Master Thesis Digital Banking & Financial Technology
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The Future of Finance
. [online] Available at: https://www.betandbetter.com/photos_forum/1425585417.pdf . Ogunode, O.A. and Akintoye, R.I. (2023). Financial Technologies and Financial Inclusion in Emerging Economies: Perspectives from Nigeria. Asian Journal of Economics, Business and Accounting , pp.38 –54. doi:10.9734/ajeba/2023/v23i1915. Reuters (2016). Singapore to update electronic payment regulations in fintech drive. Reuters . [online] 19 Aug. Available at: https://www.reuters.com/article/singapore- cenbank-fintech-idUSL3N1B01II [Accessed 27 Jan. 2023]. Sullivan, T. (2022). Financial inclusion: How fintech expands access to all . [online] Plaid. Available at: https://plaid.com/resources/fintech/financial-inclusion/. Walchek, S. (2015). The Unbundling Of Finance . [online] TechCrunch. Available at: https://techcrunch.com/2015/05/29/the-unbundling-of-finance/. Yang, S. (2015). Why Wall Street is pouring money into companies that want to eat its lunch . [online] Business Insider. Available at: https://www.businessinsider.com/wall-street-invests-in-fintech-startups-2015-3 [Accessed 27 Jan. 2023]. Zavolokina, L., Dolata, M. and Schwabe, G. (2016). FinTech – What’s in a Name? [online] www.zora.uzh.ch. doi:10.5167/uzh-126806. 51 Chapter 4: Reform of the European banking system 4.1. The characteristics of the existing framework The debate on how to improve the rules and procedures for dealing with bank failures in the European banking union began a few years ago, but gained momentum in 2017 when two major banks – both of which fell under the purview of the Single Supervisory Mechanism (SSM) and the Single Resolution Board (SRB) – failed. These incidents demonstrated how challenging it can be for the existing laws to permit the orderly market exit of various sorts of institutions whose failure could cause systemic disruption. It is somewhat paradoxical that these difficulties have become so pronounced in the EU, as this is arguably the jurisdiction that has modernized its crisis management framework the most by adopting the new international standards on bank resolution (the FSB Key Attributes) in a timely, thorough, and stringent manner (Restoy, 2022). The current role of ECB and ESCB is to (Cambis, n.d.): ⚫ Serve European Commission’s targets ⚫ Remove fragmentation and secure max benefit for EU citizens and firms ⚫ Enhance digital operation resilience framework The FSB Core Characteristics were one of the most significant regulatory measures implemented by the worldwide community in the wake of the Great Financial Crisis (GFC) to lessen the likelihood and economic effect of financial crises. They intended to implement a bank resolution mechanism that would aid in maintaining the essential functions of failing systemic institutions without requiring a significant outlay of public resources. Based on its own experiences during the global financial crisis, the EU had a clear incentive to adopt the new resolution system (Buch, Bundesbank and Dages, 2018). Europe was the region hardest damaged by the global financial crisis, necessitating substantial public aid. Between 2008 and 2014, the net cost to European governments of sustaining financial institutions exceeded €200 billion (European Union, 2020). 52 Image 6 Overview of main causes of the EU financial crisis https://www.eca.europa.eu/lists/ecadocuments/rw20_05/rw_financial_crisis_prevention_en.pdf This resulted in the adoption of procyclical fiscal austerity programs, which exacerbated the economic recession that followed the start of the crisis. Moreover, this connection between the weaknesses of banks and the need for public support sparked a destabilizing spiral between financial and sovereign risk that spawned redenomination risks, ultimately endangering the very existence of the European 53 monetary union. To preserve both the social cohesion within member countries and the resiliency of the European integration project, it was deemed necessary for Europe to develop crisis management tools that could reduce reliance on public funds to safeguard financial stability, in accordance with the FSB's Key Attributes (European Union, 2020). In response, European authorities established a single resolution mechanism (SRM) in 2014 as part of the banking union initiative. In legal parlance, the SRM creates rules, tools, and procedures for addressing the failure of systemic institutions in the banking union, or those that meet public interest criteria. These restrictions include an effective ban on government bailouts and a predominance of creditor bail- ins to preserve the essential activities of failing institutions. In addition, the new framework envisages the centralisation of resolution decisions within a European agency (the SRB) and the establishment of an industry-contributed mutualised fund (the Single Resolution Fund, SRF) (EUR-Lex, 2014, consolidated 2022). This fund may be utilized to support resolution actions, but only if a substantial number of