Glossary

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Asset-backed commercial paper (Asset Backed Commercial Paper) is a short-term debt security that normally has a maturity of between three and nine months. It is backed by a portfolio of assets (e.g. credit claims) and is typically issued by special-purpose vehicles that have bought the underlying assets from banks.

Source: Deutsche Bundesbank

An asset-backed security (ABS) is a security which is backed by credit claims, such as building loans, car loans or credit card receivables. An ABS arises when a bank sells such assets to a special-purpose vehicle (SPV) and the SPV finances its operations through ABSs' sale. The special-purpose vehicle essentially uses the underlying credit claims to pay interest and make repayments to investors. Issuers often subdivide the securities into several tranches. The incoming payments from the underlying assets are distributed among these tranches according to a specific hierarchy. The tranches first served have a relatively low default risk, although the underlying claims may be of only moderate quality on average.

Source: Deutsche Bundesbank

In a bail-in, an institution's creditors should internalize the costs of its failure instead of imposing them on taxpayers. Since the creditors together with the equity holders are the beneficiaries of the institution’s success in good times, they should recapitalize the institution during times of distress by writing down their claims or converting them into equity.

 

 

A bail-out is a measure used to rescue an institution that is facing imminent insolvency by means of debt relief or provision of new third-party loans. Enterprises or government institutions alike can be bailed out.

Source: Deutsche Bundesbank

The Bank Recovery and Resolution Directive (BRRD) harmonises the tools used in the recovery and resolution of credit institutions in the European Union. It stipulates that a failing bank's shareholders and creditors should normally be the first to absorb losses. Only then should a resolution fund financed by the entire banking industry step in. In extreme cases, government institutions can still aid the recovery or resolution of an institution ("bail-out"). This "liability cascade" shall ensure that a key tenet of the market economy – that of being liable for one's own losses – also applies to credit institutions.

Source: Deutsche Bundesbank

The banking union is a collection of European institutions that were created in response to the financial and economic crisis of 2007 onwards. The banking union comprises a Single Supervisory Mechanism (SSM), a Single Resolution Mechanism (SRM), and a common deposit guarantee scheme (DGS). All euro-area states participate in the banking union, as do any EU countries which opt in. The purpose of the banking union is to standardise and improve banking supervision in participating member states, increase financial stability in the euro area and loosen the doom loop between financial sector debt and sovereign debt by standardising the bank resolution process. The creation of a common DGS has been postponed until further notice. Instead, efforts are first being focused on the harmonisation of national DGSs.


Source: Deutsche Bundesbank

The Basel Committee on Banking Supervision, located at the Bank for International Settlements (BIS) in Basel, develops internationally coordinated regulations for supervising the banking sector. Representatives of central banks and supervisory authorities from different countries constitute its members.

Source: Deutsche Bundesbank

 

 

Basel III is a comprehensive regulatory framework for the banking sector. The Basel III framework agreed upon by the Basel Committee on Banking Supervision in September 2010 builds upon, and gradually replaces, the Basel II rulebook. Among other things, Basel III requires banks to hold capital of a higher quantity and quality than under the Basel II regime, thereby significantly improving banks' resilience to losses. Basel III also defines bank liquidity standards and a minimum leverage ratio as well as a countercyclical capital buffer activated on supervisors' request. The Basel III rules are implemented in Europe through the "Capital Requirements Directive IV/Capital Requirements Regulation" (CRD IV/CRR).

Source: Deutsche Bundesbank

The Capital Requirements Directive IV (CRD IV) and the Capital Requirements Regulation (CRR) are the EU legislation implementing the banking supervision regulations defined by the Basel III regime.

Source: Deutsche Bundesbank

An entity that interposes itself, in one or more markets, between the counterparties of the contracts traded, becoming the buyer to every seller and the seller to every buyer and thereby guaranteeing the performance of open contracts.

Source: Deutsche Bundesbank

A collateralised debt obligation (CDO) is a structured financial instrument backed by securities, which, in turn, are backed by credit claims, such as building loans, student loans or car loans. CDOs are subdivided into several classes – also known as tranches. The incoming payments from the underlying assets are distributed among these tranches according to a specific hierarchy. The tranches first served have a relatively low default risk, although the underlying claims may be of only moderate quality on average.

Source: Deutsche Bundesbank

A conduit is a special type of special-purpose vehicle that purchases receivables and refinances them by issuing asset-backed commercial paper and similar securities usually with a short or medium-term maturity. The investment strategy thus exploits the fact that yields fall with the decline in bond maturity.

