Interview with Financial Times

Interview with Danièle Nouy, Chair of the Supervisory Board of the Single Supervisory Mechanism,
published on 10 February 2014

Could we get a sense of your targets in terms of the start-up of the SSM and when you expect to have the full complements of staff?

The numbers are about 800 supervisors for the SSM, plus about 200 in support services, for example IT, statistics, legal, and we plan to have, if possible, all of those people when we start supervising the significant banks directly in November 2014. We are aware that depending on the origin of these recruited people it may take a little bit more time for certain people to join. For example, the national competent authorities are more willing to let the recruited people go faster to the ECB. When they come from the private sector there are some rules. They cannot leave as fast in general.

It’s been reported that your second favourite drug of choice after coffee was internationalism. And this is supposed to be the ultimate international job, coordinating between these different nationalities and also dealing with the sensitivities of different member states. Is that a fair summary of the challenge for you?

Yes, certainly. Well, this is true that I like working in international circles. The challenge of the SSM is to cooperate in the framework of a single system. It has to be a single supervisory system with the maximum consistency at all levels, and I think that this is achievable because precisely we have been working together for quite a number of years in the different fora within the Basel Committee and elsewhere. So I am quite optimistic and positive on the fact that we will be able to deliver a single framework, a single system, and we are learning by doing during the comprehensive assessment. That’s the first test of our capacity to work as a single system.

What kind of state do you think Europe’s banks are in? How healthy do you think the sector is right now?

Well, I think that European banks have already made a lot of efforts to repair their balance sheets. Euro-area banks have increased their capital ratios, bringing the median core tier one ratio to 11,2%, as of June 2013 . That’s four percentage points more than before the crisis, than in 2008, and we are not even talking about the same definition of the capital ratio. Also, a lot of provisions have been made, especially on the trading book assets, the legacy assets. I think the problem that we are facing is probably insufficient transparency regarding the balance sheets of the European banks. This is why we are conducting this comprehensive assessment to increase significantly the level of transparency, to repair balance sheets when there is a need for repairing balance sheets, and to restore confidence. This will ensure that the banks, if need be, will get equity from investors because they will be reassured by the transparency and the knowledge they will have about the situation of the balance sheet, and also the funding that allows them to finance the economy.

So if you think that the banks are in better shape than the market believes right now, you think that the comprehensive assessment will end up not showing the banks’ flaws but showing their strengths?

I think globally the efforts that have been made are underestimated and, yes, indeed, I believe the situation of the SSM banks on average is better than the assessment of the market. That’s normal. If the market believes that they don’t have enough information and there is a lack of transparency, the reaction is to be more pessimistic. Of course, we may discover through the exercise that there are banks where there is a need for repairing the balance sheet; that probably will be the case, and we will have to do it. There is a firm commitment to do whatever has to be done to make sure that the SSM banking sector is seen as sound and safe and transparent. We know that we have a single opportunity to establish our credibility and reputation, and we want to reach the highest level of quality.

Do you agree with those who say that for the exercise to be credible there have to be failures?

Well, the president of the ECB has said that that was one condition so I will certainly agree {laughs} with what the president of the ECB has said, and it seems precisely what markets expect from such an exercise; so, yes, probably that’s the case. I do not have any idea of how many banks have to fail. What I know is that we want to have the highest level of quality. So, about repairing balance sheets, we want to do whatever has to be done to be safe when you start supervising the significant banks. A failure of a bank may happen: we will have to deal with the national resolution authorities because for the time being there is no single resolution mechanism in Europe. There have been strong commitments from the European Council in June and from the Ecofin in November that backstops will be at a level to care for banks that need the backstop. I believe that we are well-equipped to face whatever situation we encounter in the exercise.

How confident are you that the individual resolution scheme plans in place are sufficient and how confident are you that something could be worked out if a cross border bank failed?

A number of SSM banks are cross-border banks so we have to be ready and we are ready to address the possible difficulties of cross-border banks. Addressing such difficulties with the SSM and supervision by the ECB after November is a much more comfortable situation than the situation previously without a single supervisor. So we are getting ready to address whatever the difficult situations will be.

