Financial Stability and Crisis Management
Expert-defined terms from the Global Certification Course in European Union Law and Banking Regulation course at London School of Business and Administration. Free to read, free to share, paired with a globally recognised certification pathway.
Financial Stability and Crisis Management Glossary #
Financial Stability and Crisis Management Glossary
A #
A
Asset #
Asset
- Definition: An asset is any resource owned by a person or company that… #
- Definition: An asset is any resource owned by a person or company that has economic value and can be converted into cash.
- Example: Examples of assets include cash, stocks, bonds, real estate, a… #
- Example: Examples of assets include cash, stocks, bonds, real estate, and vehicles.
Asset Quality Review (AQR) #
Asset Quality Review (AQR)
- Definition: A process used by regulators to assess the value of a bank'… #
- Definition: A process used by regulators to assess the value of a bank's assets by reviewing its balance sheet to identify potential risks and vulnerabilities.
- Example: The European Central Bank conducts Asset Quality Reviews to en… #
- Example: The European Central Bank conducts Asset Quality Reviews to ensure the financial stability of banks within the Eurozone.
B #
B
Bank Resolution #
Bank Resolution
- Definition: The process by which a failing bank is restructured or woun… #
- Definition: The process by which a failing bank is restructured or wound down in an orderly manner to minimize the impact on financial stability and protect depositors.
- Example: In 2017, the Italian government used a bank resolution mechani… #
- Example: In 2017, the Italian government used a bank resolution mechanism to rescue two failing banks, Banca Popolare di Vicenza and Veneto Banca.
Bail #
in
- Definition: A bank resolution strategy in which a failing bank's credit… #
- Definition: A bank resolution strategy in which a failing bank's creditors and depositors are forced to take losses or convert their claims into equity to recapitalize the bank.
- Example: In 2013, Cyprus became the first country to use a bail-in to r… #
- Example: In 2013, Cyprus became the first country to use a bail-in to rescue its banking sector during the financial crisis.
C #
C
Capital Adequacy #
Capital Adequacy
- Definition: The ability of a bank to meet its financial obligations and… #
- Definition: The ability of a bank to meet its financial obligations and absorb losses without compromising its financial stability.
- Example: Banks are required to maintain a minimum level of capital adeq… #
- Example: Banks are required to maintain a minimum level of capital adequacy to ensure they can withstand economic downturns and financial shocks.
Central Counterparty (CCP) #
Central Counterparty (CCP)
- Definition: An entity that acts as an intermediary in financial transac… #
- Definition: An entity that acts as an intermediary in financial transactions, guaranteeing the settlement of trades to reduce counterparty risk and enhance market stability.
- Example: The European Central Bank oversees central counterparties in t… #
- Example: The European Central Bank oversees central counterparties in the Eurozone to ensure the stability of the financial system.
D #
D
Deposit Insurance Scheme #
Deposit Insurance Scheme
- Definition: A government-backed program that protects depositors by gua… #
- Definition: A government-backed program that protects depositors by guaranteeing a certain amount of their deposits in case a bank fails.
- Example: The European Union has a harmonized deposit insurance scheme t… #
- Example: The European Union has a harmonized deposit insurance scheme to protect depositors across member states.
Derivatives #
Derivatives
- Definition: Financial instruments whose value is derived from an underl… #
- Definition: Financial instruments whose value is derived from an underlying asset, index, or interest rate, used for hedging, speculation, and risk management.
- Example: Interest rate swaps are a common type of derivative used by ba… #
- Example: Interest rate swaps are a common type of derivative used by banks to manage their exposure to interest rate fluctuations.
E #
E
European Banking Authority (EBA) #
European Banking Authority (EBA)
- Definition: An independent EU agency responsible for ensuring the effec… #
- Definition: An independent EU agency responsible for ensuring the effective and consistent regulation and supervision of banks within the European Union.
- Example: The European Banking Authority conducts stress tests to assess… #
- Example: The European Banking Authority conducts stress tests to assess the resilience of European banks to adverse economic scenarios.
European Central Bank (ECB) #
European Central Bank (ECB)
- Definition: The central bank for the euro area that is responsible for… #
- Definition: The central bank for the euro area that is responsible for monetary policy, financial stability, and banking supervision within the European Union.
- Example: The ECB plays a crucial role in maintaining financial stabilit… #
- Example: The ECB plays a crucial role in maintaining financial stability in the Eurozone by setting interest rates and conducting monetary operations.
