The European Commission has published a speech by Charlie McCreevy (European Commissioner for Internal Market and Services) entitled The credit crisis - Looking ahead.
In his speech Commissioner McCreevy identifies certain problems that have occurred in the world’s capital markets over the past 18 months. These are:
- In the case of legislators there had been too much "regulatory capture" by the sell side of the financial services market. By contrast there had been too little engagement on the buy side. That is an imbalance that legislators must be much more conscious of.
- A second problem for regulators, supervisors, and credit rating agencies was the pressure on the availability of adequate resources. A common problem across all markets was that when the investment banking markets were booming, regulators and supervisors found it difficult to get the budgets and the resources to keep up with innovation or to police the markets. In the future, Member States will have to commit the necessary resources to ensure that oversight of risk management in financial institutions is more robust. It must be subject to much more detailed and frequent hands-on supervisory inspections.
- A third problem is misaligned incentives. Incentive structures have been too aligned to short term performance rather than performance through the cycle. Commissioner McCreevy states that tougher measures in the revised Capital Requirements Directive will require thorough independent due diligence on securitisations, proper cash flow sensitivity analysis, and less reliance on issuer pay and conflicted credit rating agencies. Originators or managers of these securitisations will be required to retain a meaningful stake in each tranche of the securitization issue.
Commissioner McCreevy also states that accounting standards and capital requirements have also exacerbated the markets' recent problems because of rules that are "pro-cyclical". When market liquidity becomes tight, sales decisions and valuations based on the so-called 'mark-to-market value' reinforce the downward spiral. They result in further forced sell-offs, which in turn reinforce and amplify the falls in mark-to-market prices.
Commissioner McCreevy states that he would like to see a return, more broadly, to dynamic provisioning by banks. A system that introduces significant counter-cyclicality, requiring banks to build up buffers in good times, makes sense when trying to reduce bank failure. It also restrains excessive expansion during boom times. It also reduces the likelihood of a more diminished capital base in times of recession which makes it more difficult for banks to lend which prevents economic recovery.
View EC speech - The credit crisis – Looking ahead, 9 February 2009