«BLUEPRINT SERIES 25 EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS Dirk Schoenmaker and Nicolas Véron, editors Thomas Gehrig, Marcello Messori, ...»
Effectiveness In the short period from the June 2012 political decision to embrace banking union to the effective start of European banking supervision in November 2014, the ECB and NCAs managed a generally smooth transition from the previous national frameworks. The size of the task is illustrated by the ECB hiring by the end of 2014 approximately 900 staff for banking supervision and related shared support services25. The reliance on existing ECB infrastructure, including human-resources support, information systems and facilities, was crucial in realising 23 The picture looks fairly similar if one uses aggregate NPL ratios based on the sample of supervised banks in Table 6, which is based on SNL Financial, instead of national data collected by the IMF.
24 In line with many others, our collective reference to ‘the NCAs’ also encompasses national central banks that play a role in their respective countries alongside the NCA, eg the Deutsche Bundesbank or Austrian National Bank.
25 See ECB (2016a, page 15). Around three-quarters of the new staff came from the NCAs.
22 | BRUEGEL BLUEPRINT this. Our assessment is that the ECB has successfully mobilised its own resources and those of the NCAs to set-up an effective supervisory organisation, on time as mandated by EU law26.
The following country-specific chapters, combined with our own observations across the euro area, lead us to the view that the JSTs work much better than the previous supervisory colleges for cross-border banks, because there is a clear line of command and decision-making. Next, both home and host NCAs in the euro area are fully engaged in the same supervisory effort. Information-sharing between home and host supervisors in the pre-banking-union era was limited by many factors that became particularly acute in times of stress, notwithstanding the memoranda of understanding. One consequence was that host supervisors tended to err on the side of caution and add local requirements that were unnecessary and suboptimal from a consolidated prudential perspective. By contrast, the ECB and the NCAs now use connected databases with a common data format, and the legislative framework guarantees the adequate pooling of supervisory information. The larger size of the JST for a euro-area-headquartered banking group, compared to the previous separate teams in individual countries, also allows for specialisation within the team on topics like solvency, liquidity, asset quality and governance. In sum, the JST framework enables European banking supervision to form a consolidated view at the euro-area level. European banking supervision also greatly facilitates international supervisory cooperation. As Tables 2 and 3 illustrate, many euro-area banks have significant activities outside the area as well as in several euro-area countries. The ECB, as their single home supervisor, makes coordination easier in European and global supervisory colleges with peers in the UK, United States and other jurisdictions. The ECB also participates as host in the supervisory colleges of at least some of the 16 banks that hold significant 26 The SSM Regulation gave the ECB discretion to extend the deadline of 4 November 2014, but the ECB did not use that option.
23 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSbranches and/or subsidiaries in the euro area27.
The JST framework can also, inevitably in our view, generate tensions. While the head (coordinator) of the team, who is always from ECB staff, is ultimately in charge, the sub-coordinators from the NCAs have dual reporting lines, to the JST coordinator at the ECB and to their local manager. This may lead to conflicts of interests or loyalties, for example if the ECB advocates a tougher stance than the NCA leadership. Another case is ring-fencing (see below), over which the ECB may take a softer stance on additional capital requirements at the local entity (as opposed to group) level than the respective NCAs.
Based on interviews with supervisors and supervised entities, we find that the internal culture of ECB banking supervision has coalesced rapidly and is stronger than might be expected of such a young institution. The hard deadlines and operational complexity of the comprehensive assessment appears to have acted as a ‘crucible’ in this respect, forging a sense of shared experience and common belonging among the initial cadre of ECB supervisory staff. There is little doubt that the hosting of the central supervisory function by the ECB, with its organisational strength and independence (buttressed by a single working language), has helped enormously in this outcome, as has the overall quality of the new recruits. The country chapters illustrate that most (though not all) member states accept that stronger supervision is needed compared to the pre-banking union situation. The ECB is paying attention to the challenge of strengthening the common feeling of belonging among its supervisory staff, as illustrated by its repeated references to the ‘SSM team spirit’ and ‘SSM community’ (ECB, 2016a).
The effectiveness of European banking supervision is still hampered by a lopsided legal and regulatory policy framework. Even assuming completion of the ongoing effort to minimise so-called 27 As documented in Table 6, these are: five Scandinavian banks (Danske, DNB, Nordea, SEB, Swedbank); three UK banks (Barclays, HSBC, RBS); three US banks (Bank of New York Mellon, JP Morgan, State Street); and Banesco (Venezuela), RBC (Canada), Sberbank and VTB (Russia), and UBS (Switzerland).