F #
F
Financial Stability #
Financial Stability
- Definition: The condition in which the financial system is resilient to… #
- Definition: The condition in which the financial system is resilient to shocks, able to perform its functions effectively, and supports sustainable economic growth.
- Example: Maintaining financial stability is a key objective of central… #
- Example: Maintaining financial stability is a key objective of central banks and regulatory authorities to prevent financial crises and disruptions.
Financial Crisis #
Financial Crisis
- Definition: A situation in which the financial system experiences sever… #
- Definition: A situation in which the financial system experiences severe disruptions, leading to a loss of confidence, market turmoil, and economic downturn.
- Example: The 2008 global financial crisis was triggered by the collapse… #
- Example: The 2008 global financial crisis was triggered by the collapse of the subprime mortgage market in the United States, leading to a worldwide recession.
G #
G
G #
SIBs (Global Systemically Important Banks)
- Definition: Banks that are considered critical to the global financial… #
- Definition: Banks that are considered critical to the global financial system due to their size, interconnectedness, complexity, and importance to the economy.
- Example: G-SIBs are subject to higher capital requirements and stricter… #
- Example: G-SIBs are subject to higher capital requirements and stricter regulatory oversight to prevent their failure from destabilizing the financial system.
Good Bank/Bad Bank #
Good Bank/Bad Bank
- Definition: A bank resolution strategy in which a failing bank's assets… #
- Definition: A bank resolution strategy in which a failing bank's assets and liabilities are separated into a "good bank" for viable assets and a "bad bank" for toxic assets.
- Example: During the financial crisis, the UK government used the good b… #
- Example: During the financial crisis, the UK government used the good bank/bad bank model to restructure and recapitalize troubled banks like RBS and Lloyds.
H #
H
Haircut #
Haircut
- Definition: A reduction in the value of an asset or security to reflect… #
- Definition: A reduction in the value of an asset or security to reflect a risk factor, market conditions, or default probability.
- Example: Lenders may require borrowers to provide collateral with a hai… #
- Example: Lenders may require borrowers to provide collateral with a haircut to protect against potential losses in case of default.
High #
Frequency Trading (HFT)
- Definition: A trading strategy that uses sophisticated algorithms and c… #
- Definition: A trading strategy that uses sophisticated algorithms and computer programs to execute high-speed and high-volume trades in financial markets.
- Example: HFT has been criticized for creating market volatility and con… #
S. stock markets in May 2010.
I #
I
Insolvency #
Insolvency
- Definition: The inability of an individual, company, or institution to… #
- Definition: The inability of an individual, company, or institution to meet its financial obligations and repay its debts when they become due.
- Example: Insolvency can lead to the liquidation of assets, restructurin… #
- Example: Insolvency can lead to the liquidation of assets, restructuring of debts, or bankruptcy proceedings to resolve financial distress.
Interest Rate Risk #
Interest Rate Risk
- Definition: The risk that changes in interest rates will affect the val… #
- Definition: The risk that changes in interest rates will affect the value of financial assets, liabilities, and income streams of banks and other financial institutions.
- Example: Banks face interest rate risk when they hold long-term fixed-r… #
- Example: Banks face interest rate risk when they hold long-term fixed-rate loans or investments in a rising interest rate environment.
J #
J
Junk Bonds #
Junk Bonds
- Definition: High-risk, high-yield bonds issued by companies with lower… #
- Definition: High-risk, high-yield bonds issued by companies with lower credit ratings, offering investors higher returns in exchange for greater risk of default.
- Example: Investors who purchase junk bonds are compensated with higher… #
- Example: Investors who purchase junk bonds are compensated with higher interest rates to offset the increased risk of default compared to investment-grade bonds.
Joint Resolution #
Joint Resolution
- Definition: A coordinated approach by multiple authorities or instituti… #
- Definition: A coordinated approach by multiple authorities or institutions to resolve a failing bank or financial institution in a cross-border context to maintain financial stability.
- Example: The European Union has established mechanisms for joint resolu… #
- Example: The European Union has established mechanisms for joint resolution of failing banks to prevent contagion and ensure a harmonized approach to crisis management.
K #
K
Key Performance Indicators (KPIs) #
Key Performance Indicators (KPIs)
- Definition: Quantifiable metrics used to evaluate the performance of ba… #
- Definition: Quantifiable metrics used to evaluate the performance of banks and financial institutions in achieving their strategic objectives and operational goals.
