An International Monetary Fund (IMF) working paper first published in August last year is circulating among asset managers beginning to despair at the waves of legislation building up across the European industry.
The paper has two key objectives: (i) to present similarities and differences among Pillar 1 requirements of the two accords; and (ii) to discuss possible unintended consequences of their implementation.
It is intentionally limited to aspects related to Pillar 1 (minimum capital requirement) in the two capital accords, and acknowledges that there can be significant overlap in the business activities of banks and insurers.
For example, consumers save with banks through deposits and with life insurers through annuity with savings products. In addition, banks and insurers invest in many of the same types of assets and they compete with one another in raising capital, both in the capital markets and within the financial conglomerates of which many are members.
Due to this overlap, differences in the two accords can generate unintended consequences in the area of cost of capital, funding patterns, and interconnectedness, and promote risk/product migration across or away from the two sectors. These unintended consequences are summarized in the conclusions together with policy considerations.
Finally, the paper acknowledges that other sources of arbitrage not analyzed in this paper, like differences in Pillar 2 (supervisory approach) and Pillar 3 (market discipline), as well as differences in accounting (partially discussed here) and tax treatments, could reinforce or offset the impact of differences in the capital regulatory frameworks.
The authors: Ahmed Al-Darwish is Special Appointee at the IMF; Michael Hafeman is an actuary and consultant on insurance and pension supervision; Gregorio Impavido is Senior Financial Sector Expert at the IMF; Malcolm Kemp is Managing Director at Nematrian and an Adjunct Professor at Imperial College Business School, London; and Padraic O’Malley is Consulting Actuary at Milliman.
“Possible Unintended Consequences of Basel III and Solvency II“, prepared by Ahmed Al-Darwish, Michael Hafeman, Gregorio Impavido, Malcolm Kemp, and Padraic O’Malley observes that in today’s financial system, complex financial institutions are connected through an opaque network of financial exposures.
These connections contribute to financial deepening and greater savings allocation efficiency, but are also unstable channels of contagion. Basel III and Solvency II should improve the stability of these connections, but could have unintended consequences for cost of capital, funding patterns, interconnectedness, and risk migration, the authors claim.
Click here to read: Possible Unintended Consequences of Basel III and Solvency II
This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate