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«BLUEPRINT SERIES 25 EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS Dirk Schoenmaker and Nicolas Véron, editors Thomas Gehrig, Marcello Messori, ...»

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French bankers are generally positive on the quality and effectiveness of Joint Supervisory Teams (JSTs), which are seen as displaying the right blend of regulatory, consulting and banking backgrounds and skills. They are appreciative of the fact that teams have been hired, trained and assembled within a very short timeframe. Day-to-day contacts are easy even though communication with the ECB is much more formal than it used to be with APCR, and is more systematically based on templates. Banks generally understand that JSTs methodically request additional data, in comparison to the national framework in which regulators had more ex-ante knowledge of their processes


and people. Coordination with supervisors outside of the euro area is perceived as continuing along the same path as before the SSM, in both situations: supervision of the non-euro area operations of French banking groups, and of the French operations of non-euro area banks.

The expectation is that the creation of the SSM as a strong pan-European institution will enhance Europe’s global influence, in particular within the Basel Committee, which is seen as having been greatly influenced by American arguments in recent times.

The new European supervision is also reckoned to be an agent of positive transformation within the French banking sector. It has brought a fresh and international view on controls and governance.

The granularity of banks’ in-house information has been improved.

Information systems have been upgraded. Governance has been

enhanced in order to:

• Clarify structures: major changes have taken place in mutual banks;

• Train and empower directors in subsidiaries and branches, and ensure the effectiveness of board committees;

• Qualify and quantify risk in a more systematic way, with a focus on business models, guarantees and collateral, and comparisons with peer banking groups.

The SSM’s thematic programmes are viewed as useful in terms of generating new ideas and in order to anticipate forthcoming inspections.

All the aforementioned issues are not common to all banks and certainly not applicable at every level of each bank, but they provide some idea of the positive influence of European banking supervision, as seen by the top level of French banks.

French banks’ specific interests All national financial systems have local idiosyncrasies, reflected in the 167 ‘options and national discretions’ (ONDs) identified by the 82 | BRUEGEL BLUEPRINT SSM. France is no exception. The financial framework historically was

designed to optimise the use of scarce capital. In particular:

• French banks are very large, with a significant international footprint. The sector is very concentrated, with limited foreign presence;

• Banks are truly universal, with investment banking arms very relevant at European or global levels in certain lines of business;

• Bancassurance is a strong component of the product mix, in a country in which life insurance represents a massive 75 percent of GDP;

• Specific rate-regulated (and tax-favoured) savings products (‘épargne réglementée’) represent a total around €840 billion77;

• Mutual banks have structures that are more centralised than in other countries, and the French believe that this feature should be properly taken into account in supervisory risk assessment.

The SSM’s willingness to eradicate all ONDs has been a cause for concern, even though worries are less acute now than at the outset of the process. The 2012 ‘Danish compromise’ for the EU implementation of Basel III, which acknowledged the inclusion of insurance subsidiaries’ capital into the consolidated group capital ratio and thus supports the bancassurance model, has not been reversed by the SSM so far.

French banks adamantly defend their view that intra-group exposures (at national level for mutual banks or at the international level) should 77 ‘Epargne réglementée’ savings products are collected by banks, but their yield is decided by the government. Within this category, Livret A, LDD and LEP (€410 billion in total) have a special status: about three-fifths of the inventory is ‘centralised’ (ie in mandated custody) at Caisse des Dépôts et Consignations.

The calculation of CET1 ratios takes all of these savings into account, although only part of them is effectively managed and put at risk by the banks. The impact is particularly strong for mutual banks, because they used to have a monopoly on the distribution of Livret A and still play a major role in this segment. See http://www.fbf.fr/fr/files/9NJCEC/Rapport-observatoire-epargne-reglementee-2014-BDF.pdf.


not be limited. The unique features of épargne réglementée are seen as legitimate and in need of being defended, even though bankers also acknowledge that they are difficult to explain in an international context.

Shortcomings Of course, it is not all rosy. Several aspects of European banking supervision have been identified by the French financial community as needing improvement.

First there is the risk of bureaucratic drift. Bank workloads to comply with SSM requests are extremely heavy, and continue to increase. Very detailed demands may arrive at short notice.

