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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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While Article 7 of CRR provides for a possible waiver, this is associated with strict requirements that are not met by the two German IPSs.

Importantly, neither the savings nor the cooperative banks are part of a holding company that owns a majority of the voting shares and is able to actively intervene in the individual savings or cooperative banks.

Banks that are part of an IPS have advantages in terms of capital


requirements and limits on their exposures to banks that are part of the same IPS (CRR Art. 113, 6 & 7). They do not have to hold capital against these exposures (zero risk-weights), and there are no large exposure limits (as opposed to, for example, corporate exposures which are limited to 25 percent of Tier 1 capital). Advantages in terms of zero risk-weights and concentration limits apply to exposures to banks within Germany. Exposures to subsidiaries outside of Germany are not affected.

IPSs, however, can also carry risks. Savings banks were particularly affected because of their investments in Landesbanken during the 2007-09 financial crisis. These Landesbanken (WestLB, Sachsen LB and Bayern LB in particular) took large risks in the US subprime mortgage market that eventually spilled over to the savings banks82.

HSH Nordbank is another example, and as a Landesbank, is also part of the IPS of the savings banks. It is publicly owned, 95 percent jointly by the states of Hamburg and Schleswig-Holstein and 5 percent by the Sparkassen- und Giroverband Schleswig-Holstein. HSH Nordbank had to be bailed out by the federal government during the global financial crisis of 2008-09. In 2008, it reported a group net loss of €2.70 billion, along with dramatically higher loan loss provisions. Poor asset quality has continued to be an issue – its nonperforming loan ratio was 23 percent at the end of September 2015, based on data from its annual and quarterly reports. In March 2016, the German government and the European Commission came to an agreement on how the problem loans should be dealt with. This agreement also stipulates that HSH Nordbank has to be privatised by 2018 or to be wound down.

Because it might prove difficult to find a buyer, the latter is not an unlikely scenario, and it is unclear how losses might then be shared. It might be that the IPS will have to bear considerable losses in order to 82 Puri, Rocholl and Steffen (2011) show that affected savings banks reduced consumer lending substantially after the Landesbanken incurred these losses.

Fischer et al (2016) link those losses to the elevated risk taking behaviour of Landesbanken associated with the loss of their government guarantee in 2005.

98 | BRUEGEL BLUEPRINT avoid the imposition of losses on bondholders.

It is thus critical that IPSs are supervised not only at the individual bank level, but also at the combined IPS level, and that the interconnectedness of these banks is taken into account. SIs and LSIs that are in the same IPS require additional coordination from all relevant supervisors. In early 2016, the ECB conducted a consultation on IPSs (ECB, 2016d). The ECB’s consultation document “sets out the ECB’s approach concerning the assessment of the eligibility of ISPs for prudential supervisory purposes. It aims to ensure coherence, effectiveness and transparency regarding the policy that will be applied when assessing IPSs […]”. In this approach, the ECB is not questioning the advantages in the CRR associated with IPSs, but rather investigates how effectively to supervise IPSs.

LSIs are also confronted with an increasing number of data requests, though to a lesser extent than the SIs. Cooperative banks and savings banks have centralised their IT systems, and created IT centres throughout Germany to manage data and processes such as the calibration of internal ratings models. The data requests from the ECB usually contain new information and are ad hoc and have to be met within a short period of time, sometimes within days. LSIs have to react to these requests at individual bank level, which increases administrative and IT costs for individual LSIs. If data requests were standardised, the IT centres could better implement these requests and centrally collect the data from the individual institutions. LSIs are concerned that standardised data requests (including for Financial Reporting (FINREP) and AnaCredit) will not replace the ECB’s ad-hoc requests.

LSIs complain about a lack of transparency in this process. They do not receive feedback on how the ECB uses the data. The LSIs are worried that the data is not only used in the supervisory process, but that the standardised data requests (FINREP and AnaCredit) will be used by the ECB to unduly modify and fine-tune their business models.

As with SIs, the data requests raise issues of accounting regimes.

Germany, like several other European countries, requires banks to


use national accounting standards, not IFRS, for entity-level financial statements, and also allows national accounting standards for the consolidated financial statements of banking groups that are not publicly listed. Because of potential problems in translating financial statements drawn up according to national (ie German) accounting standards so that they meet the IFRS requirements, data quality and the extent to which the data can be used in the supervisory process might be concerns.