creditors' claims have been bailed in. According with these minimal bail-in standards, banks are ordinarily required to issue huge quantities of financial instruments that could become loss-absorbing at the time of insolvency (the minimum requirement for own funds and eligible liabilities, MREL) (Single Resolution Board, 2022a). Image 7 Internal MREL for an expanded scope of non-resolution entities Expanding the number of subsidiaries for whom the SRB will establish an internal MREL. Entities providing important functions and/or those surpassing the 32% criterion of the resolution group's total risk exposure amount, or leverage exposure, 54 or total operational income (the previous requirement was 43%), or those with total assets exceeding EUR 10bn are included in the scope. They are known as RLEs. Notably, entities delivering vital functions are included in the definition of RLEs even if their size falls below the threshold. In addition, the SRB establishes internal MREL for intermediate entities, which are defined as subsidiaries of resolution entities that are the parent entities of at least one RLE. In accordance with the SRB's guideline on the scope of LDR reporting, the above-mentioned companies are required to submit an LDR to guarantee that the financial data required to calculate MREL is accessible. As considered appropriate in future cycles, the SRB will reevaluate the extent of subsidiaries with internal MREL (Single Resolution Board, 2022a). The regulations governing the SRM represent a strict adaptation of the FSB Core Characteristics. No other jurisdiction has arguably put more specific and stringent restrictions on the use of foreign funding (public or private) to facilitate resolution. In addition, it is uncommon for authorities outside the EU to require banks (and not just internationally systemic ones) to meet MREL-type obligations. Again, the severity of these limits is essentially a political reaction to recent events and the particular institutional constraints created by the multinational nature of the European banking union (Arda & Dobler, 2022). Image 8 European institutions for financial supervision and resolution in a Banking Union While the design of the EU resolution mechanism is internally coherent, it does not provide a robust blueprint for addressing the failure of a significant portion of banking union institutions. In this regard, it is crucial to underline that the common resolution framework coexists alongside a constellation of domestic insolvency regimes enshrined in national law that have not altered significantly in recent years. When failing institutions do not meet the required resolution criteria relating to the public interest, national regimes – which frequently involve the administration of court-based general insolvency proceedings – are nonetheless implemented. Intriguingly, the availability of public assistance during insolvency (in the form of liquidation aid) is, on average, far less constrained than during resolution. 55 The Single Resolution Mechanism is a component of the European Banking Union's broader structure. Image 8 depicts the steps of decision-making and the relevant bodies in this new emerging European governance structure. The European Central Bank (ECB) assumes the role of supervisor and lender of last resort for the European financial sector, while the European Commission retains its regulatory authority. If this level fails to fix difficulties, resolution is the next step (i.e. a single resolution mechanism). Schoenmaker and Gros (2012) advocate for the establishment of an independent European Deposit Insurance and Resolution Authority (EDIRA) that would be responsible for this phase. The third component of the governance structure is the fiscal backstop. The European Stability Mechanism (ESM) was established to serve as a fiscal safety net for member nations, but it may also serve as a fiscal safety net for the banking systems of member countries experiencing financial trouble. Hence, the arrow for the fiscal backstop is reversed in Image 8. Given the necessity for a fiscal backstop, the new SRM (in the form of an EDIRA) must work closely with the ESM. Notwithstanding this, it is crucial to preserve the independence of the resolution authority, as the ESM is governed by the ministries of finance (Beck, Gros and Schoenmaker, 2013). Image 9 table of vulnerabilities https://www.bankingsupervision.europa.eu/ecb/pub/ra/html/ssm.ra2021~edbbea1f8f.en.html 56 Bail-in policies improve market discipline by guaranteeing that the agents responsible for bank distress are held accountable by removing the bank's managers and lowering shareholder and creditor rights. Shareholders and creditors are held accountable for monitoring the bank and limiting excessive risk-taking, specifically through the pricing of shares and debt. Prior to the crisis, market discipline was failing due to the too big to fail subsidy on the debt of giant banks; troubled banks were not compelled to pay higher borrowing costs. In addition, the capital infusions decreased the losses owners and