Targeted review of the macroprudential framework

Prepared by Johanne Evrard, Nadya Jahn, Ana Sofia Melo and Balázs Zsámboki

The European Commission’s proposals for the reform of EU banking rules aim to complete the post-crisis reform agenda and to address shortcomings in the current regulatory framework, notably in the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD IV). Once implemented, the changes will strengthen the regulatory architecture in the European Union, thereby contributing to the reduction of risks in the banking sector and paving the way for commensurate progress in completing the banking union. This article outlines and explains the ECB’s key messages concerning these proposals that are of particular importance for macroprudential regulation and policy. In particular, the ECB considers that the ongoing discussions on the CRR/CRD IV package provide the opportunity to make targeted changes to the macroprudential toolkit to make it more efficient and consistent. In the medium term, a comprehensive review of the macroprudential toolkit is still necessary to streamline procedures within the framework and to complement it with tools to address risks in the real estate and non-banking sectors.


1 Introduction

The financial crisis highlighted the need for a macroprudential perspective in financial regulation. The crisis revealed that not all prudential policies were equally effective in addressing systemic risk. For instance, ensuring the soundness of individual banks through microprudential policies may not be sufficient to safeguard the resilience of the financial system as a whole. The EU regulatory framework has therefore been revised to integrate a macroprudential perspective in financial regulation. With effect from 1 January 2014, European banking legislation (CRR/CRD IV) includes a broad set of macroprudential instruments that complement microprudential measures by targeting systemic risks linked to particular cyclical or structural features in the economy. Macroprudential instruments are primarily in the hands of national authorities; however, the regulatory framework entails coordination requirements at the EU level to ensure a proper exchange of information on the risks in the system and to take into account possible spillovers across the European Union. In addition, the SSM Regulation[1] provides the ECB with the authority to use macroprudential instruments to address systemic or macroprudential risks in the SSM countries.[2]


2 Review of the macroprudential policy framework

2.1 A comprehensive review of the macroprudential framework is needed to integrate lessons learned on the use of tools and to reflect the changes in the institutional set-up

In 2016 the European Commission launched a consultation on the review of the macroprudential policy framework, to which the ECB provided its contribution in December 2016.[3] Following up on the consultation, in 2017 the Commission published a proposal on targeted changes to the governance of the European Systemic Risk Board.[4] However, the Commission concluded that an overhaul of the macroprudential toolbox was not needed at the current juncture.[5] Consequently, the Commission’s proposals on the review of the CRR/CRD IV[6] (referred to as the banking package) were not accompanied by specific proposals on the revision of the macroprudential regulatory framework.

The ongoing discussions on the banking package provide an opportunity for targeted changes to the macroprudential toolkit, before a broader review is conducted in the medium term. Over the past few years, authorities have increasingly made use of macroprudential policies and a number of lessons can already be drawn from the experience gained so far. This can feed into the discussions ongoing at the Council and at the European Parliament on the banking package.

Nevertheless, the ECB would continue to see benefits in conducting a comprehensive review of the macroprudential policy framework in the medium term, with the primary objective of enhancing its effectiveness, without impeding the effectiveness of other complementary policies. The changes in the institutional set-up, notably the establishment of the Single Supervisory Mechanism (SSM) and the distribution of tasks between the national macroprudential authorities and the ECB would also merit being reflected in the framework. Therefore, this article focuses on possible targeted changes to the existing toolkit, which would allow enhancing its effectiveness at the current juncture, and also proposes avenues to be considered in the context of a broader review to be conducted in the medium term.

2.2 Short-term changes to the macroprudential policy framework

The reform package on the CRR/CRD IV[7] proposed by the European Commission in 2016 introduces changes to the Pillar 2 framework, namely by clarifying its institution-specific nature. In particular, the banking package foresees that Pillar 2 requirements, which are implemented by microprudential authorities, should not be used to address macroprudential concerns. From an ECB perspective, it is important that the reduction in authorities’ flexibility to use Pillar 2 for macroprudential purposes is accompanied by extending the toolkit at the disposal of the macroprudential authorities or by easing the use of existing instruments. This is also the direction that was followed in the ongoing discussions at the Council of the European Union and the European Parliament.

