LATVIA: FCMC might be morphed into a Central Bank division

2 June 2020 — Cosmin CONCEATU
At the end of May 2020, the Ministry of Finance (MoF) from Latvia has submitted to the Cabinet of Ministers an assessment prepared in co-operation with the Central Bank of Latvia and the Financial and Capital Market Commission (FCMC) regarding a possible merge between the Central Bank and FCMC, planned to start in 2022 - 2023.

Janis Reirs, Minister of Finance, stated:

"The synergies of information and competencies will help to assess risks in these financial institutions more comprehensively, leading to better operational, informed and problem-oriented decisions. This will allow a more effective monitoring and development of the financial sector in the future."

Bank of Latvia considers that an important outcome that will result from the merger of the two institutions will be a more effective way to promote financial stability and mitigate systemic risks, given the wider pooling of knowledge and skills and faster exchange and use of information.

The planned benefits also include a more comprehensive view over changes in Latvian financial and capital markets, as well as a more efficient response to financial stability shocks and crises. Greater efficiency in the implementation of macro-prudential policy and micro-prudential supervision is also expected by the initiators of the project, as well as a more efficient administrative process for the competent authority to take decisions and appeal. Annual operating costs could also drop by 3.4% starting with the third year after the merge.

Currently, in 11 out of 19 euro area member states the central banks are actively involved in the supervision of the financial sectors. Santa Purgaile, Chairwoman of FCMC, emphasized:

"The implementation of monetary policy and financial sector supervision functions in a single institution is not a unique case. There are several countries in Europe where such a model was successfully implemented."

Although the merge seems like the obvious next step, a few problems might arise. The most significant risks come from a greater concentration of influence in the financial system to a single institution, as well as a potential conflict of interest between monetary policy, macro-prudential supervision and micro-prudential supervision, especially the risk of incorrect incentives.

The MoF's report indicates that the supervisory, resolution and defense system activation functions may have a potentially negative impact on the Central Bank's reputation, which is an important precondition for the conduct of monetary and macro-prudential policies. It is also possible to challenge Central Bank assets in connection with micro-prudential and resolution decisions, which may limit the Central Bank's capacity and jeopardize its financial independence.

However, the identified risks must be managed by implementing appropriate risk mitigation measures, including the appropriate division of duties, rights and responsibilities, the operation of the internal control system and the regulatory framework. With regard to decision-making at the Bank of Latvia's decision-making level, it should be noted that key Eurosystem policy-making and implementation decisions (e.g. monetary policy decisions) and a large number of individual decisions in the area of micro-prudential supervision are taken by the Governing Council of the institution. Certain types of decisions (such as individual supervisory decisions) would be delegated to a dedicated Monitoring Committee, the proposed project mentions.

Martins Kazaks, Governor of the Bank of Latvia, said:

"There are several important preconditions required for a smooth inclusion of the FCMC in the Bank of Latvia (...). One of the most significant is changing the Central Bank's governance model, including the separation of monetary policy and financial sector supervisory functions. Therefore, one of my short-term priorities will be the development of a new, modern law `On the Bank of Latvia`."

FCMC was established in July 2001. FCMC acts as an autonomous public institution, which carries out the supervision of Latvian banks, credit unions, insurance companies and insurance brokerage companies, participants of financial instruments market, as well as private pension funds, payment institutions and electronic money institutions. Starting October 2019, the institution is led by Santa Purgaile, Chairwoman of FCMC.


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