creditors of bailed-out banks incurred during the crisis. Bail-ins would save the bank from failure, but shareholders and creditors would be responsible for losses and costs associated with the bail-in. The prices of stocks and bonds should be adjusted to reflect these anticipated losses (Meehl, 2022). Owing to the change in payoffs to shareholders and creditors in the event of a bail-in, the equilibrium values of shares and debt under this new regime should differ from those under the bailout regime. Banks' exit, entry, risk-taking, and debt-to-equity financing decisions could be affected by a shift in prices. For instance, the greater cost of borrowing for banks following the abolition of bailouts could lead to a reduction in investment and lending, which could inadvertently affect consumers. In addition, a prospective loss of shares due to a bail-in may discourage shareholders from investing in a new bank, so limiting the industry's growth. While the bailing-in of a bank may preserve its services for some customers, decreasing entry may result in a decline in banking services generally. Hence, the consequences of this new policy on consumers are unknown, and a structural model is required to compare equilibrium conditions under each policy. A few bail-ins have occurred in the EU thus far, although these resolutions occurred before the Financial Recovery and Resolution Regulation was finalized. In conducting these bail-ins, there was no single policy to follow, and many of them were only partial bail-ins that also included bailout elements. In addition, it is unknown whether banks and their creditors anticipated bail-ins. Consequently, it is impractical to predict how banks' decisions might alter under a "bail-in regime" using EU banking data collected after the financial crisis and before to the finalization of Banking Recovery and Resolution Directive (Meehl, 2022). If bail-in becomes a crucial component of contemplated resolution procedures, the current structure is ineffective for dealing with the failure of banks whose liabilities cannot be utilised for loss absorption or recapitalization without causing a major disturbance. This describes medium-sized banks that are primarily funded by deposits. These institutions are often too large to be subject to traditional insolvency liquidation procedures, but too small and inexperienced to issue the substantial sums 57 of bail-in-able debt (such as subordinated bonds) required for resolution. In the absence of those instruments on these banks' balance sheets, authorities would not be able to recapitalise the institutions by making use of internal funds or by gaining access to the resolution funds as the minimal bail-in conditions for the latter would not be met (Restoy, 2016). Authorities have handled the issues provided by the failure of mid-sized banks by utilizing national insolvency procedures and utilizing public funds to enable a smooth withdrawal from the market. This has necessitated delicacy in the evaluation of the systemic consequences of bank collapses. In specifically, in order to be subject to national insolvency, those failures have to fail the public interest test for resolution. To justify the use of taxpayer cash, these projects have to be judged as having a negative impact on the economic or financial system (Restoy, Vrbaski and Walters, 2020). This strategy is suboptimal. It implies, rather paradoxically, that in order to activate the necessary support to prevent systemic stress, authorities must avoid employing the framework specifically created to deal with systemic bank crises (resolution) and instead deploy the regime intended for less significant institutions (insolvency) (European Commission, 2014). Moreover, the extensive use of national insolvency regimes – funded entirely with domestic resources – represents a departure from the principles that inspired the creation of the banking union, namely the urgent need to sever the destabilizing link between domestic financial risks and the sovereign. It would necessitate the renationalization of bank failure management and, thus, the renationalization of bank risks. Prior to addressing the flaws of the current framework for crisis management in the banking union, greater harmonization of domestic insolvency procedures is required. While a comprehensive common insolvency framework appears politically unfeasible at this time, there should be room to further harmonise those domestic solutions that have the greatest potential to cause friction with the common resolution scheme. Moreover, when facing the failure of mid-sized banks, it is necessary to avoid the paradoxical choice between open bank bail-in under resolution and piecemeal liquidation under insolvency, as both approaches have the potential to destabilize the financial system. Additionally, relying on public assistance during insolvency cannot be regarded to be a viable solution to this situation (Garicano, 2020). Facilitating sale-of-business (SoB) (or purchase-and-assumption) transactions to arrange the orderly exit of failing banks