- Example: Common KPIs for banks include return on equity, net interest m… #
- Example: Common KPIs for banks include return on equity, net interest margin, cost-to-income ratio, and non-performing loan ratio.
KYC (Know Your Customer) #
KYC (Know Your Customer)
- Definition: Regulatory requirements that mandate banks to verify and id… #
- Definition: Regulatory requirements that mandate banks to verify and identify their customers, assess their risk profile, and monitor their transactions to prevent money laundering and terrorist financing.
- Example: Banks use KYC procedures to collect customer information, veri… #
- Example: Banks use KYC procedures to collect customer information, verify identities, and detect suspicious activities to comply with regulatory obligations and protect against financial crime.
L #
L
Leverage Ratio #
Leverage Ratio
- Definition: A measure of a bank's capital adequacy that compares its ca… #
- Definition: A measure of a bank's capital adequacy that compares its capital to its total assets to assess the level of leverage and risk-taking in its balance sheet.
- Example: The leverage ratio is designed to limit excessive leverage and… #
- Example: The leverage ratio is designed to limit excessive leverage and promote financial stability by ensuring banks have an adequate capital buffer to absorb losses.
Liquidity Risk #
Liquidity Risk
- Definition: The risk that a bank may not be able to meet its short-term… #
- Definition: The risk that a bank may not be able to meet its short-term obligations or fund its operations due to a shortage of liquid assets or inability to access funding sources.
- Example: Banks manage liquidity risk by maintaining sufficient liquid a… #
- Example: Banks manage liquidity risk by maintaining sufficient liquid assets, diversifying funding sources, and establishing contingency plans to address funding gaps.
M #
M
Macroprudential Policy #
Macroprudential Policy
- Definition: Policies implemented by regulators and central banks to mon… #
- Definition: Policies implemented by regulators and central banks to monitor and address systemic risks that can destabilize the financial system and threaten financial stability.
- Example: Macroprudential policies include capital buffers, stress tests… #
- Example: Macroprudential policies include capital buffers, stress tests, loan-to-value ratios, and reserve requirements to mitigate risks and safeguard financial stability.
Market Risk #
Market Risk
- Definition: The risk of financial loss due to changes in market prices,… #
- Definition: The risk of financial loss due to changes in market prices, interest rates, exchange rates, and other external factors that impact the value of assets and liabilities.
- Example: Banks are exposed to market risk through their trading activit… #
- Example: Banks are exposed to market risk through their trading activities, investment portfolios, and foreign exchange transactions, requiring risk management strategies to mitigate exposure.
N #
N
Non #
Performing Loan (NPL)
- Definition: A loan that is in default or is not being serviced accordin… #
- Definition: A loan that is in default or is not being serviced according to the agreed terms, posing a risk to the lender's financial health and requiring provisions for potential losses.
- Example: Banks classify loans as non-performing when borrowers fail to… #
- Example: Banks classify loans as non-performing when borrowers fail to make payments for a certain period, leading to impaired assets and increased credit risk.
Net Stable Funding Ratio (NSFR) #
Net Stable Funding Ratio (NSFR)
- Definition: A regulatory requirement that mandates banks to maintain a… #
- Definition: A regulatory requirement that mandates banks to maintain a stable funding profile in relation to their assets and activities over a one-year horizon to promote funding stability.
- Example: The NSFR measures the long-term stability of a bank's funding… #
- Example: The NSFR measures the long-term stability of a bank's funding sources to ensure it has adequate liquidity to support its activities and withstand funding stress.
O #
O
Operational Risk #
Operational Risk
- Definition: The risk of financial loss resulting from inadequate or fai… #
- Definition: The risk of financial loss resulting from inadequate or failed internal processes, systems, human errors, external events, or misconduct that disrupt a bank's operations.
- Example: Operational risk includes fraud, IT failures, legal disputes,… #
- Example: Operational risk includes fraud, IT failures, legal disputes, and regulatory violations that can impact a bank's reputation, financial performance, and regulatory compliance.
Over #
the-Counter (OTC) Market
- Definition: A decentralized market where financial instruments such as… #
- Definition: A decentralized market where financial instruments such as stocks, bonds, derivatives, and currencies are traded directly between buyers and sellers without a centralized exchange.
- Example: OTC markets provide flexibility and customization for trading… #
- Example: OTC markets provide flexibility and customization for trading complex products but may pose risks related to counterparty credit risk, price transparency, and market integrity.
