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Symposium 'Ethics and Moral Hazard in the Banking Union'

On the 10th November 2016, The Hazelhoff Centre for Financial Law organised a symposium on “Ethics and Moral Hazard in the Banking Union” in the historic Academy Building of Leiden University.

After the financial crisis, ethics and moral hazard became a top priority of regulators. They consider it as one of the primary sources of the latest financial crisis. The European Union (“EU”) tried to tackle the problem by issuing a whole new legislative framework. The European Resolution Mechanism and the possible European Deposit Insurance Scheme aim to create strong safety nets for the Eurozone financial system. At the same time – and perhaps paradoxically – it may be argued that these safety nets lead to greater risk taking, and thus jeopardises the stability of the financial system. Various parties, such as, bank managers, shareholders, depositors and financial counterparties might put their trust in Member States bailing them out. What is more, Member States could be of the opinion that the EU  will bail out their national banking system. Leading experts in this field discussed from their own point of view the relationship between moral hazard and the Single Resolution Mechanism (“SRM”) in connection with the European Banking Union (“EBU”).                                                                                          

The event was chaired by prof. dr. Matthias Haentjens and dr. Gijsbert ter Kuile. Matthias Haentjens is full professor (chair) of financial law and director of the Hazelhoff Centre for Financial Law at Leiden University. Gijsbert ter Kuile currently works as legal counsel at the Secretariat of the Supervisory Board of the European Central Bank (“ECB”).

Bank management and risk taking: psychology & wrong incentives

The first two speakers focused on the issue of risk taking by  bank management. They were introduced by  Professor Haentjens, who gave an introduction on the notion of moral hazard and on several regulatory responses intended to prevent malfunctioning  within the financial markets. Professor Haentjens focused, in particular, on the establishment of the SRM  and the related Bank Recovery and Resolution Directive.

After this short introduction, the floor was given to Mr Frank Elderson, Executive Director of the Central Dutch Bank (“DNB”). , As Executive Director of DNB, Mr Elderson  is currently responsible for the supervision of pension funds, horizontal supervisory functions, banking resolution and legal affairs. In this capacity, Mr Elderson stated that, “as supervisors we cannot prevent moral hazard by financial institutions, but we can diminish the likelihood of bank insolvencies”. Elderson focused on a new type of supervision by DNB, which partly consists of taking psychological assessments at the bank management level. He emphasized that DNB’s supervision is currently better matched to the psychological pitfalls, which lie at the root of irrational behaviour of bank management. According to  Elderson, credit institutions, as well as the ECB, are enthusiastic about this new method as it is considered  as an opportunity to stimulate ethical behavior by bank managers.

The second speaker of the symposium was Petra van Hoeken. She is a member of the Executive Board and Chief Risk Officer at Rabobank. During her speech, Van Hoeken argued that a resolution fund under the SRM will create a new safety net but also warned that historical evidence suggests that regulators may try  to abolish this new mechanism. However, such a safety net does not necessarily create an unintended incentive to act irrationally. Indeed, moral empowerment is a key factor in creating a client-oriented business and ongoing innovation in the banking sector. According to Van Hoeken, regulatory pressure is widely felt and that leads to an un-level playing field for banks, as regulated institutions are now in competition  with unregulated institutions. These unregulated entities , such as Fintech companies, are posing an enormous challenge to  regulators.. It is therefore crucial  that supervisors develop and adjust their view in the same way as banks do.

Bicycle helmets and balloons

The second part of the symposium was opened by dr. Gijsbert ter Kuile, who  argued that taking risk is part of running a business. Therefore, risk itself is not immoral, but excessive risk is; thus a safety net is needed to protect societies from hazardous activities by banks. Interesting research by the University of Bath has shown that people wearing bicycle helmets while blowing a balloon take more risk than people  not wearing  helmets while blowing a balloon. Humans adapt their risk taking behaviour on the basis of perceptions of safety. The results suggest that unconscious activation of safety-related concepts lead to greater risk taking. The study demonstrates human incapability to assess protective measures with respect to certain risks. Indeed, protection may even lead to excessive risk taking. According to Gijsbert ter Kuile, a discussion about moral hazard in the financial sector is important because it suggests that safety nets may not always prevent people from taking excessive risk.

Jan Reinder De Carpentier was the third speaker of the symposium. He discussed the second pillar of the Banking Union, the SRM. He joined the Single Resolution Board (“SRB”) in Brussels as General Counsel responsible for the legal service, corporate secretariat and compliance. The goal of the SRB is to ensure an orderly resolution of banks, with minimum impact on the real economy and the society of the participating Member States of the Banking Union. In accomplishing this, the SRB closely cooperates with the national resolution authorities. Together with the national resolution authorities, the SRB forms the SRM. The SRB is directly responsible for the resolution of significant banks in the Eurozone. One of its tasks is to take decisions on the resolution of failing banks in the Eurozone. The European bank resolution rules aim to ensure that shareholders and creditors of a nearly failing bank bear the first losses. This is achieved by taking into account appropriate safeguards. One of the safeguards is that no creditor is worse off once the bail in process begins. In addition, the Single Resolution Fund can be used in the application of the resolution tools and powers of the SRB, but only under strict conditions. This regulatory framework will eventually lead to avoiding moral hazard and strengthen the stability in the financial sector.

Karl-Philipp Woijcik was the last speaker of the symposium. He is a member of the European Commission’s Legal Service, and specialises on all matters of financial services regulation. In particular, banking supervision, the bank recovery and resolution framework, deposit guarantee schemes, insurance supervision and the regulatory framework of the European Supervisory Authorities. He has been deeply involved in the development of the Banking Union. During his speech, Woijcik argued that risk taking is not a bad thing as such. The problem is excessive risk and moral hazard. Whether the link between a bank and Member State is really broken, and a bank is no longer rescued with tax payers money depends, inter alia, on the effectiveness of the resolution tool. One of its aims is to ensure that shareholders and creditors bear the costs of a bank failure, which is the bail-in tool, as well as the establishment and operation of the resolution fund. It may be argued that bail-in can cause significant systemic risk as systemically important banks often hold shares and notes in other banks. An answer to the question whether the newly introduced second pillar of the EBU leads to excessive risk taking cannot yet be given. For that answer we are, unfortunately, at the mercy of the whims of a next financial crisis.

This symposium was organised with support of EURO-CEFG.

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