Glossary

asset
Anything of value that is owned. See also: balance sheet.
bail-in
A bail-in resolution is a way of allocating losses to a bank’s shareholders and potentially to some of its creditors. The bail-in procedure follows a legal order of priorities in terms of liability (‘liability cascade’). The first step is to write down the bank’s equity capital to reflect the losses incurred. If these funds are insufficient, other liabilities, such as bonds, are written down or converted into equity.
balance sheet
A record of the assets, liabilities, and net worth of an economic actor such as a household, bank, firm, or government.
bank bailout
The government buys an equity stake in a bank or makes some other intervention to prevent it from failing.
bank lending
A loan where the lender (the bank) provides a borrower with a sum of money for a limited period of time. The borrower is obliged to pay interest to the lender. There are numerous types of loans, which are characterized by different maturities (date the final repayment is due), type and scope of collateral, or use (e.g. real estate credit, overdraft facility, instalment loan). Source: Bundesbank glossary.
bank run
A situation in which depositors withdraw funds from a bank because they fear that it may go bankrupt and not honour its liabilities (that is, not repay the funds owed to depositors).
bank
A firm that creates money in the form of bank deposits in the process of supplying credit.
Basel Committee on Banking Supervision
An international group that develops international standards for supervising and regulating the banking sector. The most important regulatory frameworks are known as Basel II and Basel III. Representatives of central banks and supervisory authorities from different countries are members of the Basel Committee. The committee is located at the Bank for International Settlements (BIS) in Basel. Source: Bundesbank glossary.
capital (firms and banks)
The money that a firm has obtained from its shareholders and any profit that it has made and not paid out.
capital requirements
A rule requiring banks to meet or exceed a certain capital ratio. The ratio is calculated by dividing available capital by risk-weighted assets. This rule is necessary because banks take risks. For example, there is the risk of a borrower being unable to repay their loan (credit default risk) or financial market prices becoming unfavourable for the bank (market risk). In order to protect its creditors, the bank therefore needs sufficient equity capital to absorb any losses arising from this risk. Source: Bundesbank glossary. See also: leverage ratio (for banks or households).
capitalization
The expansion of a bank’s capital base. Capital is the money that a bank has obtained from its shareholders and any profit that it has made and not paid out. Consequently, if a bank wants to expand its capital base, it can do so by issuing more shares or retaining profits, rather than paying them out as dividends to shareholders. Source: ECB.
collateral
An asset that a borrower pledges to a lender as a security for a loan. If the borrower is not able to make the loan payments as promised, the lender becomes the owner of the asset.
credit rating
A classification of debtors or securities in terms of their creditworthiness or credit quality. These classifications are generally carried out by credit rating agencies. The highest creditworthiness rankings are denoted as AAA or Aaa by the most well-known agencies, while less creditworthy ratings are denoted with different combinations of letters and numbers. Credit ratings agencies consider the credit quality of debtors or securities rated BBB- or better as ‘investment grade’. Those with a lower rating are classified as speculative; such securities are also referred to as high-yield bonds. Source: Bundesbank glossary.
credit ratings agency
A firm which collects information to calculate the credit-worthiness of individuals or companies, and sells the resulting rating for a fee to interested parties.
default risk
The risk that credit given as loans will not be repaid.
European Systemic Risk Board (ESRB)
The (ESRB) is an EU body which is responsible for overseeing the financial system in the EU as a whole and for the timely identification of systemic risk (macroprudential oversight). The ESRB can issue warnings, making such warnings public where appropriate, and make recommendations. Based at the European Central Bank (ECB), the ESRB comprises representatives from the ECB, national central banks, supervisory authorities and the European Commission. Source: Bundesbank glossary.
external effect
A positive or negative effect of a production, consumption, or other economic decision on another person or people that is not specified as a benefit or liability in a contract. It is called an external effect because the effect in question is outside the contract. Also known as: externality. See also: incomplete contract, market failure.
