I would like, first, to distinguish between two arguments normally used to defend the application of the proportionality principle that are often link in the public debate. On the one hand, there are those who argue that the non-application of this principle, insofar as regulators went too far and legislation is excessive, may be generating more costs than benefits. On the other hand, there are those who defend the proportional application of the regulation and supervision by virtue of the characteristics of the banking institutions. That is to say, they argue that the current regulation and supervision corresponds too much to a one-size-fits-all model and that, therefore, we should move towards a more tailor-made model that adapts the different requirements and controls to the nature of the diverse business models that coexist within the European banking sector.
So far, no impact assessment covering all the regulatory reforms adopted in recent years exist so I will not comment on whether a cost-benefit analysis would yield a positive or negative result. Although let me clarify that I am among those who believe that we have not over-regulate and gone to the other extreme of the pendulum, after the period of deregulation prior to the crisis.
In this sense, I want to limit my intervention to the second debate, the one that defends a greater granularity in the adoption and application of financial regulation and supervision.
In any case, it is important to separate both approaches because the proportionality debate is often use, not to achieve a better fine-tuning in the application of regulation or supervision, but to openly question all the effort invested in recent years in regulating the financial market.
Concentrating, then, my intervention on the convenience or not of adopting the principle of proportionality in banking regulation, as I see it, and especially in Europe, I would like first to present another principle that I always follow when faced with a new legislative proposal.
In general, my preference always goes to defend a universally applicable regulation that avoids the creation of regulatory niches and potential loopholes that only encourage arbitrage and distort business decisions.
I tend to favor simple and universal regulations against the temptation of the regulator, always influenced by specific interest groups, to adopt safeguards, exceptions, or particularities for one or another sector or for one or another entity, which in the end ends up generating some legislative texts that are sometimes incoherent and difficult to comply with. Therefore, from a general point of view, I must say that when I hear that the application of the principle of proportionality in a certain regulation is necessary, in an intuitive way I always think of the exception to the rule being require by some pressure group.
It is also necessary to take into account that any «proportional» application of regulation or supervisory practices should not generate undesired incentives for bank managers. While it is true that the regulation itself always affects managers’ decisions (after all that is their goal, that is why laws are made) it is also true that not all of those «induced» decisions are in the regulator’s intention. Therefore, it is necessary to scrutinize in depth the incentives, or disincentives, created by regulation, not only for its entirety but also for its «proportional» application. When the legislation allows for different application of the rules justified by the profile of the regulated, it could encourage the latter not to make decisions that could, in the end, correct the need for such proportional application of the rule.
Therefore, the principle of proportionality incorporates also a problem of potential undesired consequences. If any regulation can lead to meddling in the management of the entities to the point of encouraging undesirable decisions and risky behavior, its proportional application may further increase this problem.
Nonetheless, I recognize that sometimes to achieve a level play field it is necessary to treat those who are not equal, differently. Therefore, I concede that it is necessary to rethink the reality of legislation and supervision by virtue of the principle of proportionality. However, it is important to stress that, although having competitive financial markets is one of the objectives of good regulation, so is, obviously, financial stability or the general well-being of the consumer, be it saver or debtor.
Certainly, these objectives might be difficult to reconcile.
In fact, and especially after the crisis, little has to be said about the necessary financial stability for the achievement of healthy and sustainable economic growth in the medium term. However, this objective may collide with the maximization of competitive conditions in the banking market and with consumer satisfaction and protection to the extent that the supervisor may prohibit or discourage the provision of some services to end customers.
I will abstain referring to the existing tension between the principle of financial stability and the management of monetary policy that conditions competition in the given final market. In fact, the input price of the banking production process, if such expression can be use, is determined by a public monopolist entity such as central banks. In this way, the competitive principle has always been conditioned in the banking market, to the very existence of monetary policy.
So, let me again clarify that, among the three objectives referred to previously, and in light of the crisis experience, which, I believe, was quickly forgot, I place financial stability above the rest.
In the last decade, we have decided to make the financial sector less volatile and risky, assuming implicitly the reaching of lower peaks in growth, in exchange for having a safer sector, not undermining, nevertheless, higher levels of structural growth. The main objective was to safeguard against future shocks. All insurance demands a premium, and an increase in costs to which our economy must resist, is one. In the long term, however, this strategy will pay-off with expected growth to be higher.
In my view, in order to maximize financial stability, we should evaluate the application of the principle of proportionality by starting by considering banks’ different business models by virtue of their financial balance sheets.
By examining the liabilities of credit institutions, it is clear that not all of them share the same capital model. On the one hand, there are private banks whose shares are listed on organized markets. On the other hand, there are entities, such as, regional and community banks, savings and loan associations, credit unions or cooperative banks that have (sometimes) mixed (public/private) and, often, less clear ownership systems.
The different property models affect banks in an unequal way in the face of a solvency or liquidity crisis. In some cases, managers can agree on capital increases, in others not so easily. Thus, it would seem reasonable to demand higher capital requirements from those entities that could face serious problems in raising capital in the face of an idiosyncratic or systemic shock and, in turn, demand lower requirements for disclosing information in their periodic reports to the extent that they do not they have ordinary «shareholders».
Similarly, on the asset side, the effects of different financial activities on the risk assumed by credit institutions could be evaluated. Thus, those entities focused on long-term loans or liabilities, for example, mortgage loans and term deposits, assume a relatively lower risk than those focused on short-term activity. Therefore, it would be possible to apply some requirements with special attention to business models, although some of them are already implicit in the calculations of liquidity ratios such as the Net Stable Funding Ratio.
In any case, it is certain that such approach could also be applied in other matters. In this debate, not all the risks in banks’ balance sheets or income statements can be easily identified, especially when the use of internal models is the norm.
The past crisis reminds us that there are risks that derive from the interconnections between banks, that instead of reducing the aggregated risk, as we believed until then, increase it and, what is worse, makes it difficult to calculate, internalize and control.
For this reason, large bank entities have stricter capital requirements, which, in itself, already internalizes the principle of proportionality, which we are discussing around the table today.
However, along with the problem of too-big-to-fail, we can also face a too-many-to-fail problem, which should be enough to make us not to lower our guard with smaller entities.
In assessing all these issues, the European Union has decided to review, among others, the CRR / CRD and the BRRD legislation, a reform that is now under trialogue procedure and I trust that the Council and the Parliament will agree on a common position in the coming months.
As an example for the debate on proportionality, I would like to highlight, among others, the following changes being discuss on the revision of the CRR/CRD:
1. Revision of the definition of small and non-complex institutions;
2. Differentiation in reporting requirements according to size and complexity;
3. Simplified standardized approach for market risks.
As a conclusion, I would like to finish by saying that, although the application of the proportionality principle has its virtues, it should be use carefully, to solve specific unintended consequences resulting from regulation, and never, as a mean to relax demanding requirements and legislation. Financial stability is the legislator main goal and we should ever give it up.