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Capital market activities (repo, market making…): regulatory impacts and future trends - Economic and monetary challenges

Promoting European growth: potential unintended consequences of bank capital and funding rules

By Jennings Jeff - Managing Director, Head of Prime Services EMEA, Credit Suisse

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To revive economic growth and promote investment in European companies and infrastructure, the European Commission’s Capital Markets Union aims to shift credit intermediation to become less reliant on banks, and more on capital markets. It will take time to achieve a material rebalance; in the interim there are obstacles in the current bank regulatory framework that must be addressed to facilitate this transition.

The efficiency of the capital markets relies in large part on the health of the secondary markets, where banks play a crucial role as liquidity providers. However, bank activities have become increasingly constrained under new capital and funding rules. As an example, certain aspects of the leverage ratio adversely impact centrally cleared products. Consider a pension fund that invests in equity index futures and clears these transactions through a central clearing house via their prime broker. Though these are traditionally liquid, transparent markets, under the new rules cleared products are ascribed an exposure measure commensurate with products that have an inherently different risk profile, increasing costs for the bank, pension fund, and ultimately, for the end investor.

We need to take a close look at how individual regulatory measures like the leverage ratio or net stable funding ratio impact each element of a bank’s activities, and consider the cumulative impact.

Acting in an intermediary function, banks help “grease the wheels” of the secondary market, increasing liquidity and efficiency, and reducing costs for the real economy. We need to take a close look at how individual regulatory measures like the leverage ratio or net stable funding ratio impact each element of a bank’s activities, and consider the cumulative impact.

If we agree that Europe needs more capital market activity and ultimately more equity risk capital for productive investment in the system, then we must calibrate impending prudential regulation with an understanding of the impacts across the system. While a more stable funding model is critical, our aim should be to avoid side effects that penalize economically useful activity. We are strongly supportive of the European Commission’s Call for Evidence on the “EU Regulatory Framework for Financial Services” as a mechanism to identify, assess, and address such issues.