P #
P
Precautionary Recapitalization #
Precautionary Recapitalization
- Definition: A measure that allows a bank to receive public funds to str… #
- Definition: A measure that allows a bank to receive public funds to strengthen its capital position and address potential solvency issues before they escalate into a crisis.
- Example: Precautionary recapitalization is used to prevent bank failure… #
- Example: Precautionary recapitalization is used to prevent bank failures, maintain financial stability, and protect depositors and creditors from losses.
Prudential Regulation #
Prudential Regulation
- Definition: Rules and requirements imposed by regulators on banks and f… #
- Definition: Rules and requirements imposed by regulators on banks and financial institutions to ensure their soundness, stability, and compliance with safety and soundness standards.
- Example: Prudential regulations set limits on capital levels, risk-taki… #
- Example: Prudential regulations set limits on capital levels, risk-taking activities, lending practices, and disclosure requirements to protect depositors, investors, and the financial system.
Q #
Q
Quantitative Easing (QE) #
Quantitative Easing (QE)
- Definition: A monetary policy tool used by central banks to stimulate t… #
- Definition: A monetary policy tool used by central banks to stimulate the economy by purchasing government bonds and other financial assets to lower interest rates and increase liquidity.
- Example: The ECB implemented quantitative easing to support economic re… #
- Example: The ECB implemented quantitative easing to support economic recovery, boost inflation, and maintain financial stability during the Eurozone crisis.
Quick Ratio #
Quick Ratio
- Definition: A financial ratio that measures a company's ability to meet… #
- Definition: A financial ratio that measures a company's ability to meet its short-term liabilities with its most liquid assets by excluding inventory from current assets.
- Example: The quick ratio helps assess a company's liquidity and financi… #
- Example: The quick ratio helps assess a company's liquidity and financial health by focusing on its ability to cover immediate obligations without relying on slow-moving or illiquid assets.
R #
R
Resolution Authority #
Resolution Authority
- Definition: A designated entity or agency responsible for managing the… #
- Definition: A designated entity or agency responsible for managing the resolution of failing banks or financial institutions in an orderly manner to protect financial stability.
- Example: The Single Resolution Board is the resolution authority for ba… #
- Example: The Single Resolution Board is the resolution authority for banks in the Eurozone, overseeing the resolution process and ensuring the effective use of resolution tools.
Risk Management #
Risk Management
- Definition: The process of identifying, assessing, monitoring, and miti… #
- Definition: The process of identifying, assessing, monitoring, and mitigating risks that could affect a bank's financial health, operations, reputation, and compliance with regulations.
- Example: Effective risk management practices help banks anticipate and… #
- Example: Effective risk management practices help banks anticipate and respond to risks, protect against losses, and maintain financial stability in a changing and uncertain environment.
S #
S
Securitization #
Securitization
- Definition: The process of pooling and repackaging financial assets suc… #
- Definition: The process of pooling and repackaging financial assets such as loans, mortgages, or receivables into securities that can be sold to investors to raise capital.
- Example: Mortgage-backed securities are a common form of securitization… #
- Example: Mortgage-backed securities are a common form of securitization that allows banks to transfer credit risk, diversify funding sources, and free up capital for new lending.
Single Supervisory Mechanism (SSM) #
Single Supervisory Mechanism (SSM)
- Definition: A system established by the European Central Bank to overse… #
- Definition: A system established by the European Central Bank to oversee and supervise significant banks in the Eurozone to ensure consistent and effective prudential regulation.
- Example: The SSM conducts on-site inspections, off-site monitoring, and… #
- Example: The SSM conducts on-site inspections, off-site monitoring, and risk assessments to enhance the resilience and stability of the banking sector in the Eurozone.
T #
T
Too Big to Fail (TBTF) #
Too Big to Fail (TBTF)
- Definition: A concept that refers to banks or financial institutions th… #
- Definition: A concept that refers to banks or financial institutions that are considered so large, interconnected, or critical that their failure would have systemic consequences.
- Example: TBTF institutions are subject to heightened regulatory scrutin… #
- Example: TBTF institutions are subject to heightened regulatory scrutiny, capital requirements, and resolution planning to prevent their failure from destabilizing the financial system.
Trading Book #
Trading Book
- Definition: The accounting designation for financial instruments held b… #
- Definition: The accounting designation for financial instruments held by banks for trading purposes, subject to mark-to-market accounting, valuation adjustments,