What are your thoughts on ring-fencing capital when you do have banks operating in different countries? For example, with UniCredit in Italy and HVB in Munich where there are transfers of capital and the German regulator is currently not so happy about that and they’d like to have some kind of national protection of capital.

I think ring-fencing is against the letter and the spirit of the regulation of the Union. I can understand the reactions of colleagues of mine in supervisory authorities that have a tendency to protect their depositors, their investors, but precisely what the crisis taught us is that we have to have a single European mechanism to avoid ring-fencing when the problems start and when crises emerge. I think with a single supervisory authority in the SSM this will be prevented because the ECB will be the consolidated supervisor of all the SSM banks – that’s a big asset. And, of course, we need to have in place very rapidly a single resolution mechanism, credible and efficient, because that’s an important component of the banking union. Without the SRM the banking union and the SSM will not be as powerful as intended. That’s why we would like very much to see the SRM implemented on 1st January 2015, which means that there is still a little gap between November 2014 - and the end of our comprehensive assessment- and the beginning of the SRM, Altogether these reforms have been undertaken extremely fast in the European environment. It is incredible how fast we have been able to get these arrangements, so I’m optimistic on the fact that something credible and efficient will be achieved on the SRM.

In your career you, as a supervisor, saw two major banking crises. What are the big lessons that you’ve drawn from those experiences as a supervisor now that your task is monumentally bigger even than those tasks you faced then?

Even for the French banks (not only for the supervisor), the crisis of the 90s was a big trauma and we all learned our lesson, which was that supervisors have to be tough. Whether it makes them unpopular is not a problem, but they have to be tough. I must say that it was largely accepted by French banks. They were not pleased about that, but they accepted our decisions. Before the crisis we went for high quality capital, and, when possible, more capital, but always high quality capital, and that was accepted because everybody could remember the consequences of the 90s crisis. Regarding cross-border banks, it is very difficult for a national supervisor to supervise efficiently a cross-border bank with multiple foreign establishments. When you have a bank which is more a European bank than a national bank, you really need to have a single European supervisor for this bank.

I would say that to a large extent distance between the bank and the supervisor is helpful. Somebody has to say: now it’s time to take the tough decisions and move forward.

Obviously the largest banks are directly supervised by the SSM, but how often do you expect to be intervening in banks which are still under the direct supervision of national authorities? Will you be using that power regularly?

Yes, absolutely. It’s a single system. The ECB will get data from all the banks, the significant and the less-significant. All the banks will have to be supervised according to the same manual, the same rules, the same recommendations, the same guidelines and the ECB can take supervision directly of a small bank. It’s difficult to say now how often we will exercise this kind of power, but we are fully committed to do it as often as needed. What I can say is that we will not be shy. If we have a doubt, if we believe that it makes sense, we will just do it. You have to demonstrate that you are serious about it.

In a paper that appeared in the Banque de France’s financial stability review back in 2011, you present a pretty convincing case of why it’s perhaps a little wrong to attach zero risk rates to sovereign debt. Is that a view that you still hold and, if so, is it something that you’d consider applying once the SSM takes charge?

I think personally that one of the big lessons of the current crisis is that there is no risk-free asset, absolutely no risk-free asset. So sovereigns are not risk-free assets. That has been demonstrated, so now we have to react. What I would admit is that maybe it’s not the best moment in the middle of the crisis to change the rules – that’s possible. This being said, there is the possibility to do more and some countries are applying stricter rules. For example, some big banks are using models where the normal treatment of sovereign risk for them is not the zero risk rate of the standardised approach. In many, many cases there are risk weights for sovereign risk which is normal. I would say that probably – and that’s a personal opinion, it will have to be decided –probably some rules on the division of risk for those exposures, just like for any risk, should be implemented: some kind of large exposure limits so you don’t put all your eggs in the same basket. That’s a simple principle that is quite good. To the best of my knowledge certain countries do that as well without speaking publicly about it.

