VLADISLAV PAVLAT UNIVERSITY OF FINANCE AND ADMINISTRATION, PRAGUE, CZECH REPUBLIC Re-shaping the Global Financial Architecture: Dual SIFIs´ Role

Introduction The aim of my presentation is to explain the role played by big financial institutions in the world economy and to demonstrate the measures proposed by international bodies how the big financial institutions probably will be regulated. The expression „Global Financial Architecture“ has been used at the G20 Washington Summit in 2008 for the first time to label a broad framework of measures necessary for a way-out of the World financial crisis.

Introduction Since the burst out of financial crisis in the USA, big American banks and other financial corporations were attacked by the press: they were accused to be responsible for the financial crisis. But: are they really the main “culprits”? Are they “dangerous” for people? Should they be “dissolved”? Are they to be “punished”? The latest events – the Wall Street meetings and meetings in many European cities show that there is a common opinion that the power if these “giants” should be limited by effective regulation.

Introduction What do we really know about the risks posed by the big financial institutions in national and international economy? During the last decade, intensive research on these questions has been going on. The elements of theory of the so called SIFIs (systemically important financial institutions), was created. This theory is used as a basis for a national and international policy of practical measures limiting the risks and mitigating the negative effects of activities of the big financial companies.

Research results Let us briefly resume the main results of the research on SIFIS. First, the concept of “systemic risk” was re-defined. Second, the concept of “systemic importance” was modified and the “too-big-to-fail” principle was partially abandoned. Third, criteria for recognition of “systemically important institutions” were developed. Fourth, new regulatory instruments on national and international levels were proposed.

Systemic significance of Financial Institutions If systemic risk is dangerous, it is necessary to manage it. The bigger the company, the higher its potential systemic risk for national economy. The role of supervisory authorities is to minimize this risk as much as possible. To be able to manage systemic risks arising from the existence of economically significant financial companies, it is necessary to identify the significance of big financial companies,

Systemic significance of Financial Institutions to classify these companies from the point of view of potential losses caused by their activities, to reduce the number of potentially “dangerous” companies for financial stability. For a long time, the company size was considered to be the most important indicator of its economic power, in other words – for its macro-economic significance.

TBTS DILEMMA On the national economy level, practical problems caused by excessive concentration and a harmful monopolization which is able to damage competition were – under normal conditions – solved by instruments defined in National Antimonopoly Legislation. Until the world financial crisis, the problem of size was known as the “too-big-to-save” dilemma of national regulatory authorities.

Four „C“- s The „too-big-to-fail“ theory supposes that big size companies, in case of a failure, should be saved by state subsidies etc. to prevent further bigger losses caused by their big size. The so called “four C´s”, i. e. contagion, concentration, correlation and conditions were proposed as important criteria for SIFIs´ identification; several categories of SIFIs were defined.

FIVE SIFIs categories Category 1 - size alone or concentration; Category 2 - interconnectedness ; Category 3 - groups with correlated risk-exposure; Category 4 – large financial firms that are not systemically important, but whose failure could have economically significant implications for regional economies; Category 5 – financial institutions not included in the other categories, consisting primarily of community financial institutions

Two SIFIs´ categories Later on, the categorization of financial companies was partially abandoned A new approach – the so-called Bucketing approach - was proposed The Bucketing approach implies the existence of two SIFIs´ categories”: 1. A global SIFI, big in size and affecting the world, called G-SIFIs (for Global SIFIs). 2. A national SIFI affecting only its home country.

BUCKETING METHOD The Bucketing method consists in distinguishing G- SIFIs from other financial institutions, based on systemic importance estimations. The Committee buckets the financial institutions according to quantitative and qualitative indicators. Different policies and regulations will be applied to each bucket.

ALL SIFIs´ REGULATIONS To all SIFIs the following policies and regulations probably will be applied: 1. Higher loss absorbency capacity with application to G-SIFIs (inicially); effective resolution framework; intensive supervision; robust core financial market infrastructures to reduce contagion risk. 2. Supplementary prudential regulations by national authorities.

Global SIFIs´ REGULATIONS 1.Development of Recovery and Resolution Plans; firm-specific cooperation agreement for X-border resolution; 2. Peer Review Council to monitor implementations. It is probable that G-SIFIs will be charged with higher loss absorbency capacities. Such tools as capital surcharges, contingent capital and bail-in- debt instruments for G-SIFIs loss absorbency regulation will be applied.

A new definition of a SIFI A SIFI is a firm whose disorderly failure would cause significant disruption to the wider financial system and to overall economic activity because of its size, complexity and systemic interconnectedness.

SYSTEMIC SIGNIFICANCE Systemic significance of a big financial company or of a financial group/conglomerate can be characterized by the following features: 1. Size, 2. Interconnectedness, 3. Substitutability, 4. Global activity, 5. Complexity.

Dual role of SIFIs What is the role of SIFIs? SIFIs play a dual role in the economy: if they are robust, they contribute to financial stability, if the are vulnerable, they contribute to financial distress.

SIFIs REGULATION AND SUPERVISION The experience of the last world financial crisis showed that regulation and supervision of financial institutions is most desirable. The biggest is an economic entity, the greater is the need for a reasonable and efficient regulation and supervision.

CONCLUSION SIFIs regulation will have to be different according to the different needs of different countries. Some countries are sceptical about the possibility of an efficient international SIFIs regulation according to their view, national regulation and supervision should be preferred.

CONCLUSION At the international level, the discussion on the most suitable regulatory measures is still going on. For the next future, an efficient international coordination is the most desirable goal, and – in my opinion – maximum what can be achieved.

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