Source: Deutsche Bundesbank

The current account is a component of the balance of payments. It consists of trade in goods (1), trade in services (2), primary income (3) and secondary income (4). A current account surplus means that the relevant economy is producing more than its consumption of domestic and foreign goods. The economy thus accumulates external assets. In a current account deficit, the situation is reversed.

Source: Deutsche Bundesbank

The creation of a common deposit guarantee scheme (DGS) was originally envisaged as one pillar of the banking union but is now postponed until further notice. Alternatively, policymakers aim at a harmonisation of national deposit guarantee schemes.

Source: Deutsche Bundesbank

Deposit insurance is a scheme designed to protect an insolvent bank's customers from losing their deposits. The statutory deposit protection scheme covers deposits in current accounts, savings accounts, notice accounts and time deposit accounts, for example, up to a value of €100,000 per customer.

Source: Deutsche Bundesbank

The Dodd-Frank Act on Wall Street reform and consumer protection was signed in 2010 and represents a unique regulatory framework, which includes titles on bank employees' compensation, capital requirements, derivatives, credit rating agencies, hedge funds regulation and consumer protection. 

The European Banking Authority (EBA), founded in 2011 and headquartered in London, is an EU regulatory agency. Its main tasks include the setting of standards for EU banking supervision, the harmonization of supervisory practices and the execution of stress tests.

Source: Deutsche Bundesbank

The European Insurance and Occupational Pensions Authority (EIOPA) is an EU supervisory body established in 2011 and based in Frankfurt am Main. It is one of the three European Supervisory Authorities, the other two being the European Banking Authority and the European Securities and Markets Authority.

Source: Deutsche Bundesbank

The European Markets Infrastructure Regulation (EMIR; EU Regulation on OTC derivatives, central counterparties and trade repositories) of 2012 contains provisions governing over-the-counter trading of derivative products. Reporting all over-the-counter derivative transactions to a trade repository and clearing standardised derivative products through a central counterparty are among the obligations under EMIR.

Source: Deutsche Bundesbank

The European Securities and Markets Authority (ESMA), founded in 2011, is an EU supervisory agency headquartered in Paris. It is one of the three European Supervisory Authorities, the other two being the European Banking Authority and the European Securities and Markets Authority.

Source: Deutsche Bundesbank

The European Stability Mechanism (ESM) is an intergovernmental financial institution located in Luxembourg. It was established in response to the financial and sovereign debt crisis as a permanent crisis resolution mechanism and began operations in October 2012. Its task is to protect the solvency of euro-area member states experiencing temporary financing difficulties by employing tools such as granting loans or purchasing sovereign debt. On 1 July 2013, the ESM replaced the European Financial Stability Facility (EFSF), which had been set up as a temporary crisis resolution mechanism. 

Source: Deutsche Bundesbank

The European Systemic Risk Board (ESRB) is an independent EU body, responsible for the oversight of the EU financial system as a whole and for the timely identification of systemic risk (macroprudential oversight). The ESRB can issue warnings, disclose them if necessary, and make recommendations. Based at the European Central Bank (ECB), the ESRB comprises representatives from the ECB, national central banks, supervisory authorities and the European Commission.

Source: Deutsche Bundesbank

An independent deposit insurance agency in the US created by Congress in 1933 to maintain stability and public confidence in the nation's banking system. The FDIC promotes safety and soundness of insured depository institutions and the U.S. financial system as a whole. It identifies, monitors and addresses risks to the deposit insurance funds. Moreover, FDIC aims at (1) minimizing disruptive effects from the failure of banks and savings associations and (2) ensuring fairness in the sale of financial products and the provision of financial services. 

The Financial Stability Board (FSB) ensures international coordination between national financial supervisory authorities and international standard-setting bodies in the financial sector. It comprises representatives from central banks, finance ministries, supervisory authorities and international organisations. The FSB's secretariat is located at the Bank for International Settlements. 

Source: Deutsche Bundesbank

There is no common agreement on the definition of financialization in the literature, but most broadly financialization means the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies.

Source: Epstein, F., 2005: Financialization and the World Economy, Cheltenham: Edward Elgar 

In the groups of seven, eight, ten, twenty and twenty-four (G7, G8, G10, G20 and G24), countries with similar economic interests meet in informal advisory sessions to make joint decisions and discuss new proposals. The Group of Eight (G8) includes Canada, France, Germany, Italy, Japan, Russia, the United Kingdom and the United States. It was formed when Russia joined the Group of Seven (G7). The Group of Ten (G10) is actually made up of eleven – originally ten – industrial countries: the G7 plus Belgium, the Netherlands, Sweden and Switzerland. It addresses currency and financial market problems. The members of the Group of Twenty (G20) are the G8 plus the EU, Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Saudi Arabia, South Africa, South Korea and Turkey. It thus represents around two-thirds of the global population. The Group of Twenty-Four (G24) was set up to coordinate the positions of developing countries on monetary and fiscal policy. Several G20 members are also represented here: Argentina, Brazil, India, Mexico and South Africa, with China having the status of special invitee.