Financial Stability Board (FSB)
An international institution that coordinates the work of national financial supervisory authorities and international standard-setting bodies in the financial sector. It consists of representatives from central banks, finance ministries, supervisory authorities and international organisations. The FSB’s secretariat is located at the Bank for International Settlements. The FSB is the successor of the Financial Stability Forum, which was set up by G7 countries in 1999 and underwent reforms (including renaming) in 2009. Source: Bundesbank glossary.
financial stability
A state in which the financial system is always able to perform its economic functions. A stable financial system: (1) can absorb financial and real economic shocks, (2) can prevent contagion and feedback effects and (3) should neither cause nor excessively amplify a downturn in overall economic activity. Market participants can constantly adapt to evolving conditions or exit the market without jeopardising the functioning of the financial system. Macroprudential policy should be formulated such that it safeguards financial system stability. Source: Bundesbank glossary.
fire sale
The sale of something at a very low price because of the seller’s urgent need for money.
funding cost advantages
The difference between a financial institution’s actual funding cost and its hypothetical funding costs if it were not benefiting from an implicit guarantee. Funding cost advantages are a measure of the implicit government subsidy accruing to systemically important banks and thus the expected bailout that bondholders expect to receive. See also: implicit guarantees.
funding structure of bank
Every bank has two sources of funds: capital and debt. Debt is the money that it has borrowed from its creditors and will have to pay back. Debt includes among other things deposits from customers, debt securities issued and loans taken out by the bank. Source: ECB.
G20
A group of 20 jurisdictions with similar economic interests that meet in informal advisory sessions to make joint decisions and share initiatives. The members of the G20 are Canada, France, Germany, Italy, Japan, the UK, the US, the EU, Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa, South Korea and Turkey. The G20 represents around two-thirds of the global population and 80% of world GDP. Source: Bundesbank glossary.
global financial crisis
This began in 2007 with the collapse of house prices in the US, leading to the fall in prices of assets based on subprime mortgages and to widespread uncertainty about the solvency of banks in the US and Europe, which had borrowed to purchase such assets. The ramifications were felt around the world, as global trade was cut back sharply. Goverments and central banks responded aggressively with stabilization policies.
hidden actions (problem of)
This occurs when some action taken by one party to an exchange is not known or cannot be verified by the other. For example, the employer cannot know (or cannot verify) how hard the worker she has employed is actually working. Also known as: moral hazard. See also: hidden attributes (problem of).
implicit guarantees
Where market participants believe that the government would support a bank in case of its financial distress to avoid feedback effects with the real economy, the bank and its creditors are said to enjoy an implicit guarantee. See also: funding cost advantages.
incomplete contract
A contract that does not specify, in an enforceable way, every aspect of the exchange that affects the interests of parties to the exchange (or of others).
insolvent
An entity is insolvent if the value of its assets is less than the value of its liabilities. See also: solvent.
interbank market
A market in which banks borrow to and lend from each other.
investment bank
A financial institution that does not make loans or accept deposits, but instead carries out other banking activities such as helping companies and public sector institutions to issue securities, trading securities, foreign exchange, and all types of financial products; and advising companies on initial public offerings, mergers and acquisitions. Source: Bundesbank glossary.
leverage ratio (for banks or households)
The value of assets divided by the equity stake in those assets.
liquidity
Persons and enterprises are liquid if they are able to fulfil their payment obligations at any time. Correspondingly, assets can be categorised according to their degree of liquidity or how readily they can be converted into cash. Cash is the most liquid asset. While financial assets like shares and bonds traded in the markets have a lower degree of liquidity than cash, they are much more liquid than real estate owing to the much lengthier process of selling property. Source: Bundesbank glossary.
macroprudential policy
Measures that intend to ensure that market participants take a cautious approach to risks that could affect the whole financial system (systemic risks). Prudential policies relate to actions that promote sound practices and limit risk-taking. The prefix ‘macro’ indicates that the policies or actions relate to the whole or significant parts of the financial system rather than individual financial institutions. Source: ECB – Explainers. See also: systemic risk.
market failure
When markets allocate resources in a Pareto-inefficient way. Examples of market failure are moral hazard, external effects and ‘hidden actions’ problem. See also: external effects, hidden actions (problems of) and moral hazard
maturity transformation
The practice of borrowing money short-term and lending it long-term. For example, a bank accepts deposits, which it promises to repay at short notice or no notice, and makes long-term loans (which can be repaid over many years). Also known as: liquidity transformation.
microprudential supervision
The supervision of individual institutions, which mainly involves supervisors overseeing compliance with qualitative (e.g. risk management) and quantitative (e.g. capital) requirements. Source: Bundesbank glossary. See also: capital requirements.
