Transparency for efficiency and financial stability

Higher transparency requirements after the financial crisis

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Higher transparency requirements after the financial crisis

Banks' transparency requirements and Pillar 3

Published: 3 November 2022

The purpose of imposing regulatory requirements on banks is to ensure that they have the capacity to manage losses. In this way, the impact of financial crises on the banking system and society can be prevented and mitigated. The Basel Committee on Banking Supervision develops minimum requirements to be applied to banks worldwide. The requirements are usually divided into three groups, or pillars. Pillar 1 consists of minimum capital and liquidity requirements that apply generally to all banks. Pillar 2 consists of bank-specific requirements, in addition to the minimum requirements in Pillar 1. These are set by the respective supervisory authority on the basis of each bank's specific risk profile. Pillar 3 consists of requirements for banks to disclose information about their own operations so that the bank's risk profile can be assessed - in other words, transparency requirements.

A lack of transparency contributed to the crisis

During the crisis, many banks experienced severe liquidity problems, prompting central banks around the world to implement liquidity support measures. The problems arose because many banks had taken large liquidity risks and were unable to pay. As the transparency regarding these risks was virtually non-existent, they could build up without investors having the opportunity to react in time.

For credit risk, too, there were clear problems linked to a lack of transparency during the financial crisis. Banks' operations and products had become increasingly complex over a long period of time, making it difficult for investors to assess the credit risk of financial products, such as securitised home loans.[3] Problems in so-called subprime loans, i.e. securitised mortgages, were a contributing factor to the emergence of the financial crisis. When turbulence hit the property market and property prices fell, investors found it difficult to assess credit risk because they had too little information about how these loans were actually constructed. This led many investors to choose to divest these instruments which then lost value. One factor contributing to the problems was that banks used external credit rating agencies to assess the credit risk of different instruments. In many cases, their assessment turned out to be wrong and instruments that had been rated as low credit risk, i.e. AAA, were in reality much higher credit risk. Overall, this led to a loss of confidence in banks and they suffered large loan losses. The experience of the crisis was thus that accurate information on asset quality and the liquidity situation of banks is one of the most important factors in maintaining confidence in the financial market and assessing financial stability.

Shortly after the onset of the financial crisis, the Basel Committee therefore undertook a major revision of Pillar 3, requiring banks to disclose more comprehensive and detailed information on financial risks. Much of the information has also become easier to compare across banks and countries as they now have to use the same risk measures and standardised reporting templates. The Basel Committee's review had a broad focus and covered several risk areas, such as credit risk, market risk and liquidity and operational risk. An important part of the review concerned liquidity risk, with new disclosure requirements on banks' short-term (LCR) and long-term (NSFR) solvency.[4] The liquidity coverage ratio (LCR) aims to ensure that banks have sufficient liquid assets to cope with short-term liquidity stress. The net stable funding ratio (NSFR) is a measure that relates a bank's stable funding to its illiquid assets and aims to promote the resilience of banks over a longer period of time. The work continued for several years and the regulatory changes have been introduced in stages. The final stage of the revision is to be implemented from 1 January 2023.[5] See Pillar 3 disclosure requirements - updated framework ( The Pillar 3 transparency requirements are based on a proportionality principle whereby larger and more complex banks must disclose more information.[6] See Appendix 1 for a description of Pillar 3 and its contents. When and how the final stages of Pillar 3 will be implemented in the EU is currently under negotiation. [7] The implementation of the final Basel 3 in the EU is part of the "Banking Package 2021: New EU rules for more resilient banks and better preparedness for the future".

The increasing information requirements become clear if you look, for example, at the major Swedish banks where the financial reports have become increasingly longer since the crisis.[8] For the three largest banks in Sweden, the number of pages in the annual report has more than doubled from an average of 104 in 2000 to an average of 261 pages in 2021. The growing complexity and size of large banks also reflects an increased need for information. The size of the three major banks, measured in terms of balance sheet total, increased significantly from the year 2000 (SEK 915bn) to 2021 (SEK 3,133bn). In addition to the annual report, banks are required to produce a specific report on their risk and capital situation (Pillar 3 report).[9] For 2021, the average number of pages in the risk report is 98 for the three largest Swedish banks. Banks also produce so-called sustainability reports which include some environmental information.[10] Sustainability reports are in some cases included as part of the annual report. Sustainability is an umbrella term that shows how a company takes into account environmental, social and corporate governance issues. The term ESG (environmental, social and governance) is often used to describe sustainability.