is a potentially effective strategy for tackling the aforementioned difficulties. These strategies – in which 58 deposits and other sensitive liabilities of failing banks are transferred to stronger institutions – have been employed successfully in other jurisdictions, such as the United States, for a number of years but cannot be easily implemented in the European context at this time (FDIC, 2013). Clearly, the success of SoB tactics is contingent upon the presence of a suitable customer. This is highly dependent on the value of the failing bank's transferable assets and the availability of external finance to compensate buyers for assuming failing banks' deposits if, as is frequently the case, the available assets are insufficient. It is possible to raise the amount of assets that can be transferred by forcing medium-sized banks to keep, as a counterpart, liabilities that can be written off or converted into capital as the banks fail. Hence, a correctly calibrated MREL could facilitate the implementation of transfer schemes. Yet, given the restricted ability of mid-sized banks to perpetually issue and reimburse bail-in-eligible liabilities, external funds should be available to compensate buyers. In certain jurisdictions, the deposit guarantee scheme (DGS) can offer this external money. However, DGS funding is often constrained to a financial ceiling: it is only accessible if the anticipated cost of the intervention is less than the cost of paying out deposits in liquidation (Restoy, 2022). In the case of the EU, DGS assistance for SoB transactions is severely constrained (if not rendered irrelevant) by legal rules that place DGS claims above uncovered deposits in the hierarchy of creditors. This "super-preference" of DGS claims shields them from incurring liquidation losses. The conclusion is that European DGS are unable to enable SoB transactions, even though they would prevent a potentially disruptive and value-destroying piecemeal liquidation (European Banking Authority, 2019). Similarly, the SRF is not an appropriate source of capital to enable SoB transactions for mid-sized banks under the current system. The SRF is only available to failing institutions that satisfy the public interest criteria for resolution and only after a substantial bail-in of creditors has been implemented. As previously noted, it will frequently be extremely challenging for mid-sized banks to achieve these standards (Restoy, 2021). Thus, the viability of SoB transactions necessitates substantial modifications to the current structure to permit adequate coverage of their finance requirements. One alternative is to loosen the limit on the use of DGS money to assist transfer transactions, which is now tied to the expenses associated with payout deposits in liquidation (European Commission, 2012). But, any action in this area must retain the DGS's ability to fulfill its primary mission, which is to safeguard insured deposits. Whether the existing super-priority of DGS claims in Europe is justified on public 59 policy grounds is a topic of controversy. It might be claimed that there is no clear policy justification for DGS claims to take precedence over uncovered deposits. In fact, the super-preference of DGS claims implies that individuals holding deposits in excess of the maximum amount insured by the DGS are less protected in insolvency than the indirect positions held by DGS-affiliated banks in relation to the failing organization. In addition, following the example of other countries, such as the United States, and replacing the super-preferred of DGS claims with a general deposit preference rule could assist in mitigating risks of bank runs, hence preserving financial stability. This alternative preference rule would automatically loosen the current restriction on the use of DGS money to support SoB transactions, without jeopardizing the DGS's primary objectives (Mecatti, 2020). The SRF could serve as an alternate source of financing. This would necessitate relaxing the current minimum bail-in requirements for the usage of these resources. In fact, there appears to be a compelling case for considering that the conditions for the SRF to facilitate an orderly market exit of failing banks, such as through a SoB transaction, should be less stringent than those imposed to ensure that the failing bank could continue operating and performing essential functions. Following a SoB resolution method, it is conceivable that banks (usually medium- sized) might be subject to less stringent minimum bail-in criteria. Note that while funds from the SRF would only be available for banks submitted to resolution, funding from the DGS could support bank failures regardless of whether the public interest requirement is met (Single Resolution Board, 2022b). 