TITLE:
Regulating Liquidity Risks within “Institutional Protection Schemes”
AUTHORS:
Thomas Stern
KEYWORDS:
Liquidity, Liquidity Risk, Basel, IPS, Institutional Protection Schemes, Rabobank, CRR, Financial Regulation, Banks
JOURNAL NAME:
Beijing Law Review,
Vol.5 No.3,
September
29,
2014
ABSTRACT: During an early phase of the financial crisis (2007), many financial
institutions—in spite of adequate
capital levels—faced
heavy difficulties because they didn’t manage their liquidity profile in a
prudent manner. Suddenly the crisis reminded the respective sector on the
importance of liquidity to the proper functioning of financial markets. In
front of the times of crisis, asset markets were broad and deep, funding was
readily available at low cost. The quick change in market conditions showed how
fast liquidity can dry up, and that illiquidity can endure for an extended period
of time. The banks faced severe stress, which required actions by central banks
to—one the one
hand—keep alive
both the functioning of capital and money markets and—on the other hand— support individual banks or banking groups,
which lost their most important funding sources. The impact of a liquidity
crisis broadly differs among jurisdiction, markets and concrete market participants.
Empirically banks, which were very reliant on interbank funding and closely
connected to other financial institutions, suffered during the crisis more than
e.g. banks with a business model in favour of funding by retail deposits and
holding sufficient Liquidity buffers. Especially in Austria and Germany, there
is a phenomenon rising of so called “Institutional Protection Schemes” (in the
following: “IPS”). The establishment of an IPS means the foundation of a
“contractual or statutory liability arrangement which protects those
institutions and in particular ensures their liquidity and solvency to avoid
bankruptcy where necessary” (Article 113 para 7 CRR). Currently it seems that a
huge part of Austrian banks (about 800 institutions in total) will apply for a
membership in an IPS. Given that banks within the same IPS are strongly
connected and the role of an IPS is to ensure the ongoing solvency and
liquidity of its member institutions, such banking networks may create special
needs for liquidity risk management and supervision. This paper deals with the
question whether IPS’ are sufficiently regulated by CRR and CRD IV, focusing on
the topic liquidity and liquidity risk. As mentioned, the basic notion of Basel
III focuses on banking groups, not on banking networks and by no means on IPS.
This raises the question whether the scope and content of the European
regulations regarding liquidity risk deals with networks of banks, especially IPS,
in an appropriate manner.