, suggesting that their content is more difficult to absorb. At the same time, while press releases that are similar to the previous one generate less market volatility, once their wording is updated, volatility increases substantially.
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- Last Update: Wednesday 03 August 2016, 16:04.
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