Duplication and contradictions (between the ECB’s DGMS I and DGMS IV, and between the ECB and other agencies) are unwelcome in this context, all the more because few executives have a full grasp of top-level issues, information systems and details.

The review of models is a much-debated question in terms of timing, because it takes place at the same time as the Basel Committee’s Fundamental Review of the Trading Book, and because it creates uncertainties inside banks and slows the development of new businesses.

Bankers recognise that much centralisation of decision-making in Frankfurt is unavoidable, but they feel that some of the rules should be changed. Delegation should be made possible for lower-level decisions, such as the vetting of new directors, and changes at small subsidiaries. More generally, the view prevails that the principle of proportionality should be better applied by European banking supervision. Small subsidiaries are currently subject to the same supervisory controls as group-level entities.

Delays in ECB decision-making (eg more than six months to produce a follow-up letter) are perceived as undermining the effectiveness of supervision. By contrast, SSM-imposed deadlines for remediation plans are very short. More fundamentally, bankers expect that 84 | BRUEGEL BLUEPRINT substantive feedback should be provided by European banking supervision in exchange for the very detailed information they provide.

They understand that the SSM is young and that its doctrine is still in the making, so that its staff might not wish to publicise views that they might subsequently have to amend. Even so, the current situation is not considered satisfactory.

Another cause for concern is that all SSM initiatives in the first year have been seen as opportunities to add new layers of capital in a systematic way, with little consideration of previous efforts. This perception, however, might be alleviated by Danièle Nouy’s recent declarations that capital requirements will not increase beyond their current level.

At a more fundamental level, French stakeholders worry about an overly prescriptive European supervisory approach to banking business models. They generally welcome harmonisation as a way to create a level playing field, as noted before. But they are wary that the ECB might promote a normalised banking model, on the basis that it would be easier to monitor and control. The argument is that several banking models should coexist. For example, European banking supervision has to adapt to different ways of considering housing risk (which is very much shaped by national legal systems), or the way mutual banks manage their base of shareholders.

A specific episode has been the SSM’s wobbly stance on Pillar-2 capital requirements and maximum distributable amounts (MDA), which is seen by several French stakeholders as having partially contributed to the surge of volatility in bank share prices in early 2016.

Although this bout of volatility was triggered by questions about Deutsche Bank’s ability to pay down dividends on its additional Tier 1 debt (AT1, including contingent convertible instruments known as CoCos), an issue linked to the application of country-specific German law, investors started to look at the European regulatory framework relevant to the situation. They found that the MDA definition was not entirely clear, nor the stacking order of various instruments.


Scandinavian, UK and euro-area banks seemed to operate under different regimes in terms of Pillar-2 constraints and disclosure obligations. In particular, the SSM had asked banks not to publish MDA information, in order to enhance the quality of its dialogue with banks.

This situation was perceived as having been particularly detrimental to French banks, which manage their MDA buffer tightly.

A common view in France is that a distinction should be made between what is required (and published) by the supervisor, and what is part of the private dialogue between it and the supervised bank. This position seems to have been eventually endorsed by the European Commission and the ECB. The SSM’s communication, however, was less than clear. In its SREP methodology booklet (published on 19 February 2016), the ECB stated that AT1 instruments were not taken into account in SREP 2015 decisions; but the following week, it added that AT1 may be taken into account in SREP 2016. The ECB’s clarifications were interpreted by market participants as implying some future relaxation of automatic AT1 coupon cancellations and a move towards the UK approach to Pillar-2 requirements, currently the most advanced and transparent within the EU. This approach entails Pillar-2 specifications across all capital tiers, and a split of Pillar-2 into a ‘hard’ component, before all buffers, and a ‘soft’ component, on top of the buffers for, for example, adverse stress test scenarios and initially not binding for MDA restrictions78. In the same vein, later in March, the Commission asked regulators to differentiate between capital ‘guidance’ they give to individual banks, and enforceable capital requirements79. In the light of this episode, it is plain that European banking supervision should intensify its dialogue with market participants in order to prevent unnecessary differences in perception.

78 BIHC, ‘Commission review raises hopes after EBA bombshell’ March 2016,, http://bihcapital.com/2016/03/commission-review-raises-hopes-after-eba-bombshell/.

