«BLUEPRINT SERIES 25 EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS Dirk Schoenmaker and Nicolas Véron, editors Thomas Gehrig, Marcello Messori, ...»
In general, private–sector participants in the Spanish banking system point out that the SSM has contributed decisively to the financial stability of the euro area and has established itself as a professional and reputable supervisory institution, and is on its way towards establishing a genuine European supervisory culture. All are impressive achievements, especially given the diversity of the previous supervisory cultures of euro-area member states. Both private and public players underline that before European banking supervision was born, there seemed to be less consensus among national supervisors on how and what to supervise, than among monetary policymakers before the creation of the euro.
Furthermore, on top of all these achievements, the SSM begins its second year at full speed with a general consensus among private-sector participants that it has been able to design a framework that is broadly perceived as fair by the supervised entities, with no critically relevant biases.
As in any process of such complexity and ambition, there are still areas where full speed or a steady-state situation has not yet been
achieved. On this, comments can be grouped in four areas:
Ex-post versus forward-looking supervision Pre-SSM, supervision by the Bank of Spain had a reputation of being quite intrusive (including through on-site supervision), with a focus on data, asset valuation, classification for accounting purposes, credit risk analysis, collateral valuation and provisioning. The main objective was to identify potential provisioning deficits. The central bank was also responsible for defining the accounting framework for banks.
This approach could be labelled ex-post supervision. By contrast, the forward-looking focus of the SSM has been a real change.
The SSM has tended to focus on elements with a forward-looking component: sustainability of the business model, corporate governance, risk management and risk appetite, whether procedures and 156 | BRUEGEL BLUEPRINT reporting are adequately established and clear, and deadlines fulfilment, among others. It seems to focus more on how the institution is organised internally, and on whether it is well prepared for unexpected events, being quite hands-on in this regard. It also leads a process of convergence towards best practices in these areas. Thus, the SSM-led change for Spanish banks, unlike in other countries, has not been so much an issue of the intrusiveness of supervision, but rather an issue of its focus and scrutiny.
The new approach has arguably improved the quality and broadened the scope of supervision, with internal implications for the banks, from the organisation of credit committees all the way up to their top management and boards. The new system is more based on rules and procedures, but also on significant amounts of information being provided by the banks at the ECB’s request without full understanding of its purpose and final use, an area in which the ECB could provide some further feedback.
While this broader and more systematic approach is welcome, it would benefit from incorporation of more elements of ex-post supervision, with a focus on asset valuation, classification or provisioning policies. Admittedly, such issues are still to a great extent under the umbrella of national supervisors, but a framework for a common methodology and interpretation could be established. In fact, this is what was done in the 2014 asset quality review or, more recently, in the review of NPL definitions. The implementation of the IFRS9 standard for financial instruments accounting will be another good opportunity for this, in a context in which member states will also have to limit the use of national exceptions.
From a legal perspective, many of the tools for both ex-post and forward-looking supervision will be kept in the hands of national authorities and policymakers, at least for a while (for example some interpretations of accounting standards). But even so, there should be scope for convergence towards best practices and a broadening of the scope of supervision. This would also help mitigate the risk of a
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one-size-fits-all model of supervision (see below).
Communication issues Communication issues are always a challenge when new institutions are set up, and European banking supervision has been no exception. It has not helped that deadlines have been very tight, and that the initial steps took place in the middle of a difficult situation with a European banking sector emerging from the financial crisis.
Investors’ appetite for Spanish banks’ securities, and hence their cost of capital, have been affected by uncertainties about the final treatment of deferred tax assets and, more recently, about the framework to determine banks’ maximum distributable amounts. Lack of clarity on whether and how to communicate SREP exercise results has not helped either. More generally, there has also been uncertainty about whether the current levels of capital were seen as sufficient by ECB banking supervision, or whether additional requirements where still lying ahead. In this context, the recent ECB clarifications that capital requirements would not increase further have been very welcome, as have been a series of clarifying workshops held by the SSM on a variety of issues that have improved communication and feedback to and from banks.
There is concern about the results of several ongoing discussions, including those on potential changes in risk weights for public debt, IFRS9 implementation and internal models. All of these could have significant impact, and hence communication will continue to be very relevant.