What are your views on the usefulness of the leverage ratio and whether you could potentially go beyond the Basel III minimum level of 3 per cent?

I think we need both metrics: the leverage ratio and the risk-weighted assets. We need some kind of floor or different metrics to assess the capital requirements and altogether I think we have a good approach. At the very beginning of the discussions I must say that - maybe because I've spent so much of my time doing Basel II - , I was less convinced about the leverage ratio, especially considering that anybody can calculate it. It is simple - you take capital and the total of assets -; market participants don't need the supervisors to create the leverage ratio for them.

After the crisis, after the discussions that we had, after the work done on the leverage ratio, I must say I think now it's good to have both. And on whether 3% is the adequate level, I think it is logical to have possibly 5% or 6% in the US leverage ratio because of the difference between the accounting rules. We will see after a few years of implementation whether 3% is adequate or not. If there is a need to change it, we will change it.

The EBA will soon be discussing the implementation of the bonus rules. There are some questions as to whether the use of allowances is allowing the spirit of these rules to be avoided. Do you think the bonus cap is the right way to regulate remuneration in the banking system, from a regulatory point of view?

The devil is in the details regarding those compensation packages. I think both the letter and the spirit of the rules have to be complied with. This being said, which is the best way of complying with this principle and making sure that bonuses are not “pousse-au-crime” as we say in French, are not delivering the wrong incentive to do stupid things. To be seen. Again, let's implement the letter and the spirit of the rules that we have and then we will see whether we can improve them. And I'm sure after a certain period of time people will find a way to circumvent the rules to get what they consider the appropriate treatment. We have to constantly monitor these compensation packages. We want to be serious about the issue and this is difficult; that's more difficult than checking capital ratios of banks or their loan loss provisions.

So you don't think they're complying with the spirit at the moment?

I have doubts sometimes, but again the devil is in the details. So in order to deliver a proper assessment, I will need to see the details.

Some people have predicted that the comprehensive assessment will lead to consolidation in Europe's banks. Do you think that that is a likely outcome and do you think that that would be a good thing? Do you think that the sector needs more consolidation and do you think some areas are overbanked, perhaps some countries?

I'm not sure that the banking sector will need much more consolidation, really, because some of our banks are already quite big. And both banks and supervisors are more cautious when considering whether consolidation is really a good objective. With credible resolution authorities at the national level to start with, and then the SRM, I hope that we will be able to resolve banks, to put banks in run-off and not necessarily try to combine bad banks with good banks. We have to accept that some banks have no future; they may need resolution plans because they have to die in an orderly fashion; that's very important for financial stability. We have to let some banks disappear in an orderly fashion, and not necessarily try to merge them with other institutions. We don't want banks disappearing in a disorderly fashion, that's the main point.

One very interesting dynamic in the creation of the SSM is the relationship with the authorities in London as Europe's financial centre. Could the UK voice be diminished in terms of European regulation because of the large number of countries involved in the SSM?

I don't think that should happen. Measures have been taken to protect the voices and the votes of the non-SSM countries. I think EBA still has the same role to play. I believe that it will be helpful for EBA to have “more discipline in the European debate” thanks to the SSM; I am absolutely of the view that the SSM has to be an asset for the single market and for EBA. There is no reason for the SSM to be undertaken to the detriment of the single market.

In my view there is no problem, no possible future problem between EBA and the SSM that cannot be fixed by Andrea [Enria] and I.

Regarding who will be working for the SSM, do you have any ideas how the split will work between, let us say the private sector and existing regulators? Is the plan to attach certain weights to employing people from certain Eurozone countries, and is there a certain focus on employing people outside the Eurozone as well?