There is increasing consolidation among smaller institutions in Germany. In 2014 (the last official statistic available from the Bundesbank before the start of the SSM), the number of banks was 1.9 percent less than in 2013. Since 1990, the number of banks in Germany has decreased from more than 4,500 to 1,990 in 2014 (Bundesbank, 2014). But this is unrelated to European banking supervision or the costs associated with new regulations. This trend started before the start of the banking union, and reflects, amongst other things, that some savings banks or cooperative banks do not have a viable business model and thus merge with other banks, usually in the same region.

How much progress has European banking supervision brought?

The SSM is the first pillar of the banking union, and its completion is of great importance for further integration in the euro area. Some of the problems and concerns highlighted in this chapter (such as those related to supervisory complexity and accounting issues) are predictable frictions at the beginning of European banking supervision. While it will be a huge task to implement a single supervisor for a diverse set of countries, there is an expectation that many issues will be solved as time passes and supervisory processes improve83. Such issues are not critical for the success of European banking supervision.

83 Saunders (2014) argues that even though the US implemented its first national banking regulation in 1863, it might still fall short of what might be viewed as a banking union. Implementation of a banking union in Europe might be even more challenging.

100 | BRUEGEL BLUEPRINT Communication and transparency in the supervisory process, on the other hand, are important because shortcomings in these areas might increase uncertainty on the part of market participants and erode market discipline.

More generally, the banking union was supposed to help address the shortcomings of the regulatory framework, which became obvious during the financial crisis of 2008-09 and the euro-area crisis since 2010 in the context of an incomplete monetary union. Government bonds are not risk-free and affect banks whose balance sheets are bloated with these bonds; regulation has not been harmonised across the 19 euro-area member states; and the fact that bank solvency was a national problem led to the emergence of ‘zombie banks’ in several parts of the euro area.

European banking supervision is an integral part of the banking union, and is supposed to harmonise supervision throughout the euro-area countries and to reduce the linkages between sovereigns and the financial sector. Acharya and Steffen (2015) argue that there are substantial risks to the stability of the banking union ahead, despite significant reform progress, such as through the SSM. They argue that the asset quality review conducted by the EBA and the ECB before the start of the banking union in October 2014 did not achieve a genuine cleaning up of the balance sheets of an over-leveraged banking sector in Europe, posing substantial challenges to the credibility of the ECB as a central bank and single supervisor and to sustainable growth in Europe. The ECB’s non-standard policy measures and the associated asset price inflation incentivise banks to shift portfolios into these securities, crowding out lending to the real economy and making these securities systemically important. Whether the banking union is eventually able to address these shortcomings remains to be seen.

7 Greece Miranda Xafa The Greek banking landscape Banking sector consolidation has been particularly intense in Greece since the onset of the crisis in 2010. As noted by the ECB84, Greece has recorded the largest relative decrease in the number of banks among euro-area countries, followed by Cyprus and Spain. From 2009 to 2014, the workforce in the banking sector shrunk by more than 30 percent;

a third of branches were closed and foreign ownership of assets nearly disappeared.

Piraeus Bank absorbed Geniki Bank (a subsidiary of Société Générale), Millenium Bank (a subsidiary of Portugal’s Millenium Group), the Greek branches of three Cypriot banks and the ‘healthy’ part of the Agricultural Bank of Greece. Alpha Bank absorbed Emporiki (a subsidiary of Crédit Agricole). National Bank of Greece (NBG) and Eurobank acquired smaller Greek banks and cooperative banks.

BNP Paribas closed its branches in Greece in early 2012. Following this wave of consolidation, the four systemic banks that emerged have a combined market share of 98 percent of total assets: 32 percent at NBG, 25 percent at Piraeus Bank, 21 percent at Eurobank Ergasias and 19 percent at Alpha Bank85. The remaining 2 percent is split between a small bank (Bank of Attica) and cooperative banks.