4.2. Crisis management for EU banks The creation of a crisis management framework for failing or likely-to-fail institutions is a crucial step towards enhancing the resilience of the financial sector. In the absence of a proper structure to handle the process in an orderly manner, bank failures can have enormous disruptive impacts on the economy. In order to address these concerns, the EU has devised a comprehensive crisis management framework for banks, which consists of the Banking Recovery and Resolution Directive and the Single Resolution Mechanism Regulation (European Union, 2020). Four essential steps comprise the crisis management framework for banks (see Image 10). In the preparatory phase, supervisors watch banks to detect any 60 impending crises as soon as possible. In addition, resolution authorities guarantee that all banks are resolvable and that all resolution plans are current. Supervisors may employ early intervention methods if a bank encounters difficulty. Yet, if the situation worsens, regulators or resolution authorities must proclaim the bank to be failing or likely to fail (FOLTF). After determining if resolution is required, appropriate, and in the public interest, resolution authorities must devise a resolution strategy. If resolution is not in the public's best interest, the bank is liquidated in accordance with national insolvency proceedings (European Union, 2020). Image 10 Four phases of crisis management for EU banks https://www.eca.europa.eu/lists/ecadocuments/rw20_05/rw_financial_crisis_prevention_en.pdf The new resolution framework includes the write-down and conversion of capital instruments tool and the bail-in tool, which are designed to shift the loss burden from taxpayers to shareholders and creditors (who would have benefited from any profits). It also contains three resolution tools: "sale of business," "bridge institution," and "asset separation." To defend the right to private property, the "no- creditor-worse-off" concept ensures that under national insolvency laws, no shareholder or creditor is treated less favorably in resolution than in liquidation (European Union, 2020). The requirement that banks keep a sufficient level of loss-absorbing capacity in the form of the minimum requirement for own funds and eligible liabilities (MREL) is a crucial element for ensuring resolvability, as it enables the use of the bail-in tool. The MREL comprises of the required capital and bail-in-eligible liabilities, which could be utilized to recapitalize the bank (Single Resolution Board, 2017). The identification and elimination of substantive barriers to resolution is another crucial step. In addition to the bail-in mechanism, the SRF, the required Deposit Guarantee Schemes, and the proposed EDIS supplement the resolution framework to permit banks to fail in an 61 orderly way without resorting to public bailouts, which might potentially start the doomsday loop. They are sponsored in advance by the industry (European Union, 2020). All of the aforementioned resolution steps are intended to break the doomsday loop and prevent banks from becoming "too big to fail." The Banks Recovery and Resolution Directive stipulates that public funds may only be utilized "in the most exceptional circumstances of a systemic crisis, as a last option," and under stringent restrictions and requirements. Both liquidation and resolution must adhere to State aid regulations anytime public funds, including the SRF, are employed. State aid regulations prohibit any use of public funding that could impair internal market competition. Throughout and after the financial crisis, the Commission issued a number of interpretative Communications on the application of State assistance rules. It still applies the Banking Communication from 2013 (European Commision, 2013). The Bank Recovery and Resolution Directive (BRRD) ushered in a new crisis management system for the European Union in 2015. (EU). The decree was intended to address the "too-big-to-fail" problem and eliminate the need for public bailouts in the case of bank collapses. In accordance with the Key Attributes of Effective Resolution Regimes for Financial Institutions published by the FSB in the wake of the global financial crisis of 2007-08, the focus of this reform was on systemically important banks, i.e., those banks whose failure would likely threaten financial stability and have severe repercussions for the domestic and international real economy. During the global financial crisis, as as as during prior crises, the bailout of these institutions was extremely expensive for governments and, ultimately, taxpayers. Hence, the answer envisioned on a worldwide scale was to internalize the losses through the deployment of "bail-in," the principal instrument supporting the new resolution structure. By moving the cost of the financial crisis from taxpayers to investors and creditors, the framework aimed to decrease moral hazard and level the playing field between larger and smaller banks by eliminating the implicit subsidies enjoyed by the former. However, less attention has been paid to banks that are not systemic, especially the vast majority of EU banks, which are small and medium- sized (Cunliffe, 2016). Nonetheless, small and medium-sized banks contribute significantly to the economy's finance. In the euro area, smaller banks own 19% of the