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Laura Casini 701816 Meetings with the Banking and Financial Industry

CASMEF Working Paper Series: Financial Regulation and Supervision in Europe: Emerging Trends, Costs and Effectiveness As a consequence of the tremendous impact of the crisis of 2008 and the 2010-2011 sovereign debt crisis, European financial regulation and supervision have undergone drastic and needed changes over the last year. The financial crisis, in one hand, triggered financial regulation and supervision’ developments; on the other hand, it brought questions on supervisor’ performance (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Financial problems and crisis have always been controlled by the financial regulation and its objectives are distributed at two different level: the micro-financial stability level, which consists the preservation of the stability of individual firms; and the macrofinancial stability level, regarding the financial system as a whole (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Moreover, another important objective is the protection of savers and investors, which is considered crucial in order to facilitate the channeling of resources from surplus entities to deficit entities, also through the mitigation of asymmetric information problems, with transparency and disclosure requirements. Last but not least, financial regulation and supervision aims at the efficient and competitive functioning of banking and financial markets. These objectives are achievable by the act of entrusting regulatory and supervisory authorities with the necessary powers and tools. Countries over time, has chosen different institutional structure of regulation and supervision: different architectures point out different visions regarding the best approaches and strategies used in order to achieve the desired goals. Over the last three decades, these structures have been subjects of transformation in a large number of countries. As the authors of the working paper stated: “These transformations were driven by dramatic changes in the structure and functioning of financial markets, triggered or at a minimum facilitated by deregulation and crosssector integration in the financial industry” (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). The study of Professor Jacopo Carmassi, Professor Domenico Curcio and Professor Giorgio Di Giorgio

aims at overviewing the emerging trends in financial regulation and supervision at European Level, with a particular focus on various institutions, the role of central banks and the post-crisis reforms both at individual courtiers and at European level. Moreover, the research aims at lighting the direct costs of regulation and supervision. The empirical study of this research analyses the fact that the supervisors’ trend has become larger over time, in term of budget and of number of people involved, also due to problems and failures of previous regulations and supervisors. Authors observed a heterogeneity across national systems and different supervisors in terms of direct costs data availability and reporting practices. They emphasizes the belief that a comprehensive analysis of supervisors’ performance cannot be based only on a cost-side evaluation, even if it is adjusted to account for the dimension of supervised industries and markets. Quantitative and qualitative indicators are needed in order to evaluate supervision effectiveness (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). In the first chapter of the selected working paper, authors point out an overview of the main approaches used in order to achieve financial regulation and supervision, especially on the institutional architectures and with a particular focus on their evolution in advanced countries, putting a special attention for Europe and the Euro Area (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Authors came out with two main beliefs after major crisis: the first is that the single regulator model (the one used by regulators until that point) is not the best model, the second is that the action of splitting micro and macro-prudential supervision can be considered a risky choice and the two functions should be taken under the supervision of the central bank (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). As a consequence, some countries (e.g. UK and Belgium) have abandoned the single regulator model; instead, in other countries as Germany single regulation is still in place. In general, the institutional arrangements for supervision across countries have been uneven and heterogeneous across countries. This leads to a complex distinction of different national supervisory architectures. Moreover, the first chapter explains the creation of the Single Supervisory Mechanism (SSM), which is the latest step of a 20-year long series of transformations of regulatory 2

and supervisory institutional arrangements in European countries. Authors concluded that nowadays there is not a final and efficient regulation and supervision which permits a secure financial stability at a micro and macro level. Following, the second chapter of the represented study paper regards the cost of financial supervisions. Authors divide the costs of regulations in those three classifications: 1. Direct cost, which are borne by the authorities, the financial industry and the state as a whole in order to allow the effective performance of the activity of regulation and supervision; 2. Indirect or incremental costs, which are needed to comply with regulatory requirements. Those costs are called incremental because they can be regarded as an alternative scenario without regulation and regulators; 3. Distortion costs, which are costs deriving from the potential distortions created by regulation. The empirical analysis in this chapter is focused on the measurement of direct costs of supervision and costs’ relative revenues. Authors find out that the two measures are often close to each other, in fact, costs are paid mostly with fees raised on supervised entities, and such fees are set in order to cover supervisors’ costs. In data analysis, the authors have chosen not to include the number of surplus in total revenues of authorities, in order to be able to focus only on the revenues of each year corresponding to the costs borne. Results indicates that the size of UK authorities is by far the largest, both with the now abolished FSA and with the new regulators by objectives, PRA and FCA (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). The Bank of Italy follows, while BaFin and ACPR are half as big as the Bank of Italy supervisory division in terms of costs of supervisory activities. All other authorities are much smaller (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). The most relevant component of total expenses is the cost for personnel which includes net salaries, taxes and pension contributions. Authors pointed out that the share of this cost on total costs is generally 3

