Large, global banks may be avoiding the higher capital requirements that come with being designated as “systemically important” by prettying up their balance sheets ahead of assessment time, new research suggests.
In a new staff working paper published by the Bank for International Settlements (BIS), researchers from the BIS, the European Banking Authority and the University of Basel found that banks appear to “window dress” their balance sheets at year-end — by temporarily reducing their derivatives positions, for example — which may enable them to face less stringent regulation under the regime for overseeing global systemically important banks (G-SIBs).
Tougher regulation of G-SIBs was adopted in the wake of the global financial crisis. Each November, the list of G-SIBs is updated and banks are categorized based on their systemic importance, with “more important” banks facing higher capital requirements and closer supervision.
These assessments and banks’ rankings are largely based on the condition of bank balance sheets at year-end.
The researchers found that banks’ G-SIB scores appear to be “compressed” when measured at year-end compared with their estimated quarterly scores.
“Our analysis uncovers a large and systematic contraction in the score of EU G-SIBs at year-end,” the paper reported. “These adjustments distort the supervisory assessment of banks’ systemic importance.”
In some cases, the adjustments reduced the banks’ capital requirements, the paper noted. “Moreover, a few banks appear to have avoided G-SIB designation altogether in some years.”
The researchers concluded that the discovery of this window-dressing behaviour creates an argument for “moving away from using point-in-time data in regulatory requirements and making greater use of averages.”
Further, the findings “also highlight the importance of supervisory judgment in the assessment of G-SIBs. This could help address banks’ window dressing and mitigate any associated adverse impact on financial markets,” the paper said.