In the absence of a comprehensive review of the EU macroprudential framework in the short term, targeted changes should be introduced in the context of the CRR/CRD IV review. To enhance the effectiveness of the toolkit where possible, the ECB welcomes the ongoing discussions among EU co-legislators and considers it essential to take the opportunity presented by the current revision of the CRR/CRD IV to implement some targeted changes to the macroprudential toolkit, based on the experience gained so far. In this context, in its contribution to the European Commission consultation on the macroprudential review, the ECB called for: (i) the delineation of the roles and responsibilities of macro- and microprudential authorities, including the restriction of the use of Pillar 2 solely for microprudential purposes and strictly on an institution-by-institution basis; (ii) the elimination of overlaps between instruments and greater flexibility in the capital buffer framework; (iii) the streamlining of activation procedures, where these do not add value in terms of safeguarding the Single Market; and (iv) provision of a review clause to allow for further adjustments in the future. The following paragraphs motivate and further specify these proposals.

Changes introduced in the Pillar 2 framework

Besides clarifying the institution-specific nature of Pillar 2, the European Commission’s proposal provides for refinements to the Pillar 2 framework, distinguishing between “requirements” and “guidance”. This is in line with current ECB banking supervision practice, in which Pillar 2 capital add-ons are split into two components: (i) a binding Pillar 2 requirement that addresses risks not adequately covered by Pillar 1 requirements; and (ii) a Pillar 2 guidance (P2G) element that serves as a guide to the appropriate level of capital needed as a buffer to withstand stress scenarios.

The policy objective of P2G should, however, be better defined to avoid possible overlaps with other macroprudential instruments, in particular the combined buffer requirement. While the Commission proposal introduces a clear and distinct allocation of responsibilities and instruments between the microprudential and macroprudential authorities as regards Pillar 2 requirements, it does not clearly set out the policy objective of P2G and its interaction with the combined buffer requirement. For instance, the Commission text specifies that the P2G should be used to ensure that cyclical economic fluctuations do not lead to a breach of banks’ capital requirements. This specification may lead to a double counting of risks with other instruments, in particular the countercyclical capital buffer (CCyB), which is intended to act as a buffer against cyclical risk. Further clarification is needed to avoid possible overlaps between P2G and the buffer requirements.

Risk weights for residential and commercial real estate exposures

The tasks and powers of competent and designated authorities in setting higher risk weights for real estate exposures should be better delineated. In the current framework, Articles 124 and164 of the CRR define rules on increasing risk weights and loss given default (LGD) floors for residential and commercial real estate exposures respectively. The aim of these articles is to increase banks’ resilience towards risks stemming from the real estate sector. Currently, these articles can be applied by competent (i.e. microprudential) authorities both from a micro- and macroprudential perspective.[8] This hybrid use of the tools may lead to confusion in their objective and to potential inaction bias. At the same time, Articles 124 and 164 do not provide for macroprudential authorities’ involvement. Short-term changes to the macroprudential toolkit should therefore envisage competent authorities maintaining the use of these tools to deal with risks to firms’ safety and soundness, provided that their scope is narrowed to a microprudential use. At the same time, the macroprudential toolkit should also include instruments that can target the systemic dimension of these risks. In this regard, a separate article providing for a macroprudential use of these instruments, namely to apply targeted risk weights at a sectoral level and LGD floors for macroprudential purposes on a system-wide basis, should be included in the legal framework. This would provide a clear allocation of distinct sets of instruments and responsibilities to the competent and designated authorities, enhancing accountability and therefore increasing the effectiveness of the policies.

