The public interest assessment and bank-insurance contagion

The SRB is continuously enhancing its approach to the public interest assessment (PIA). This is the main policy tool used to assess whether a failing bank should be resolved in the public interest, or whether it can be liquidated under normal insolvency proceedings.

A key element of the assessment is to test contagion from a failing bank to direct counterparties and other market participants, including cross-sector contagion to other financial intermediaries and markets. In my previous blog on the PIA, I explained how we updated our approach to take into account system-wide events, in addition to idiosyncratic scenarios. The assessment has to be conducted each year for all banks under the SRB’s remit as part of regular resolution planning and will be repeated in case a bank is failing or likely to fail. In this blog, I will focus on how the SRB will assess cross-sector contagion, namely from the banking sector to the insurance one.

The public interest assessment is a key safeguard in bank resolution, to protect taxpayers and financial stability. Financial stability could be considered at risk if a bank’s sudden market exit could have significant adverse effects on financial markets. This analysis needs to take into account the direct impact on counterparties of the failing bank, as well as the indirect impact on other institutions in the financial system.

The bank-insurance nexus is of particular interest for a number of reasons. First, the insurance sector holds a non-negligible amount of assets issued by the banks under the SRB’s remit. Moreover, the SRB is the resolution authority for a number of bank-insurance conglomerates, where we need to fully understand the intra-group interconnectedness and potential for contagion. Lastly, there are examples from the past where a bank’s failure has led to financial problems in the insurance sector.

The SRB is working with the European Insurance and Occupational Pensions Authority (EIOPA) to test a methodology for assessing contagion from a bank’s failure in the European insurance sector. The first results of this cooperation were recently published in the EIOPA Financial Stability Report. The results confirm that insurers’ exposures towards the banking sector are material. At the same time, the direct contagion risk, tested in a ‘what-if’ analysis, stemming from an idiosyncratic failure of a bank under the SRB’s remit, seems to be contained.

There are a number of relevant features in the analysis. First, it is the first time that a multi-layered bank-insurance network has been analysed, using Solvency II reporting data and granular insolvency categories. Second, the simulated write-down of instruments held by insurance companies was under some assumptions applied following the national insolvency hierarchy (which differs across countries). The SRB, together with EIOPA, is considering how this approach could be further strengthened.

As I mentioned, the interconnection between insurers and banks, that is, the impact that potential fragility of insurance companies could have on banks, is particularly relevant in case of financial conglomerates. The SRB is also building up expertise in this specific field. A deep understanding of the interdependencies, as well as of the impact of any policy action, in close cooperation with the insurance authorities, can pave the ground for a further improvement of financial stability safeguards.