Source: Deutsche Bundesbank

The Markets in Financial Instruments Directive (MIFID II) has been in source since 1 November 2007. It was drawn by the European Union with the aim of improving investor protection, increasing competition and harmonising the European financial market. MiFID applies to the EU/EEA Member States and to the financial services providers registered there.

Source: SIX Swiss Exchange

The Minimum Requirements for Own Funds and Eligible Liabilities (MREL) is the ratio of equity capital and bail-in-able liabilities to total liabilities and equity capital. Therefore, the ratio is independent of an institution's risk weighted assets and set to 8% for all financial institutions situated in the Eurozone and in other EU Member States that opted in the Single Resolution Mechanism (SRM). Since MREL is embedded in the BRRD, all financial institutions within the scope of BRRD have to comply with it. 

Moral hazard describes a situation in which someone has an incentive to behave immorally, e.g irresponsibly. A typical example of moral hazard is if an insured person takes excessive risks, because not he or she but the insurance company pays any damage.

Source: Deutsche Bundesbank

Securities that are backed by a pool of mortgage loans. Depending on the nature of the underlying loan, two types of MBS exist: commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS).

Source: Deutsche Bundesbank

The Orderly Liquidation Authority (OLA) provision constitutes a part of the Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). The legislation authorizes the Federal Deposit Insurance Corporation (FDIC) to pursue an agency-administered wind down for certain troubled financial firms. Such wind down represents an alternative to bankruptcy or bailout. 

Source: Pellerin, S. and John R. Walter. (2012). Orderly Liquidation Authority as an Alternative to Bankruptcy. Economic Quarterly, 98(1), 1-31.

Traditionally, banks used deposits to fund loans that they then kept on their balance sheets until maturity (originate-to-hold model of lending). Later, however, banks replaced this model with the originate-to-distribute model. In accordance with this model banks started distributing the loans they issued through (1) syndication, (2) selling in the secondary loan market or (3) selling to investment management companies (SIVs, SPVs) for securitization.

Source: Bord, V. M. and Santos J. A. C. (2012). The Rise of the Originate-to-Distribute Model and the Role of Banks in Financial Intermediation. Federal Reserve Bank of New York Economic Policy Review, 21-34. 

The term over-the-counter (OTC) subsumes all financial market transactions not traded on an exchange.

Source: Deutsche Bundesbank

The Financial Stability Board (FSB) defines shadow banks as financial market players engaging in activities similar to those of banks (particularly lending) without being subject to banking regulation. Regulated credit institutions can outsource operations to specialised shadow banks (i.e. SPV, SIV etc.) and thus – perfectly legally – circumvent regulatory measures. As the financial crisis the shadow banking system can contribute to the build-up of systemic risks. Therefore, policymakers make efforts to regulate shadow banks both at the global and EU level. Despite their name shadow banks do not belong to the semi-legal or illegal "shadow economy". Some of them, however, may operate semi-legally, in a legal grey area or illegally.

Source: Deutsche Bundesbank

The Single Resolution Board (SRB) is part of the Single Resolution Mechanism (SRM), the banking union's second pillar. It is an independent European agency empowered to decide on the resolution of (1) all banks supervised directly by the European Central Bank and (2) all banks owning subsidiaries in other member states taking part in the Single Supervisory Mechanism (SSM). The SRB's plenary session is composed of the chair, vice-chair, four other permanent members and representatives of the national resolution authorities. It decides on policy issues as well as individual resolution cases where these involve the use of the Single Resolution Fund (SRF) above a threshold of €5 billion. For issues pertaining to the resolution of a bank, only the full-time members and the representatives of the bank's member state take part (executive session).

Source: Deutsche Bundesbank

Beginning in 2016 the national resolution funds have largely been replaced by the Single Resolution Fund (SRF) in all member states participating in the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). Together with the Single Resolution Board (SRB), it is the second core element of the Single Resolution Mechanism (SRM) and serves as a second line of defence when it comes to funding the resolution of an institution. The idea is for shareholders and creditors to primarily bear the burden of bankruptcy, for example through a bail-in, instead of the tax payer. The target fund volume is at least 1% of the covered deposits of all the institutions authorised in the member states (around €55 billion), and this volume should be reached by the end of 2023. The fund is financed by bank levies.