banking sector's total assets; in some countries, such as Austria, Germany, Ireland, and Luxembourg, this proportion exceeds 33% (European Central Bank, 2020). In addition, small and medium-sized institutions may suffer the most from the pandemic's economic 62 repercussions. Could this generate an unprecedented "too-many-to-fail" dilemma that is challenging to solve within the existing framework? A recent Bank of Italy analysis reveals that the impact of the pandemic on Italian banks' credit risk exposure could be greater for smaller institutions than for larger ones, due to the disparate sectoral compositions of their loan portfolios (Banca d'Italia, 2020). The national insolvency proceedings of EU member states are extremely diverse. Some nations, for instance, have special insolvency regimes that apply primarily to banks, while others have standard bankruptcy regimes that apply to all types of businesses; some countries have judicial-based frameworks while others implement administrative-based frameworks. This diversity causes an issue with equal playing fields, as creditors and depositors may be handled differently within the Union, thereby fostering financial fragmentation (Visco, 2021). The primary goal of any change of the current system should be to prevent disorderly, fragmented liquidations and the resultant wasteful destruction of assets. In Europe, this objective is being pursued in the area of insolvency procedures for non- financial enterprises, for which continual efforts at harmonization are made. It should also be followed, a priori, in the banking industry, where it is essential not only to prevent the destruction of value but also to maintain public confidence in the banking system. In recent years, disorderly liquidations may have become more common due to a number of causes. Banks are reducing their branch network as a result of technological advancement and shifting consumer preferences; a fundamental consequence of this phenomenon is a diminished appetite for purchasing failing institutions. The economic crisis is also causing "overcapacity" in the EU banking industry, which struggles to remunerate capital on average, further lowering merger and acquisition returns. In these circumstances, the "franchise value" of failing banks is low, and potential buyers are frequently only willing to transact at negative prices. It is common knowledge, piecemeal liquidation would immediately undermine the bank's basic operations. Assets would have to be liquidated quickly at fire sale prices, and collateral would have to be enforced; non-insured liability holders would have to endure lengthy delays to receive only partial reimbursement; and borrowers, particularly small businesses, would be exposed to liquidity constraints, which could then lead to solvency issues. Other banks' confidence could be undermined, heightening the hazards for the economy as a whole. Consequently, disorderly piecemeal liquidation is largely untested at this time (Visco, 2021). 63 4.3. Developments in Greece In the first half of 2022, the stock of nonperforming loans (NPLs) in the banking sector continued to decline. The stock decreased by 20% from the end of 2021 and stood at EUR 14.8 billion as of June 2022, showing a 10% non-performing loan ratio compared to 12.8% at the end of 2021. This decline was caused by loan write-offs, the accounting reclassification of the remaining Hercules securitizations, and certain outright sale transactions. By the end of 2024, the systemic banks hope to be closer to the average of their EU peers. Given the expiration of the Hercules Asset Protection Scheme in October 2022, systemic banks will need to rely increasingly on their in-house management of loans in default or at risk of default, as well as their capacity to offer viable long-term solutions or proceed with effective collateral recovery, to achieve this objective. This may prove to be more difficult than the inorganic NPL reduction strategy that has been the norm to until, especially for smaller institutions with large nonperforming loan percentages that have not utilized the Hercules plan (European Union, 2022). Image 11 Evolution of the stock of gross nonperforming loans and the corresponding non-performing loans ratio for Greek banks https://economy-finance.ec.europa.eu/system/files/2022-11/ip191_en.pdf The net flow of new non-performing loans remains modest, but there are early indications of a rise in delinquencies as asset quality problems persist. Despite the 64 fact that pandemic-related state support measures (Gefyra I and II schemes) have nearly expired, default rates for these programs remain low (between 5 and 7 percent). In the second quarter, there were no indications of a significant increase in the gross inflows of nonperforming loans into banks' loan portfolios. In addition, systemic banks continue to report lower-than-anticipated default rates for loans that have exited the Covid-19 payment moratorium, including instances in which Yüklə 0,77 Mb. Dostları ilə paylaş:
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