Tag Archives: Bank supervision

“Wer hat Angst vor Blockchain? (Who’s Afraid of the Blockchain?),” NZZ, 2016

NZZ, November 29, 2016. HTML, PDF. Longer version published on Ökonomenstimme, December 14, 2016. HTML.

Central banks are increasingly interested in employing blockchain technologies, and they should be.

  • The blockchain threatens the intermediation business.
  • Central banks encounter the blockchain in the form of new krypto currencies, and as the technology underlying new clearing and settlement systems.
  • Krypto currencies bear the risk of “dollarization,” but in the major currency areas this risk is still small.
  • New clearing and settlement systems benefit from central bank participation. But central banks benefit as well; those rejecting the new technology risk undermining the attractiveness of the home currency.

“Central Banking and Bitcoin: Not yet a Threat,” VoxEU, 2016

VoxEU, October 19, 2016. HTML.

  • Central banks are increasingly interested in employing blockchain technologies.
  • The blockchain threatens the intermediation business.
  • Central banks encounter the blockchain in the form of new krypto currencies, and as the technology underlying new clearing and settlement systems.
  • Krypto currencies bear the risk of “dollarization,” but in the major currency areas this risk is still small.
  • New clearing and settlement systems benefit from central bank participation. But central banks benefit as well; those rejecting the new technology risk undermining the attractiveness of the home currency.
  • See the original blogpost.

Deposit Insurance: Economics and Politics

On VoxEU, Charles Calomiris and Matthew Jaremski discuss the origins of bank liability insurance. They argue that it is redistribution, not the aim to boost efficiency, which explains a lot of the action.

… there are two theoretical approaches to explaining the creation and expansion of deposit insurance. The first is an economic approach grounded in potential efficiency gains from limiting bank runs (i.e. the public interest motivation). The second is a political approach grounded in the rising power of special interest groups that favoured insurance as a means to access subsidies (i.e. the private interest motivation).

… Because insurance reduces the incentive for market discipline, it may increase fundamental insolvency risk … whether, on balance, bank liability insurance reduces or increases risk … is an empirical question. Economic theories of liability insurance only make sense on economic grounds if the gains from liquidity risk reduction tend to exceed the moral hazard or adverse selection costs from reduced market discipline.

… Political models seek to explain why liability insurance may be chosen to favour certain groups in society even when it imposes large costs on society in the form of higher systemic risk for banks. In this context, liability insurance needs to be understood as part of an equilibrium political bargain achieved by a winning political coalition. …

… we review empirical evidence about, first, which factors are shown to be instrumental in creating bank liability insurance; and second, evidence about the consequences of passing insurance … We find that political theories are much more consistent with both sets of evidence.

… the historical push for liability insurance in the US came from a coalition of small rural bankers and landowning farmers …

Worldwide, bank liability insurance remained a unique (and controversial) policy choice of the US until the late 1950s, but it spread rapidly throughout the world in recent decades …

Like the adoption of liability insurance in the US, the recent global wave of legislation creating and expanding insurance can also be traced to political influences. …

The expansion of liability insurance has been generally associated with reductions in banking system stability …

The political theories of liability insurance point to a major political advantage. It provides an effective means for a government to supply hard-to-trace subsidies to particular classes of bank borrowers … agricultural borrowers or urban mortgage borrowers …

Liability insurance can create a subsidy for banks (which they can pass through, in part, to borrowers) only if prudential regulation and supervision permit banks to take risks at the expense of the insurer. Thus, lax regulation and supervision are an important part of the political bargain that allows liability insurance to deliver subsidies to banks and targeted borrowers. …

European Monetary Union: A Status Report

In the NZZ (August 7, 2015), René Höltschi provides an excellent overview over the status of European Monetary Union (EMU).


  • EMU combines centralized monetary policy authority with decentralized fiscal powers. This creates the risk that national governments try to free ride.
  • Heterogeneity across Euro Zone member states renders centralized monetary policy difficult. Without national monetary policy instruments, prices and wages need to adjust more in the face of asynchronous business cycles.

Previous solutions:

  • The stability and growth pact was meant to address the first issue. It failed, for political reasons. Markets didn’t impose sufficient discipline either; they anticipated bailouts.
  • Hopes for reduced heterogeneity—as a consequence of EMU—have been shattered.

Reforms so far:

  • During the crisis, member states established rescue funds and agreed on various crisis measures.
  • They pursued a two-pronged strategy. On the one hand, they tried to build on the decentralized approach of the Maastricht treaty. On the other, they aimed at closer integration in the form of banking, fiscal and eventually, political union.
  • Major responsibilities in the area of banking supervision and resolution have been transferred to the European Central Bank. Bail-in procedures have been agreed upon.
  • No major changes occurred in the fiscal policy domain. The “Six-pack” and “Two-pack” measures to strengthen fiscal discipline, coordination and supervision have proved ineffective (e.g., no action against France).

Proposals and discussion:

  • The recent “Five-presidents’ report” distinguishes between short-term (until 2017) and longer-term (until 2025) measures (see below). The report proposes to strengthen the existing framework before moving towards closer integration (Euro treasury, macroeconomic stabilization, fiscal and political union). France and Italy have voiced support.
  • Fiscal union entails a common budget and potentially, a common unemployment insurance. Unity of liability and control would require that fiscal competences are centralized as well. In turn, this would require changes of the European treaties.
  • A further strengthening of banking union, e.g. delegation of banking supervision to a newly created European authority (rather than the European Central Bank), also would require treaty changes.
  • But throughout Europe, there is no desire to delegate powers to “Brussels.”
  • Instead, skeptics like the Bundesbank or the German Council of Economic Experts advocate a bankruptcy procedure for Euro-zone governments: to strengthen discipline and encourage monitoring by financial markets any assistance by the European Stability Mechanism should be preceded by private creditor bail-ins (extensions of maturity, haircuts).
  • Some observers also advocate exit from the Euro zone as an ultima ratio measure. But others argue that this very possibility would undermine the stability of the Euro area.