between 60% and 80%: therefore, they believe that an accurate analysis of these costs appears important (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). It is needed to evaluate the impact on the industry of the market-based funding mechanism. The first measurement to take into consideration is the number of people working for the supervisors, which consists of: full-time employees, workers with temporary contracts. Researches demonstrate that, across countries, the number of employees of supervisors has a huge variance. Results on researches pointed out that countries, which adopts a single regulation approach appear to have larger staff members (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Since the size of supervised financial markets can be different, authors calculated a ratio between staff units of supervisors and size of financial markets. It showed that single regulators are still the ones with larger staff members. However, another interesting information has been provided by this ratio, which is the ‘central bank effect’. According to authors it consists of “Bank of Italy staff involved in supervision, compared to the size of financial markets, has a magnitude which is in line with other single regulators, much higher than the other supervisors by objectives” (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Those factors discussed of this chapter, lead to the conclusion that, after the correction of financial markets size, single regulators remain among the largest, but supervisors, as well, may also have a considerable size. Moreover, after those considerations, authors calculated the ratio per capita cost of staff among market regulators across countries and the size of financial markets. The results showed that despite the highest number of staff members, single regulators appear to be able to keep the unitary cost of staff lower than multiple regulators. Furthermore, the empirical analysis of direct costs of supervision pointed out different indicators (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). First, supervisions and supervisors has become larger over the time, in term of both budget and staff involvement. Second, there is no a political interference in the financial supervision in the marketbased system of supervisors. Third, direct costs are heterogeneous across authorities but the size of the supervised industry and the market has to be taken into consideration. Fourth, in order to not have size bias, direct costs should be related to the number of staffs employed. Fifth, data of cost of 4

staff of supervisors are generally publicly available, however, different countries use different reporting format. The third and last chapter of the working paper discusses the effectiveness of the financial supervision. In the first part of the chapter authors describe and evaluate the measurement of effectiveness of financial supervisions, which it goes beyond the analysis of the cost-side. Authors evaluated the performance measurement, which permits supervisors to show the benefits of an industry to its shareholders. However, measure the effectiveness of financial supervisory practice is not straightforward because it is difficult to provide causality in analyzing financial institutions’ behaviour (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Furthermore, there is a conflict between the short- and long-term effect of supervisors’ interventions (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Thirdly, the level of confidentiality among shareholders regarding the effect of financial supervisions is not clear and it is different in different countries (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Authors, in order to measure the effectiveness of financial supervision uses different indicators: effort indicators, effect indicators, hard indicators and soft indicators. Effort indicators include input and throughput do not show supervisory effectiveness but it could be used to measure supervisory effectiveness. Effect indicators can be divided into three main categories: output, intermediate outcome and final outcome. Furthermore, hard indicators examine how market players evaluate the risk profile of a financial institution. Those indicators take into consideration the credit ratings, stock prices and the level of credit default wrap spread. Last but not least, the soft indicators encompass qualitative information. On example is public confidence. Authors came to the conclusions that during the last decades and because of the different crisis, the effectiveness of the financial supervisions have been increased. At the same time the frequency of supervisions increased. Recent events pointed out that there is the need of a more internationally oriented supervision for cross-border institutions. In order to best evaluate the effectiveness of financial institutions, supervision has to be intrusive, in the sense that financial supervisors have to be involved in the daily monitoring of the industry (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). 5

Moreover, authors claimed that: “In order to make financial supervision more effective, the policy and institutional environment must support the supervisory will and ability to act. This means that the following requirements should be satisfied: i) a clear and credible mandate; ii) a legal and governance structure that promotes operational independence; iii) adequate budgets that provide sufficient resources; iv) a framework of laws that allows for the effective discharge of supervisory actions; and v) tools commensurate with market sophistication” (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). Finally, analysis on the effectiveness of supervision, thought hard indicators do not indicate a correlation between higher cost of supervisions and higher benefits made by financial supervisors. The concluding remarks of the working paper regards the fact that the future shape of financial regulations and supervision in Europe will entails cultural changes and an overall comparison of different models, approaches and experiences among European Countries. Supervisory and regulatory costs, are expected to increase in the future, especially for smaller entities. Furthermore, financial institutions which have di deal with different supervisory and regulatory jurisdictions, would suffer from the complexity of the intuitional structure and of the fragmentized financial regulation and supervision. From those conclusions authors claimed that “this research can foster a debate between regulators, supervisors and the financial industry in order to actually share the rationales and objectives of these reforms, to address the issues associated with the cost of the new set of rules and make sure that a concrete increase in the effectiveness of financial regulation and supervision is consistently pursued” (Carmassi, J., Di Giorgio, G., Curcio, D. 2015). In this specific working paper, authors analyzed the developments of the different financial regulations, as a consequence of the different events upcoming during the years; furthermore, they discussed the costs and the actual effectiveness of those financial regulations and supervisions. Moreover, they made a comparison with actual data from all Member State countries in order to have an amplified view of financial institutions and supervisors. Risk management and the role of regulators and supervisors are areas which have been expended in the recent years especially for the 6

good-management of any kind of activity. Nowadays, major companies expanded their request of employment in Risk Management field; this field is really broad and there are different risks which are taken into consideration, starting for risks which entails market as a whole and risks which are specific to single industries. Because of my interest in Risk management, I have chosen the working paper of Prof. Carmassi, Prof. Curcio and Prof. Di Giorgio. I have developed my interest in that field because, before attending the course of Economics and Finance, I have attended the Master course in Risk Management. Furthermore, during the last summer I have been working for a consulting company in Milan; my working area was specifically addressed to Risk management and in particular to Liquidity Risk. Me and my colleagues worked with majors’ Italian financial institutions in order to evaluate liquidity risk management and their internal financial regulations. Because of that experience I have developed a deep interest in liquidity risk and, in particular, this working paper helped me understand that financial supervisors and regulators are essential for the effective functioning of the market as a whole.

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Bibliography Carmassi, J., Di Giorgio, G., Curcio, D. (2015), "Emerging trends in financial regulation and supervision in the European Union and the costs and benefits of financial supervision".

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