84 ECB (2015a) Report on Financial Structures, October.

85 As of 31 December 2015. Source: banks’ annual reports.

102 | BRUEGEL BLUEPRINT During the same period, bank deposits have halved, from €238 billion to €120 billion, and banks have lost access to wholesale funding, while NPLs remain a drag on credit growth and a key risk factor for capital adequacy. Greek bank exposure to the sovereign was reduced substantially to just 7.2 percent of total assets by end-March 2016, following the 2012 Greek debt exchange (known as PSI, for private-sector involvement) and buyback, and subsequent recapitalisations.

However, about one-half of bank capital consists of deferred tax assets (DTAs) and deferred tax credits (DTCs).

The Greek supervisory authority is the Bank of Greece, which is also the country’s national central bank and bank resolution authority.

Developments after the start of European banking supervision The 2014 comprehensive assessment found Greek banks well capitalised, after they had raised a total €8.3 billion in capital from private investors in April 2014. This came on top of €28 billion (of which €25.5 billion was from the official assistance programme) raised in the aftermath of the March 2012 PSI, which generated large losses for Greek banks.

Soon after the comprehensive assessment report was issued, however, a deadlocked Greek presidential selection process and the associated likelihood of new elections that would be won by the Syriza party, triggered large-scale deposit withdrawals, funding pressures and an increase in NPLs as a result of further deterioration in payment behaviour. Syriza won the January 2015 election on a defiant platform rejecting austerity and vowing to ‘tear up’ Greece’s existing agreement with official creditors (ESM, IMF and ECB). After a five-month standoff, the Greek government abruptly called a referendum on Friday 26 June, four days before the programme was due to expire, urging the Greek people to vote against a proposed new assistance agreement. Although 61 percent of Greeks followed this stance by voting no on the day of the referendum (5 July 2015), the Syriza-led government agreed to a third assistance programme at an EU Summit on 12 July 2015, under


the threat of imminent economic and financial collapse. Agreement on an ambitious three-year programme backed by €86 billion of ESM financing was finalised and a memorandum of understanding (MoU) was signed on 19 August, after the Greek parliament passed several prerequisite laws, including the national transposition of the EU Bank Recovery and Resolution Directive (BRRD).

The agreement sought to restore fiscal sustainability, promote growth, improve public sector efficiency and safeguard financial stability. To improve bank viability, the agreement set aside €25 billion for potential bank recapitalisation needs by end-2015, and called for immediate steps to tackle NPLs and to improve bank governance.

The Bank of Greece was tasked with assessing the capital needs of non-systemic banks. The financial sector strategy also included an assessment of the bank restructuring plans approved by the European Commission in 2013-14 in light of the changed circumstances of the financial system, and a plan to return the banks to private ownership in the medium term. Liquidity would be monitored through quarterly funding plans submitted to the Bank of Greece.

Liquidity vs solvency As the ECB Supervisory Board’s chair Danièle Nouy has stated, the need for recapitalisation had little to do with the Greek banks themselves, which were found to have sufficient capital in the 2014 comprehensive assessment. In her testimony to the European Parliament on 31 March 2015, she argued that political uncertainty was overshadowing the progress made by Greek banks. She also opined that Greek banks were better equipped for this political episode than in the past, thanks to the recapitalisation and restructuring efforts that had taken place. She added that the SSM was monitoring deposit outflows on a daily basis and had asked the banks to invest in assets that could be used as collateral in order to safeguard their liquidity.

In early February 2015, almost a full month before the programme was due to expire, the ECB Governing Council withdrew the waiver 104 | BRUEGEL BLUEPRINT that allowed Greek government debt to be used as collateral despite its speculative-grade credit rating, because there was no credible programme implementation86. Although the programme was subsequently extended to the end of June, Greek banks henceforth had to rely on more expensive emergency liquidity assistance (ELA) from the Greek central bank instead of the ECB’s lending window.

Appropriately, the SSM set limits on lending to the government and to public enterprises, in order to prevent deficit financing through ELA.

The ECB continued to approve liquidity provision through ELA until the Greek referendum was announced on 26 June, after which a threeweek bank holiday was declared and capital controls were imposed.

ELA provision was frozen between the bank closure and the agreement reached on 12 July, but resumed as soon as the Greek government implemented the first round of prior actions. ELA peaked at €88 billion in mid-July 2015 and gradually declined to €69 billion by early March

2016. Between September 2014 and June 2015, when capital controls were imposed, bank deposits declined by 41 percent to €120 billion, and stabilised thereafter (Figure 9).

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