79 http://washpost.bloomberg.com/Story?docId=1376-O3TZG16TTDSH01-4EM7TKL4BD0ENAC4BGPU64T4CL.

86 | BRUEGEL BLUEPRINT Last but not least, European banking supervision is blamed for having failed so far to deliver a genuine single euro-area banking market. As previously emphasised, French stakeholders understand the promise of banking union to be a loss of sovereignty in exchange for a level playing field in Europe, including further expansion of acquisitive French banks. They also feel uncomfortable with the fact that the SSM’s governance model gives significant influence to countries where the approach to banking and financial security tends to be more parochial and more supportive of geographical ring-fencing for domestic political reasons. They believe that European institutions should oppose countries reincorporating harmful ONDs, idiosyncratic treatment of deferred tax assets or obstacles to cross-border liquidity into national legislation.

Another strong belief in France is that supervision by the SSM should not be restricted to the current 129 SIs, and should be extended

to all LSIs as soon as possible for at least three reasons:

• Smaller banks can be systemically dangerous, as recently demonstrated by the 2008-11 crises, recent bankruptcies and the non-performing loan situation in Italy;

• National supervision of LSIs creates barriers to cross-border M&A;

• Unresolved issues at smaller banks create can damage the reputation of the whole euro area, in particular in the minds of investors in the US and Asia. It should be noted in this respect that all banks that failed since the inception of European banking supervision (BANIF in Portugal, the four Italian banks resolved in late 2015) were LSIs.

The dominant view in France is that the same rules should apply to all banks irrespective of size, even if reporting formats may be adjusted. Large banks are frustrated with the idea that their competitive positions are more constrained by regulation than those of others.

This may lead to adverse consequences for the financing of European corporates (Goodhart and Schoenmaker, 2016).


Prospective issues Looking ahead, one significant challenge is the multiplicity of partly overlapping regulators after the wide-ranging European reforms of the past few years. Banks face six different regulators which pursue at least partly self-defined objectives: the SSM, SRB, Basel Committee, EBA, the European Commission and their local supervisor (ACPR in France). Compliance with the prescriptions of these regulators requires resources and the parallel management of complex projects critically based on IT resources (the upgrade of legacy IT systems being a persistent challenge in many banks) and concentrated expertise.

In this respect, bankers are concerned that well-staffed agencies might want to start unnecessary projects. They understand that the ECB and SRB are independent from each other, but are concerned that the SRB develops its own methodology on risks, creating an unwelcome discontinuity between supervision and resolution. If a resolution case fails for whatever reason, fingers will point at the supervisor, and the ECB position could be weakened as a consequence. Another concern is that confusion about minimum requirements for eligible liabilities (MREL) under the EU Bank Recovery and Resolution Directive (BRRD) might replicate the difficulties encountered by European banking supervision with the definition and publication of Pillar-2 and MDA, for similar reasons. Hence a stronger dialogue with market participants is necessary, on this as on other issues.

Of course, French bankers and officials also express worries about the perceived trade-off between efficient financing of the economy and secure risk management. This issue predates European banking supervision. Basel III requirements have incentivised banks to reduce their market-making activities, and bankers argue that this has increased market volatility, which is ironic given that EU policymakers simultaneously pledge to promote a more disintermediated financial system (capital markets union).

88 | BRUEGEL BLUEPRINT Regulators and European banking supervisors would ignore this worry at their peril. They must understand markets. A widespread concern in French banking circles is that the ECB and other Europeanlevel authorities have not developed a broad enough network of contacts in order to grasp the reality of markets, despite ongoing efforts such as road-show-type meetings with (mostly European) investors.

The SSM could magnify the issue, with its insistence on capital, and given the inherent difficulty for investors to understand newly created institutions, especially when in a different time zone. The problem with markets is that they tend to materialise sell-fulfilling prophecies once a trigger point has been reached. Orderly resolution might be difficult to execute past this point.

The recent market turbulence highlights the fact that regulators cannot act in a political vacuum. In the US, federal regulators have become extremely powerful but also answer to a healthy dose of scrutiny from Congress. Efforts should be made in Europe to fill this vacuum (see also Villeroy de Galhau and Weidmann, 2016).

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