Capital buffer for systemically important institutions

Addressed risks

The systemically important institutions buffer - which includes both the global systemically important institutions (G-SIIs) as well as other systemically important institutions (O-SIIs) - is applied to financial institutions that pose substantial systemic risks to the banking system. In maximizing their private benefits, systemically important institutions (SIIs) take decisions which may cause market distortions and create risks to financial stability. These moral hazard problems arise from the assumption of implicit government guarantees given to these systemically important institutions, thereby stimulating excessive risk taking. This means that their failure might cause significant negative effects to other banks and financial institutions and, thus, might lead to high costs for the real economy and the taxpayers. To address these negative externalities, national authorities can impose stricter requirements on these institutions.

Against this background, the O-SII buffer aims at reducing SIIs probability of default, while the identification criteria also take into account the impact of a failure on the financial system. The buffer should also strengthen market confidence regarding the identified institutions through their increased loss-absorption capacity. As systemically important institutions are more likely to be supported by public money in case of a crisis, the buffer reduces the cost for the general public in case of a bank’s insolvency. Moreover, the additional capital would act as an additional cushion for the stability of individual SIIs and the prevention of consequent “domino effects” in the national banking systems. Therefore, the SII buffer also limits the systemic impact of misaligned incentives. A failure to achieve the buffer requirement results in distribution restrictions and the creation of a capital conservation plan.

Method and calibration of the other systemically important institutions (O-SII) buffer

According to Article 4i and Article 4k Banking Act, the FMA has the legal obligation to yearly identify other systemically important institutions (O-SIIs) and the respective O-SII buffer level for the Liechtenstein banking sector, to publish the results and inform the O-SIIs and the ESRB about the decision.  Identified O-SIIs may be subject to an additional Common Equity Tier 1 (CET1) buffer of up to a maximum of 3% of the total risk amount - subject to approval by the Standing Committee of the EFTA States - in accordance with Art. 92 of Regulation (EU) No. 575/2013 (CRR), pursuant to Art. 4i Banking Act.

The EBA has set out a guideline (EBA/GL/2014/10) to identify O-SIIs by assessing their systemic risks in the Liechtenstein banking sector, which is based on a minimum mandatory framework of criteria and indicators. As systemically important institutions can present negative externalities to the broader financial system, identified O-SIIs may require an O-SII buffer of up to 2% of the total risk exposure amount, consisting of Common Equity Tier 1 (CET1) capital.

The EBA guideline proposes a two-step procedure to determine O-SIIs. In the first step, a scoring process is used for each relevant institution at least at the highest level of consolidation to assess their systemic importance consisting of the following criteria: (1) size; (2) importance for the economy (including substitutability / financial system infrastructure); (3) complexity / cross-border activity and (4) interconnectedness with the financial system. These four criteria each consist of one or more mandatory indicators as depicted in the table below. All criteria are weighted equally at a weight of 25%. Indicators within each criterion are also weighted equally relative to the other indicators within the respective criterion. To calculate the score, the indicator value of each institution is, first, divided by the aggregate amount of the respective indicator values summed across all institutions in the country. Second, the resulting percentages are multiplied by 10,000 to express the indicator in terms of basis points. To calculate the category score for each institution, the simple average of the indicator scores in the respective category is taken. The overall score is calculated by taking a simple average of all four category scores. An institution is considered as an O-SII if its total score equals or exceeds 350 basis points. In a second step, optional indicators listed in the EBA guideline can also be taken into account in addition to these minimum indicators if the relevant authority regards the indicators as relevant for adequately capturing systemic risks.

Based on the calculated scores for the identification of O-SIIs, the FMA defines three systemic relevance categories, which are subsequently relevant for the amount of the O-SII buffer (Table 1). The distinction of O-SIIs into different categories allows us to categorize banks according to their degree of systemic relevance for the domestic banking sector on the basis of the calculated total scores. The systemic relevance categories therefore allow for different O-SII buffer levels to be set, with each O-SII required to hold an O-SII buffer of at least 1% of the total risk amount. The threshold for category 1 ("very high systemic importance") was set in line with common supervisory practice in other countries.

• Table 1: Categories of systemic relevance and calibrated O-SII buffer levels

Measure

In Liechtenstein, the FMA has identified the following three banks as O-SIIs: LGT Bank AG, Liechtensteinische Landesbank AG und VP Bank AG. The level of the O-SII buffer is set at 2% of total risk exposure both at the consolidated and individual level. According to the EBA guideline, an institution is considered to be an O-SII when their total score exceeds 350 basis points (out of the possible 10 000), as they play an essential role – due to their size, importance, complexity and interconnectedness – for the stability of the financial sector in Liechtenstein. A possible failure of these institutions might cause a substantial risk to the financial and economic system in Liechtenstein.

• Table 2: O-SIIs in Liechtenstein and O-SII buffer level at consolidated level

• Table 3: O-SIIs in Liechtenstein and O-SII buffer level at individual level