Source: Deutsche Bundesbank

The Single Resolution Mechanism (SRM) is the pillar of the European banking union that is responsible for the recovery and resolution of credit institutions. The SRM is based on the Bank Recovery and Resolution Directive (BRRD) and augments the Single Supervisory Mechanism (SSM). The SRM establishes a framework for the orderly resolution of failed banks, even across national borders. As a lesson learned from the financial crisis that began in 2007, it seeks to revitalise the key market economy principle of being liable for one's own losses for credit institutions as well. The SRM is responsible for all euro-area countries, as well as for those EU member states that opt in. The establishment of the Single Resolution Board (SRB), an EU agency with legal personality, is at the heart of the SRM's institutional framework. If the SRM decides to resolve an institution, the European Commission and European Council have 24 hours to object to the resolution scheme (non-objection procedure). The SRM is augmented by the Single Resolution Fund (SRF), which can provide the financial resources needed for resolution.

Source: Deutsche Bundesbank

The Single Rulebook is the common set of rules that harmonises banking supervision law in Europe and hence prevents regulatory arbitrage. The Single Rulebook encompasses several legislation texts including the Capital Requirements Directive IV and the Capital Requirements Regulation. It provides the legal basis for the European banking union and thus, in particular, for the Single Supervisory Mechanism and the Single Resolution Mechanism as well.

Source: Deutsche Bundesbank

The Single Supervisory Mechanism (SSM) is the pillar of the European banking union that is responsible for banking supervision. The SSM is implemented by the European Central Bank (ECB), headquartered in Frankfurt am Main. From November 2014, the SSM directly supervises the roughly 120 “significant” credit institutions in the participating countries. These institutions account for over 80% of the total assets of all institutions under supervision. Furthermore, the SSM is also responsible for the supervision of all the other credit institutions in SSM countries. However, these institutions are directly supervised by national competent authorities (NCAs) as a general rule. Despite this, some decisions (e.g. authorisation of a credit institution or withdrawal of such authorisation) are always made by the SSM, irrespective of the credit institution in question. The SSM ensures that rules are interpreted and applied consistently across all participating countries. The supreme governing body of the SSM is the Supervisory Board, which reports to the ECB Governing Council. The Supervisory Board's members consist of ECB representatives and representatives from the supervisory authorities of the countries that participate in the SSM. In Germany's case, these representatives are from the Federal Financial Supervisory Authority (BaFin), which has voting rights, and the Deutsche Bundesbank.

Source: Deutsche Bundesbank

A structured investment vehicle is a special purpose vehicle (SPV), investing in CDOs and other asset-backed securities with longer maturing and financing the investment by issuing short-term asset-backed commercial papers (ABCP). The investment strategy thus exploits the fact that yields fall with the decline in bond maturity. 

Source: Deutsche Bundesbank

A special-purpose vehicle (SPV) is a legal entity established for the purpose of legally shielding the debtor from the creditor in case of payment difficulties. This can occur, for example, through structured finance.

Source: Deutsche Bundesbank

A subprime loan is a loan to a low-income debtor with subprime creditworthiness.

Source: Deutsche Bundesbank

In macroprudential oversight jargon, a bank or group of banks is considered systemically important if its insolvency would have a serious impact on the functioning of the domestic financial system or important parts thereof, and would also have negative effects on the real economy. The Financial Stability Board (FSB) has classified around 30 financial institutions as systemically important. These institutions are subject to stricter capital requirements than other banks.

Source: Deutsche Bundesbank

The Total Loss-Absorbing Capacity (TLAC) is a prudential metric phased in in 2016 for global systemically important banks (G-SIBs). According to it, the world's 30 largest banks are required to maintain a TLAC of between 16% and 20% of their risk-weighted assets and 6% of their unweighted assets. TLAC is comprised of capital and other elements such as bonds which can be converted by the bank into liable capital. The specific level of capital requirements prescribed by the TLAC depends on a G-SIB's business model, risk profile and organisational structure. TLAC is part of international efforts to solve the "too big to fail" problem by enabling even systemically important banks, i.e banks that are internationally interconnected, to be wound up in future without risks for financial stability.


Source: Deutsche Bundesbank

A trade repository is an enterprise that operates an electronic database to document the conclusion, modification and termination of derivatives contracts. The objective is to increase transparency on the financial markets. Under the European Markets Infrastructure Regulation (EMIR) it was decided that standardised OTC derivatives within the meaning of the Regulation needed to be cleared via central counterparties and that OTC derivatives had to be registered with trade repositories. In total, four trade repositories have been approved by the European Securities and Markets Authority (ESMA).

Source: Deutsche Bundesbank