We are not yet at the stage of selecting the day-to-day supervisors, so that there would be a first indicator as to what is the proportion of national competent authorities and what is the proportion of people coming from outside. I note that for the four Directors General we will have been able to attract 50% private sector people. We have to have the right balance between the “new blood”, the people coming from the private sector, and the people from the national competent authorities, and an appropriate national diversity. The head of the joint supervisory team for a German bank doesn’t have to be German, or for an Italian bank he or she doesn’t have to be Italian. At the end it’s probably better to have some different nationalities in the joint supervision teams. The target is to go for the best possible people. We want the best possible people, whether they come from the public or from the private sector.

I know that you've identified some areas in advance that you think may be problem areas, such as shipping or commercial real estate in some of the banks. Have you identified banks that you think need particular attention?

No. Although I know very well a certain number of banks, starting with the banks in my own country, I don't yet know enough about the other banking systems to respond “yes” to such a question. And even when we believe we know very well the balance sheet of a bank, maybe there will be surprises. We are really open-minded. Regarding the areas of possible risk, we want to go for the most risky portfolios: that's the target, the less transparent portfolios, where we believe we could have surprises. Some areas have been mentioned. They are shipping, real estate, both commercial and residential mortgages. They will be looked at closely, probably almost everywhere, because there is a general suspicion after the crisis that maybe real estate prices are still too high, maybe it is still an area of risk. For example, I believe as a former supervisor that French mortgages are very sound. But a number of my colleagues consider that, with real-estate prices going up for a number of years, or the rate of growth in credit being high, this might be a risky zone. We will go bank by bank, targeting the most risky portfolios, and we will see what will be the outcome.

We are currently at the point where the national supervisors have sent their proposals for the selected portfolios, and they are being challenged. The final decision on what exactly will be the portfolios selected for the asset quality review will be taken by mid-February. We are in the middle of the process and there is a certain minimum coverage. The reviewed portfolio has to be at least 50% of the risk-weighted assets of the bank. That’s pretty significant.

How does this fit in with macro-prudential regulation, which is going to be done by the national regulators or the national central bank? For example you’re making calls on issues like house prices here: that might go against what macro-prudential regulators are doing?

Macro-prudential supervision is still a work in progress and, indeed, there are still powers at the national level. The ESRB is in charge of European cross-sectoral macro-prudential supervision, and it can make recommendations on the macro-prudential instruments that should be used. And, on top of that, there are new instruments, new possibilities that are offered by the CRDIV. So we are, right now, trying to see how to organise ourselves as well as possible, to build synergies between the Financial Stability General Directorate in charge at the ECB and the SSM General Directorates. The final organisation is not yet totally decided, but this is something that will be taken very seriously. Also, certain elements will still be in the hands of national supervisors, which makes sense, or the national central banks. National financial stability will also be under the national central bank because one market may need some measures to be taken, for example in real-estate.

Martin Wheatley in the UK said he thought that the foreign exchange scandal was going to be as significant as LIBOR. Have the banking sector and its players learned the lessons of the excesses that led to the big crisis we had in 2008-2009, in your view? And do you worry that the fines and litigation that we're seeing in LIBOR, if they're replicated in foreign exchange, could become a drag on prudential capital, which would then become a concern for you?

Well, considering the amounts, yes, indeed. There is litigation risk which is quite significant. So that has to be taken into account, obviously, and followed quite carefully. I hope that we will get the adequate regulation and the adequate powers following these scandals to make sure that it does not happen again. Not with this magnitude and, hopefully, not at all.

Some of the very big fines are pretty recent, so maybe the lesson has not been totally learned. Yes, it's certainly a major risk. I'm sure investors took that into account and supervisors as well.

For us, it's a very serious issue. Judicial risk and litigation risk are important issues that we will look at carefully.

From the point of view of governance and internal controls, it's quite shocking to see banks acting this way. It's not only a matter of capital requirements.

If 2008 isn't going to teach them, what will?

Well, a number of the products that were traded in 2008 are not traded any longer. And some of those assets are in run-off in the bank. This being said, human nature being human nature, I don't believe that the lessons are learned forever. So we have to be cautious and vigilant supervisors because, after a certain period of time, the lessons are forgotten. That's for sure.

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