Systemic risk buffer (SRB)

The policy objectives of the SRB should be clarified and its effectiveness enhanced. The CRD foresees that the SRB should aim to address systemic risks of a “long-term non-cyclical” nature pursuant to Article 133 of the CRD IV. Initial practical experience has shown that the various capital buffers for addressing structural systemic risks in the banking sector, namely the SRB, the other systemically important institution (O-SII) buffer and Pillar 2, are currently being used by some Member States to address similar risks. Such overlaps in the use of macroprudential tools should be eliminated without limiting the tools authorities have at their disposal to address risks in an appropriate way. This would also allow the SRB and the O-SII buffer to be additive in all cases and thereby make a clearer distinction between these two instruments.[9]

In this regard, the CRD IV should clarify that the SRB is not be applied to address risks related to the O-SII buffer framework. A clear delineation of the scope of both tools would enhance transparency in their use. At the same time, given that the SRB could no longer be used to address risks linked to the size of an institution, the existing cap on the O-SII buffer, including the cap for subsidiaries, would have to be increased to a level that is commensurate with the associated systemic risk, while still maintaining a level playing field.[10]

With regard to the effectiveness of the SRB, the ECB suggests making the instrument more flexible in various ways. Particular consideration should be given to: (i) allowing a targeted use of the instrument; (ii) imposing the mandatory transposition of the SRB into national legislation; and (iii) removing the “pecking order” for its activation, which currently requires other macroprudential instruments to be considered before the SRB can be activated.

As regards a more targeted use of the SRB, the ECB suggests allowing a sectoral activation of the instrument. This could be achieved by clarifying that the SRB can be applied to sectoral domestic exposures.[11] This would allow authorities to address risks in specific sectors in a more flexible manner, as they could address risks developing in a specific part of their financial system. In practice, the reference to “long-term non-cyclical" systemic or macroprudential risks should be removed from the legal text, as there are no generally accepted definitions of these terms; removal would also facilitate sectoral application.

Imposing a mandatory transposition of SRB requirements into national legislation should be considered. Currently, Member States can choose whether to do so or not. Introducing mandatory transposition would reinforce authorities’ flexibility in addressing risks more adequately. This would also address level playing field concerns, arising from an inconsistent transposition of the instrument, and would facilitate reciprocation of the SRB across the European Union.

Finally, the full removal of the “pecking order” for the activation of the SRB would help avoid inaction bias and contribute to an adequate choice of instrument. Instruments should be chosen according to the risks identified by authorities and on the basis of their relative effectiveness, and not based on mandatory sequencing. Sequencing may lead to inadequacies and a loss of transparency in selecting instruments, as authorities may use an instrument for purposes other than those for which it was originally designed. This does not preclude transparency and clarity in authorities’ justifications of what has led them to choose one tool over another, and how they expect the tool to address the risk identified.

Other systemically important institution (O-SII) buffer

The cap on the O-SII buffer should be raised to a level that is commensurate with the associated systemic risk. According to Article 131 of the CRD IV, the O-SII buffer and the global systemically important institution (G-SII) buffer aim to address banks’ structural systemic footprint. In the existing framework, the O-SII buffer is capped at 2% of the total risk exposure (RWA). Practical experience and economic analyses show that the current 2% cap may not be sufficient to mitigate the systemic and macroprudential risk these institutions can pose at the domestic or EU level.[12] This holds, in particular, for institutions that have a strong regional presence in a number of EU Member States, thus constituting a significant systemic risk at the national and EU levels.

The current O-SII framework promotes an undesirable practice whereby instruments designed to address structural systemic risks[13] are being used by authorities to address risks that should be addressed by the O-SII buffer. Each of these instruments is associated with different activation mechanisms and reciprocity arrangements, with different authorities – either competent or designated – also being responsible for their activation. This is likely to lead to a burdensome and opaque activation procedure and shows that the O-SII framework, as currently designed, is not effective in addressing the risks envisaged. In this regard, the O-SII framework should be revised according to the general principle that the policy objectives of macroprudential measures should be clarified in the legal text and overlaps eliminated without limiting the tools available to authorities for appropriately addressing risks.

Countercyclical capital buffer (CCyB)

The implementation process for the CCyB should be simplified and its coordination mechanism further streamlined. The CCyB, as set out in Article 136 of the CRD IV, is designed to strengthen the resilience of the banking sector during periods of excessive credit growth. Currently, national authorities are required to announce the setting of the CCyB rate on a quarterly basis by publication on their websites. Given that credit cycles usually span a longer period of time than the average business cycle length of around eight years, the corresponding activation and notification procedures on a quarterly basis are considered as overly lengthy and cumbersome, and may possibly result in some inaction bias.