moral hazard
This term originated in the insurance industry to express the problem that insurers face, namely, the person with home insurance may take less care to avoid fires or other damages to his home, thereby increasing the risk above what it would be in absence of insurance. This term now refers to any situation in which one party to an interaction is deciding on an action that affects the profits or wellbeing of the other but which the affected party cannot control by means of a contract, often because the affected party does not have adequate information on the action. It is also referred to as the ‘hidden actions’ problem. See also: incomplete contract, too big to fail.
mortgage (or mortgage loan)
A loan contracted by households and businesses to purchase a property without paying the total value at one time. Over a period of many years, the borrower repays the loan, plus interest. The debt is secured by the property itself, referred to as collateral. See also: collateral.
net worth
Assets less liabilities. See also: balance sheet.
Pigouvian tax
A tax levied on activities that generate negative external effects so as to correct an inefficient market outcome. See also: external effect.
positive feedback (process)
A process whereby some initial change sets in motion a process that magnifies the initial change.
principal–agent relationship
This relationship exists when one party (the principal) would like another party (the agent) to act in some way, or have some attribute that is in the interest of the principal, and that cannot be enforced or guaranteed in a binding contract. See also: incomplete contract. Also known as: principal–agent problem.
profitability
A measure of the ratio of profit to capital invested. Profitability is sometimes used as a synonym for return on equity, which is calculated as the ratio of net profit to equity over a specified period, expressed as a percentage. Source: Bundesbank glossary.
recession
The US National Bureau of Economic Research defines it as a period when output is declining. It is over once the economy begins to grow again. An alternative definition is a period when the level of output is below its normal level, even if the economy is growing. It is not over until output has grown enough to get back to normal. The latter definition has the problem that the ‘normal’ level is subjective.
resolution
The process of closing or restructuring a bank without interrupting its critical economic functions. Bank shareholders and some or all of the bank’s creditors bear the losses, instead of taxpayers. One approach to resolution is bail-in. See also: bail-in.
shadow banks
The Financial Stability Board (FSB) defines shadow banks as financial market players that engage in activities and perform functions similar to those of banks (particularly in the lending process) but are not banks themselves, meaning that they are not subject to banking regulation. Shadow banks do not necessarily belong to the semi-legal or illegal ‘shadow economy’. Regulated credit institutions can outsource operations to specialised shadow banks and thus – perfectly legally – circumvent regulatory measures. Source: Bundesbank glossary.
solvent
A firm or individual for which net worth is positive or zero. For example, a bank whose assets are more than its liabilities (what it owes). See also: insolvent.
stress test
A simulation calculating the effects that extreme market developments have on the balance sheet of a bank or an insurer in order to detect and assess risks to these institutions’ solvency. Source: Bundesbank glossary. See also: solvent.
systemic risk (in the financial system)
The risk that problems encountered by one or more market participants, and/or the adjustments they make in response to those problems, will impair the functioning of the financial system. Source: Bundesbank glossary.
systemic risk
A risk that threatens the financial system itself.
systemically important financial institution (SIFI)
A financial institution is considered systemically important if its insolvency would have a serious impact on the functioning of the domestic financial system and have negative effects on the real economy. Systematically important banks are subject to stricter capital requirements and loss absorbency capacity than other banks. Global systemically important banks and domestic systemically important banks are further classifications of systemically important financial institutions. Source: Bundesbank glossary.
too big to fail
Said to be a characteristic of large banks, whose central importance in the economy ensures they will be saved by the government if they are in financial difficulty. The bank thus does not bear all the costs of its activities and is therefore likely to take bigger risks. See also: moral hazard.
total loss absorbing capacity (TLAC)
A regulatory standard that requires global systemically important banks (G-SIBs) to have sufficient financial instruments available during resolution to absorb losses and enable them to be recapitalized, so they can continue performing their critical functions while the resolution process is ongoing. The objective of TLAC is to have an orderly resolution by making debt/equity holders absorb losses (enabling a ‘bail-in’) instead of using public funds (conducting a ‘bailout’). Source: BIS - TLAC – Executive Summary. See also: bail-in, bank bailout, resolution, systemically important financial institution.