The global financial crisis highlighted that micro-prudential supervision that mainly focuses on safeguarding financial stability at an individual institutional level, was insufficient to ensure stability of overall financial system. Therefore, in addition to the previous supervisory approach, macro-prudential supervision has been introduced that provides for taking appropriate measures in case of increasing cyclical (e.g. excessive credit growth) or structural (e.g. related to systemically important (too-big-to-fail) credit institutions) systemic risks.
In such cases appropriate tools may be applied, i.e. capital buffers established, minimum capital and liquidity requirements increased, more stringent restrictions on large exposures imposed and others.
In Latvia, the Bank of Latvia is the macro-prudential supervisory authority. In accordance with the provisions of Credit Institution Law, the Financial and Capital Market Commission (FCMC) is responsible for application of macro-prudential tools. For the purposes of minimizing cyclical systemic risks FCMC sets and publishes the counter-cyclical capital buffer on a quarterly basis (http://www.fktk.lv/en/publications/macroprudential-supervision/countercyclical-capital-buffer.html). Whereas in order to address the structural systemic risks, under the 25.10.2016 decision of the FCMC Board, the FCMC has identified the following institutions (in alphabetical order) as other systemically significant institutions (O-SIIs):
ABLV Bank, AS
Akciju sabiedrība “Citadele banka”
Akciju sabiedrība ”Rietumu Banka”
AS DNB banka
AS ”SEB banka”
The first FCMC decision on identifying O-SIIs was adopted on 16.12.2015 (http://www.fktk.lv/en/publications/press-releases/5491-fcmc-identifies-other-systemically-significant-institutions-o-siis.html), identifying the same six credit institutions as this year. The requirement to identify O-SII derives from Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (CRD IV). CRD IV requires identification both the global systemically important institutions (no such institutions were identified in the financial sector of the Republic of Latvia) and O-SIIs that are of systemic importance at the EU Member States’ national level.
To identify O-SIIs, the FCMC followed the methodology provided in the EBA guidelines EBA/GL/2014/10. The systemic importance of each credit institution was calculated based on the following criteria: its size, importance (including substitutability /financial system infrastructure), complexity/cross-border activity and interconnectedness. Also the following criteria were used: total assets, value of domestic payment transactions, private sector deposits from depositors in the EU, private sector loans to borrowers in the EU, value of over-the-counter derivatives (notional), cross-judicial liabilities, cross-judicial claims, intra-financial system liabilities, intra-financial system assets, debt securities outstanding.
To increase O-SII loss-absorbing capacity and thus mitigate potential systemic risks of the financial system and reduce costs to the national economy, under Article 35.15 of the Credit Institution Law the O-SII capital buffer is set for the identified O-SIIs. Credit institutions must ensure compliance with the O-SII capital buffer in line with a following transitional period:
|Credit institution||O-SII capital buffer to be maintained as of30.06.2017||O-SII capital buffer to be maintained as of 30.06.2018|
|ABLV Bank, AS||1%||2%|
|AS ”SEB banka”||1%||2%|
|Akciju sabiedrība ”Rietumu Banka”||0.75%||1.75%|
|Akciju sabiedrība “Citadele banka”||0.75%||1.50%|
|AS DNB banka||0.75%||1.50%|
The calibration of the size of the O-SII buffers was based on the equal expected impact method wherein it is dependent on the probability of an O-SII facing a financial distress and its systemic importance. The financial distress is in turn defined as an event where the credit institution faces losses during one quarter amounting to at least 2.5% of its risk weighted assets, which is equal to the size of the capital conservation buffer it is required to hold. The probability of the credit institution to face a financial distress was estimated based on the historical distribution of banking sector return on risk weighted assets (RORWA) quarterly data for period of 2004-2015.
To reduce the probability of financial stress for the identified O-SIIs, it is essential not to only increase the amount of capital buffers to be maintained, but also to ensure that they comply with the highest corporate governance standards. For reasons stated above, in areas related to the risk management and the functioning of the executive and management board and their respective committees, the identified O-SIIs are deemed as systemically important for the purpose of application of certain requirements, as well as they will not be eligible to use certain discretions contained in legislative acts, which may be granted to less significant entities under FCMC’s authorization. The requirements applicable are as follows:
– requirement to develop strategy, policies, procedures and systems that enable the timely identification, assessment, analysis and management of material risks for an institution (Article 34.2 (2) of Credit Institution Law);
– requirement not to exceed the maximum allowed number of directorships a member of the council or the board of directors may hold concurrently in the council or the board of directors of a credit institution (Article 26.1 of Credit Institution Law);
– requirement to establish a remuneration committee (Paragraph 11 of FCMC Regulation No 126; Regulation on Core Principles of the Remuneration Policy of 02.07.2014);
– requirement to establish a risk committee and a nomination committee, and the prohibition on combining the risk committee and the audit committee (Paragraphs 38, 40.1 and 40.2 of FCMC Regulation No 233; Regulation on Establishment of the Internal Control Framework of 01.11.2012).
The FCMC will review the list of identified O-SIIs annually and stricter requirements may be applied to them in the future.
Macro-prudential supervision in Latvia
In Latvia, the Bank of Latvia is the authority responsible for macro-prudential supervision. The Bank of Latvia, the Ministry of Finance and the Financial and Capital Market Commission have entered into a cooperation agreement on promoting financial stability, and the Macro-prudential Council was established in 2013. The Governor of the Bank of Latvia presides over the meetings of the Macro-prudential Council with participation of the finance minister and FCMC chairman.
Further information on the identification of O-SIIs is available in the section “Macro-prudential supervision” on the FCMC website: http://www.fktk.lv/en/publications/macroprudential-supervision/other-systemically-significant-institutions.html.
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