24 | BRUEGEL BLUEPRINT options and national discretions, the vision of a single rulebook is far from fulfilled. One area in which this is particularly evident is the accounting and auditing framework, which is a significant component of the banking supervisory infrastructure even though it also serves other purposes. Listed banks in the euro area, as in the rest of the European Union, must use International Financial Reporting Standards (IFRS) for their consolidated financial statements28. For unlisted banks, however, IFRS is mandatory under national law in Belgium, Cyprus, Finland, Estonia, Greece, Italy, Latvia, Lithuania, Malta, Portugal, Slovakia and Slovenia, but not in Austria, France, Germany, Ireland, Luxembourg, the Netherlands or Spain (Pacter, 2015). Small banks in Austria and Germany, in particular, vigorously oppose the prospect of having to use IFRS in the future, as documented in our respective country chapters. In this, the euro area is an outlier from international practice, since most non-EU jurisdictions which have required IFRS for listed companies also require them for banks irrespective of size or listed status, and the United States similarly imposes US Generally Accepted Accounting Principles on all federally supervised banks (Pacter, 2015). Similarly, in auditing, national legal regimes vary considerably, as does audit quality, and attempts at EU harmonisation have not progressed far. Whether this heterogeneity in accounting and auditing is compatible with the effectiveness of European banking supervision on a steady-state basis will surely be further debated in the years to come.
There is a longstanding debate on the possible conflicts between monetary policy and prudential supervision when conducted in the same institution (eg Goodhart and Schoenmaker, 1995; Whelan, 2012), and the ECB is no exception. To address this challenge, the SSM Regulation creates a functional separation between the Supervisory Board and the Governing Council (even though the former remains 28 With the exception of a limited change introduced by the European Commission when adopting the IAS 39 standard on financial instruments accounting in late 2004, known as the IAS 39 carve-out.
25 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSsubordinate to the latter); at a more practical level, the ECB has chosen to keep the separate arms in separate buildings. Our observation is that, notwithstanding the intrinsic tension between loose monetary policy and strict banking supervision, the Supervisory Board’s supervisory stance so far has not been distorted or softened by the ECB’s monetary policy objectives, as we discuss in the next subsection.
Toughness As is evident from this Blueprint’s country-specific chapters, European banking supervision is more intrusive than most of the national regimes it replaced, with more questions from the supervisors and more effort to verify the banks’ answers. The country chapters also suggest that there is less capture of the supervisors by the banks than before November 2014. It has become more difficult to address supervisory matters through informal negotiation or political intervention with the supervisor’s top leadership. The supervisory coordinator is now at a distance in Frankfurt, and from a different nationality.
Supervision has thus not only literally but also figuratively become more distant from the banks in the euro area. Moreover, the independence of ECB banking supervision, enshrined in the SSM Regulation29, appears to be stronger than supervisory independence at the national level, where it is easier to change the relevant financial services legislation. This is arguably particularly meaningful for the many government-controlled banks in the banking union. The corresponding tensions have been alluded to in several official speeches and interviews30, but so far we are not aware of them erupting directly into the public space, with the exception of Italy31.
29 Article 19 of the SSM Regulation. The SSM Regulation, being based on Article 127(6) of the Treaty on the Functioning of the European Union, can only be modified by unanimity among member states.
30 For example Danièle Nouy, interviewed in Handelsblatt, 1 April 2015 (English translation on the ECB website); Dombret (2015).
31 See for example Patrick Henry (2015) ‘Bank of Italy Letter Slams ‘Arbitrary’ ECB 26 | BRUEGEL BLUEPRINT The toughness of a supervisor is ultimately revealed by her or his actions. For European banking supervision, the most prominent among these so far include the 2014 comprehensive assessment, the 201432 and 2015 SREP decisions, and ad-hoc assessments made in particular in the context of the Greek crisis of summer 2015. In our view, this experience demonstrates the fact that the new supervisory regime is tougher than most (perhaps all) of the national regimes it replaced. In stark contrast to the 2010 and 2011 rounds of European stress tests, which were coordinated respectively by the Committee of European Banking Supervisors and by its successor the EBA, but for which the main inputs came from the NCAs, the 2014 comprehensive assessment has not been followed by embarrassing failures of banks that were given a clean bill of health a few months earlier33. It has also been perceived as overly demanding in several member states, as this Blueprint’s chapter on Italy illustrates. The decisions made by European banking supervision on Greek banks during the spring and summer of 2015 were vindicated by subsequent developments, as analysed in the chapter on Greece. The criticism – not least from Germany – that was directed at the ECB for being too sanguine on the solvency of Greek banks was shown with hindsight to be excessive.