To ensure that macroprudential authorities can address systemic risks in a timely manner, the activation process for the CCyB should be streamlined in such a way that each designated authority assesses the appropriate CCyB rate on a quarterly basis but sets or resets the rate only if there is a change in the intensity of systemic risks associated with excessive credit growth. In this context, the procedures for notification of the CCyB rate should also be amended to require designated authorities of Member States participating in the SSM also to notify the ECB of certain information relevant for the analysis of cyclical systemic risks in a Member State, so that the ECB can fulfil its financial stability mandate in a timely manner.

Review clause

Providing a review clause for the macroprudential framework is key to the continuous assessment of the efficiency and effectiveness of its instruments. The macroprudential framework is still in its infancy and, therefore, flexibility to adjust the toolkit and to strengthen the efficiency of its instruments will be key as further experience with the framework is gained. This particularly concerns the possible extension of the toolkit to address systemic risks stemming from non-bank activities. It is therefore suggested that a thorough review of the macroprudential framework, including the scope and appropriateness of the toolkit, is conducted by 2020, with revisions at regular intervals in the future.

2.3 Medium-term revisions to the macroprudential policy framework

Looking ahead, a comprehensive review of the macroprudential framework is warranted to enhance the effectiveness of macroprudential policy. The targeted changes discussed in the previous section would already allow some of the lessons learned from the experience gained so far to be taken into account. However, this should only be the first step towards a more thorough revision of the framework in the medium term. A comprehensive review would allow a reduction in complexity, the streamlining of procedures and enhancement of the coherence of the policy framework, as well as an extension of the framework to include new tools where necessary.

A comprehensive review would provide an opportunity to create a single macroprudential toolkit, in the hands of macroprudential authorities, to address systemic risks stemming from the banking sector. At present, references to macroprudential tools and the procedures to determine the designated authority in charge of a particular tool are scattered across the CRR and CRD IV, leading to confusion on the use of the tools and their application by authorities. Descriptions of the macroprudential use of instruments included in the CRR, as well as of the powers of macroprudential authorities, could be set out in a new chapter of the CRR, clearly allocating macroprudential tools to macroprudential authorities under a single activation procedure. Similarly, the harmonised use of the macroprudential instruments included in the CRD IV could be described in a dedicated chapter of the Directive.

Streamlining activation requirements would ensure that authorities chose specific instruments on their own merits and not on the basis of procedures. In particular, the existing hierarchy for the sequencing of the activation mechanism (the so-called “pecking order”) requires authorities to use tools in a specific order, rather than on the basis of the expected efficiency of the tool to address the risks they have identified. Removing such mandatory sequencing from the CRR/CRD would increase authorities’ flexibility and also enhance their accountability in the use of the tools at their disposal. This, together with establishing a unified and simplified activation procedure for the use of the macroprudential tools provided for in Article 458 of the CRR would allow macroprudential authorities to act in an efficient, effective and timely manner.

The mandatory reciprocity framework should be broadened to ensure the effective mitigation of cross-border spillover effects and regulatory arbitrage in the European Union. While toolkit flexibility is crucial, it is still important for the EU macroprudential framework to provide a sufficient degree of coherence between the instruments and across Member States, thereby minimising regulatory arbitrage opportunities. Extending the reciprocity framework would therefore enhance the consistency in the application of the tools and safeguard the level playing field in the Single Market. At the same time, the reciprocity framework should not lead to reciprocity in undue cases, for instance where there is no material impact. When reciprocating, Member States may therefore exempt financial institutions with non-material exposures (via the de minimis exemption).

The review should ensure that macroprudential authorities, including the ECB in its macroprudential tasks, have the necessary tools to hand to address the various emerging risks in a timely and effective manner. The existing capital and liquidity-based measures, currently part of the toolkit for banking, should be complemented with instruments addressing sectoral and activity-related risks. In this regard, macroprudential authorities should have targeted instruments in their toolkit to counter potential risks in the real-estate market given the importance of this market segment in the financial cycle and the role played by real estate crises in past financial crises.