Five-president’s report:

  • Commissioned in October 2014 by the heads of state and government, the report has been published in June 2015 by presidents Jean-Claude Juncker (European commission), Donald Tusk (European council), Jeroen Dijsselbloem (Euro group), Mario Draghi (European Central Bank) and Martin Schulz (European parliament).
  • In the short term, the report proposes: to improve elements of the previous “six-pack” and “two-pack” reforms, including streamlined coordination and supervision of national fiscal policies;
  • a common backstop for national deposit insurance systems;
  • a European fiscal council serving as watchdog; and
  • independent national agencies to monitor competitiveness.
  • For the longer term, the report proposes: completion of monetary union and fiscal union;
  • macroeconomic stabilization, stopping short of permanent transfers or income equalization schemes; and
  • a Euro zone treasury.
  • Accountability as well as the role of national parliaments and the European parliament in coordinating fiscal policy is to be strengthened. The Euro zone is to be better represented vis-a-vis third parties. Intergovernmental arrangements (for example the European Stability Mechanism) that were created during the crisis are to become integral parts of the EU treaties.

IMF Recommendations for Switzerland

The concluding statement of the IMF mission to Switzerland (consultations under Article IV) includes the following top 5 recommendations:

  • Ease monetary policy further to help limit an expected slowdown in growth and reduce risks related to very low inflation.
  • To further support growth, allow fiscal automatic stabilizers to operate freely. If the downturn is more severe than expected, consider discretionary fiscal easing.
  • Adopt pension reform to ensure the sustainability of the safety net for future generations.
  • Raise banks’ minimum leverage ratio requirements to more ambitious levels to ensure banks have adequate capital to weather future shocks without recourse to public support.
  • Pay bank auditors from a FINMA-managed, bank-financed fund rather than by the bank that is being audited to avoid conflicts of interest.

The IMF also calls for an overhaul of the deposit insurance scheme. It sees three risks to its central scenario:

  • Risks related to low inflation.
  • Uncertainty about EU relations and immigration.
  • Global economic environment.

Banking Union

Willem Buiter, Ebrahim Rahbari and Antonio Montilla provide a detailed assessment of the need for a Euro Area banking union and the progress towards it, in a Citi Research document. Some excerpts from the abstract:

… a single supervisor, a common resolution mechanism, including a joint recapitalisation back-up, and an effective lender of last resort – is necessary for the euro area (EA) to survive.

The CA’s [comprehensive assessment’s] conclusion will likely boost EA financial conditions in coming months. Even so, we believe the CA should have been more stringent, current backstops are still inadequate, and the CA will not eliminate divergences in financial conditions …

Remaining elements of narrow banking union are also very important — These are the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). In particular, the SRM and its bail-in provisions should materially reduce the likelihood that an EA sovereign will be dragged into insolvency through tax-payer-funded bank bailouts. Reduced moral hazard will also likely lower the likelihood and severity of future banking crises. And the combination of CA, SSM and SRM are also likely to mean that the ECB will be an effective lender of last resort for EA banks (and sovereigns).

… one key fragility remains: excessive two-way links between national sovereigns and banks. Risk-weighting of sovereign debt and concentration limits on sovereign debt holdings by banks are necessary to break these links.

A single deposit guarantee scheme is not necessary for monetary union and requires a deeper fiscal union than the minimal common backstops required to make monetary union work. It is therefore unlikely in the foreseeable future, in our view. An EA sovereign debt restructuring mechanism (SDRM) may be necessary to handle legacy sovereign debt restructurings and possible future sovereign insolvencies, but beyond the limited mutualised fiscal backstops necessary for banking union and the SDRM, deeper fiscal union is neither necessary for EA survival nor likely, for political reasons, in the foreseeable future.

The report contains many interesting figures, for example on the exposure of banks to their domestic governments; the correlation between sovereign and bank CDS spreads; lending standards; the share of bank loans in banks’ balance sheets etc.

IMF Discussion Note on Banking Union in the Euro Area

Rishi Goyal, Petya Koeva Brooks, Mahmood Pradhan, Thierry Tressel, Giovanni Dell’Ariccia, Ross Leckow, Ceyla Pazarbasioglu et al discuss the case for a banking union in the Euro area in an IMF Staff Discussion Note. The authors argue in favour of both a single supervisory-regulatory framework and a common resolution mechanism as well as safety net.

Iceland’s Deposit Insurance Found Non-Discriminatory

The Economist reports about an EFTA court decision concerning Iceland’s decision to discriminate among depositors after the collapse of Icesave, an online bank. The bank had collected deposits in the UK and the Netherlands, using a European “passport” which relied on the notion that the Icelandic deposit insurance scheme would back those deposits. After the collapse, the insurance turned out to be insufficient; while Icelandic savers received their money back, British and Dutch depositors did not. But eventually, their respective governments bailed them out—and now went to court.

… the court found that Iceland was obliged only to make sure that it had a deposit-insurance scheme. The state was not required to pay out if the scheme had no money because of a banking crisis. Oddly, the court also found that Iceland had not breached an obligation not to discriminate between domestic and foreign depositors, even though it made only the domestic ones whole.