Finally, while the whole institutional setup of the banking union is rather complex, with several European-level institutions (such as the ECB, SRB and EBA) interacting with national authorities, it is essential to maintain adequate coordination among the different institutions and to ensure consistency of messages and criteria.
158 | BRUEGEL BLUEPRINT Subsidiaries, diversification and the risk of a one-size-fits-all approach The Spanish international banks’ expansion into Latin America and other regions was undertaken via local subsidiaries with a high level of autonomy. Supervision is undertaken at local level, as is capital and liquidity management in most cases.
Some elements of this model seem not to have been taken sufficiently into account in the SSM’s supervision of international groups.
The subsidiary model is less common among intra-EU or intra-euro-area cross-border banking operations, where branches and a less decentralised framework are more widely used. This latter model can certainly be seen as more in line with an ideal EU single market for banking services, because it is likely to reduce fixed costs, enhance financial integration and generate economies of scale. But it is less common in the context of non-EU retail banking operations.
In addition, it would seem reasonable to accept that the risk profile and correlations (macro, but not only) are not the same intra-EU and with Latin America, for example. Together with the different levels of risk, these differences should be taken into account in various supervisory areas. Among others, the design of stress test scenarios should consider the lower correlation of economic cycles and other specific issues: for example, not assuming a simultaneous deflationary process in several big Latin American economies as a likely scenario. If correlation is not perfect, then there should be some benefits arising from geographical diversification. This can also be true of geographical diversification inside the EU or euro area.
This geographical diversification and different legal structures could also be considered in the context of potential resolution scenarios (single or multiple point of entry). Recognising and analysing different banking models on the basis of their own merits might make supervision more complex, but would help to avoid risks embedded in a one-size-fits-all approach. This risk is not immaterial, especially if one adds to the equation the fact that a more structured supervisory
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framework allows less flexibility and discretion to the supervisors.
Internal challenges Setting up an institution like the SSM inevitably involves less-public, more-internal challenges, the addressing of which also critically affects the institution’s credibility. The establishment of Joint Supervisory Teams, which is now a reality on the ground, with JST leaders from outside each bank’s home country and involving different cultures and languages, is certainly a success. JSTs seem to be working efficiently, though alignment of working methods and focus among different JSTs is not yet fully achieved.
Furthermore, and perhaps at least partly because of the legal framework under which European banking supervision was established, there is a view among Spanish bankers that procedures are very heavy and time consuming. Approvals and decision-making processes take a long time, and the perception is that these delays are excessive, for example for the vetting of a bank’s board members.
Finally, European banking supervision will have to strike the inherently difficult balance when it comes to rotating supervisory staff between different banks. If teams spend long periods supervising a particular bank, they can become too close to the supervised entity.
But quick rotations do not allow the supervisors to fully benefit from the knowledge that is acquired with experience and time. This is an issue that other institutions have had to confront, for example the IMF with its country teams. Some rotation within teams is probably part of a reasonable solution.
All in all, the SSM has been a success. Broadening the scope of supervision, improving communication, avoiding a one-size-fits-all supervisory approach and tackling some internal issues and procedures will improve it even further.
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EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSDirk Schoenmaker and Nicolas Véron, editors European banking supervision, also known as the Single Supervisory Mechanism, is the first and arguably the main component of European banking union. In late 2014, the European Central Bank became the supervisor for the region’s largest banking groups; the ECB also oversees the supervision by national authorities of smaller banks.
This Blueprint is the first in-depth study of how this ground-breaking reform is working in practice. It includes a euro-area overview and chapters on nine countries covering 95 percent of the area’s banking assets, illustrating the diversity of experiences, situations and perceptions in different member states.
Despite teething troubles and occasional misjudgements, this assessment finds that overall European banking supervision has been effective, demanding and broadly fair, at least for the banks under the ECB’s direct watch. Even so, achieving a truly single market in banking services will require more time, further supervisory initiatives and new Europe-wide regulatory and legislative steps.
Dirk Schoenmaker is a Senior Fellow at Bruegel and a Professor of Banking and Finance at the Rotterdam School of Management of Erasmus University Rotterdam.
Nicolas Véron is a Senior Fellow at Bruegel and a Visiting Fellow at the Peterson Institute for International Economics in Washington DC.