The ECB also suggests making the framework more comprehensive by complementing capital-based instruments with borrower-based instruments in EU legislation. Economic analyses show that targeted instruments that strengthen the resilience of borrowers, such as limits on loan-to-value and loan-to-income ratios, may be more effective than capital-based measures in mitigating household leverage and residential real estate price exuberance[14]. These instruments have a more direct impact on mortgage markets and have proven to be effective in addressing risks in the real estate sector, when these are associated with borrower stretch. Further macroprudential instruments could also include sectoral concentration limits and the leverage ratio.

The establishment of the banking union and the initiative to develop a capital markets union (CMU) reinforce the need to strengthen macroprudential policy at the European level. A fully fledged review of the macroprudential framework would provide an opportunity to align the framework with the progress made in the regulatory and supervisory frameworks for the banking sector following the establishment of the banking union, notably in view of the institutional changes brought by the establishment of the SSM. Owing to an increasing shift to market-based financing, mainly deriving from increased regulation in banking and incentives stemming from the CMU Action Plan, a review would also allow broadening of the framework to non-banks. Here, the framework and the powers of the related authorities at the EU level need to be strengthened to address possible risks emerging in the securities markets and in the insurance and pension sectors. While more work in the area of macroprudential tools for non-banking is needed, such instruments could include margin and haircut requirements for derivatives and securities financing transactions, and leverage and liquidity requirements for investment funds.


3 Conclusions

A robust and properly designed regulatory framework is a precondition for the effective conduct of macroprudential policy in the European Union. This is even more important in the euro area, where macroprudential policy plays a key role in addressing country-specific risks and vulnerabilities. Although the existing rules already provide a solid basis for the application of macroprudential policy tools across jurisdictions, the macroprudential framework is still incomplete and in certain elements overly complex and inconsistent. In the short term, improvements can be achieved in the context of the current negotiations on the CRR and the CRD IV to compensate for the Commission proposal on removing the use of Pillar 2 for macroprudential purposes, thereby ensuring that the macroprudential toolkit remains flexible and efficient. In the medium term, a comprehensive review remains nevertheless needed to extend the toolkit both for banks and non-banks, and to streamline the activation and coordination mechanisms to ensure financial stability and thus protect the Single Market. The ECB, as a macroprudential authority for the SSM, remains committed to contributing to the improvement of the macroprudential policy framework in the European Union and globally.

© European Central Bank, 2018

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ISSN 2467-1770 DOI 10.2866/351597
ISBN 978-92-899-3195-3 EU catalogue No QB-CA-18-001-EN-Q


[1]Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions (OJ L 287, 29.10.2013, p. 63).
[2]In particular, Article 5 of the SSM Regulation provides that the ECB may, if deemed necessary, apply higher requirements for capital buffers than applied by the national competent authorities or national designated authorities of participating Member States. These capital buffers are to be held by credit institutions at the relevant level in addition to own funds requirements. The ECB may also apply more stringent measures aimed at addressing systemic or macroprudential risks at the level of credit institutions subject to the procedures set out in Regulation (EU) No 575/2013 and Directive 2013/36/EU in the cases specifically set out in relevant Union law.
[5]See the speech by the Commission Vice-President, Mr Dombrovskis, on 19 May 2017.
[7]See the European Commission’s overview of Prudential requirements.
[8]Articles 124 and 164 of the CRR foresee that authorities may impose stricter risk weights and LGD floors on the basis of financial stability considerations.
[9]Currently, when an institution is subject to both an O-SII buffer and an SRB and the latter is imposed on all exposures, the higher of the two buffer rates applies. However, when the SRB is imposed solely on domestic (or foreign exposures), the overlap between the two buffers is more limited and the two buffers are cumulative.
[11]Currently, the SRB can be applied to all exposures or to domestic exposures only. Therefore, the SRB could be made more flexible by clarifying that the SRB can be applied to a subset of domestic exposures.
[13]Namely the SRB and Pillar 2.
[14]See, inter alia, Cerutti, E., Claessens, S. and Laeven, L., “The Use and Effectiveness of Macroprudential Policies: New Evidence”, IMF Working Paper, No 15/61, 2015; and Claessens, S., Ghosh, S.R. and Mihet, R., “Macro-Prudential Policies to Mitigate Financial System Vulnerabilities”, IMF Working Paper, No 14/155, 2014.