As for the 2015 SREP process, it represented the first round of capital requirements (applicable from 1 January 2016) that was fully prepared under the new European regime. These requirements are a combination of a CET1 capital requirement of 8 percent (as used in the October 2014 comprehensive assessment, and thus higher than the Over Capital Demands’ Bloomberg, 21 September 2015.
, 32 The 2014 SREP decisions were communicated to supervised banks in early 2015.
They were largely based on the 2014 comprehensive assessment, which is why we don’t analyse them in any depth here.
33 In 2010, for example, Allied Irish Banks passed the stress test in July but needed a rescue as part of the Irish assistance programme later that year. In 2011, Bankia in Spain and Dexia in Belgium and France passed the July stress test but experienced massive problems a few months later.
27 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSFigure 4: Pillar-2 capital requirements (end-2015 SREP decisions, in %) 10.75 10.25 10.25 10.25 10.25 10.2 9.75 9.75 9.75 9.25 9.25 9.25 9.25 9.25 9.5 9.5 9.5 9.5 9.5 9.5 9.5 9.5 9.5 9.5 9.5
Pillar-1 minimum resulting from the application of the CRR) and of a Pillar-2 add-on. The latter is based on a qualitative and quantitative assessment of a bank’s business model, internal governance and risk management, and risks to capital and liquidity. Based on EBA guidelines (European Banking Authority, 2014), the ECB has developed a common methodology and a common database to ensure a consistent process of determining the eventual SREP decision. Even so, the latter remains a judgement call of the supervisor. Figure 4 shows that the resulting Pillar-2 capital requirements range from 8.625 percent to 10.75 percent for the 27 G- and E-SIBs that have disclosed them.
The average score for these is 9.6 percent, both on a weighted and unweighted average basis. The average requirement for the full SI population is around 9.9 percent for 2015, which is an increase of 30 basis points compared to the average for 2014 (ECB, 2016e). These 28 | BRUEGEL BLUEPRINT figures reveal that the ECB has not shied away from setting core capital requirements at a high level.
This should be seen in the context of gradual strengthening of euroarea banks’ capital ratios over the last few years, driven both by market pressure and by new regulations and predating the establishment of banking union. Figure 5 shows this trend for the 100 euro-area banking groups supervised by the ECB34.
A bank’s governance is important for determining its risk appetite, risk management and internal controls. Commercial, cooperative and government-owned banks all face specific governance challenges.
Commercial banks could have too strong a focus on return on equity, neglecting the interests of depositors and financial stability. While cooperative banks in principle have incentives to put clients’ interests first, their internal decision-making can be too decentralised and fuzzy, or captured by special-interest groups, as illustrated by cases such as Banca Popolare di Vicenza35. For some large cooperative banking groups, ECB banking supervision has acted to strengthen and streamline their governance (see eg the case of Rabobank in the chapter on the Netherlands). Finally, government-controlled banks could be too responsive to politics, losing sight of the need for efficiency and cost-effectiveness. Now that capital requirements have been raised to a reasonably high level, the focus of European banking supervision appears indeed to be shifting towards ‘softer’ matters of governance, 34 Note that for Figures 5 and 7 we used balanced samples within each variable, ie we exclude banks for which at least one data point is missing (after imputing) during the time period. This is why 2015 values in Figure 5 slightly differ from those in Tables 1, 3, and 4. We impute missing values by using a simple average if data is missing in between two values in a series of three consecutive years. If an average cannot be taken – ie if more than one data point is missing in between available observations or data point missing at beginning (end) of available time series – the previous (former) value is taken. Otherwise, the missing value remains.
35 Valentina Za, ‘Blind faith turns to disbelief in Italian banking’s heartland’ Reuters,, 26 April 2016.
29 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSrisk management and risk appetite (ECB, 2016a).
Source: Bruegel based on SNL Financial. Note: CET1 capital ratios and leverage ratios are aggregated by computing an average of banks’ ratios weighted by total assets, for the 100 euro-area-based SIs. See also footnote 34.