Interview with Il Sole 24 Ore

Danièle Nouy, Chair of the Supervisory Board of the Single Supervisory Mechanism,
with Alessando Merli - Il Sole 24 Ore, 11 July 2014

Q. What is the present state of the comprehensive assessment (CA). According to your own timetable, you should already be doing the third phase, the stress tests.

A. The CA is going well. We are paranoid about delays. The stress tests have started, with some overlap with the asset quality review (AQR), at the end of May. Banks should deliver by mid-July the work they have done. At the same time, we are finishing the AQR: we are in the last 10 days of the last part, which is collective provisioning, evaluation of collateral, particularly for real estate, and level-3 assets for the banks that are tested for their trading books. Quality assurance for the AQR starts right now. So far, so good with respect to the calendar.

Q You are also doing the preparation for your new supervisory duties, which will start in November. So you are doing the CA and getting ready for the SSM at the same time. You also have a lot of hiring to do, 1,000 people in all.

A Recruiting is the most time consuming part. We are victims of our own success, receiving a lot of applications and cv’s. There is a lot of work to screen cv’s, to make sure that adequate people go to test and interviews. It’s a top-down process: the new hirings recruit the people at the lower level. In terms of the rest of the preparatory work, the framework regulation was done by the end of April. By September 4, we’ll have the list of significant banks. We have notified our intentions to the banks and they have two weeks to respond. The Governing Council of the ECB will adopt the final list. There will be some changes from banks that are in the CA. In particular because we had a buffer, including in the CA banks with assets over E27bn as of end of 2012. The final list will include banks with over E30bn of assets as of end of 2013. There will be a few differences. The banks doing the CA, will finish it, even if they are not on the final list. The national authorities will then enforce the outcome, to make sure capital shortfalls are covered. Banks that are not in the CA, but are on the list, will have to do a similar exercise later. We have also launched the fee framework for a public consultation, which ends on 11 July . There is no reason to believe we will not be ready. We’ll work over the summer.

Q No holidays, then.

A We have a lot of hard work to do, now and later. But everybody should be able to take a break. At least a short one.

Q Cooperation with national supervisors is often underlined. At the same time, one of the reasons why the need for the SSM arose was the faults of national supervision in several countries during the crisis.

A The SSM is not only about improving supervision. It is really more and more difficult to supervise cross-border activities and international banks on a national basis. We are a single market with a single currency. The eurozone is SSM banks’ domestic market. We therefore need European supervision. A number of institutions, about 3,700, will be under the supervision of national authorities because they are less significant, but they will be supervised according to the SSM manual. It is a single system with a single culture of supervision. About 120 groups, comprising 1,200 institutions, will be supervised directly by the ECB. The cornerstone will be the joint supervisory teams. The coordinator of the team will be in Frankfurt, with 9-10 people for the largest banks, and they will rely on national supervisors. In each country where these significant banks operate, there will be a local coordinator. It will be a bottom-up process, as it is now. The information will go from the local coordinators to the head of the joint team. Small decisions, not very sensitive ones, will be made at this level. More important ones will go to the Director Generals. If they are even more important and more sensitive, to the Supervisory Board. Distance in decision-making is very helpful. We’ll have the best of both worlds: the proximity of supervisors to the banks and some distance for the decision making. The head of the joint team in Frankfurt will make recommendations to the Supervisory Board. If the national authorities do not agree, their position will be mentioned in the note to the Board. But it will not be on equal footing: the most important is the recommendation at the centre. The Board has 6 votes for the centre – including myself, the Vice Chair and the four nominees of the ECB, if we all agree among ourselves. It’s already a significant group of votes. There are then 18 representatives of national authorities. But on equal basis: for example, the vote of the Slovenian authority will be as important for Deutsche Bank as that of (German supervisor) Bafin. It’s a European institution, taking decision without a national bias.

Q There is trade-off between cleaning up bank balance sheets, raising capital and providing the credit supply needed for the recovery of the economy. Are banks in a holding pattern in terms of providing credit, while they wait for the exercise to be completed?

A European banks did more in repairing the balance sheets, raising capital and selling legacy assets from the crisis than the markets gave them credit for. US banks, for instance, are better treated by the markets. It is very important that we have this transparency exercise. The CA is a solvency exercise, but also a communication, a transparency exercise.. We believe that thanks to this transparency, investors will be ready to provide capital and funding to European banks, so that they will be able to finance the economy. But I do not believe that only the banks are responsible for the lack of growth. We need structural reforms in a number of countries, including my own. However, as supervisors we are doing our part of the job, make sure that the banks have clean balance sheets and that thanks to this transparency, the market are convinced that they know what is in the balance sheet of banks and will provide them with funding.

Q Recently there has been quite a lot of enthusiasm of investors for bank shares, a shift from the sentiment you were describing. In the case of Italian banks and others, outside investors came in. Are you satisfied with what the banks have done so far?

A There is still work to do. Until we have the outcome of the CA, we won’t know the exact amount of capital that banks need. We are telling banks they should put their house in order, prepare themselves for the outcome of the exercise. At the end of October, beginning of November, the market for raising equity, or contingent capital, will be crowded. The sooner they do it, the better. They should do it before the outcome of the exercise. And if they are not sure about the amount, they should go for more, not for less. Another reason for doing that: we are moving towards bail-in of senior debt in 2016. If they want to have a reasonable cost of funding, they have to protect senior debt from possible bail-in by issuing more contingent capital now.

Q The first part of the CA was done on the basis of the figures at the end of December 2013. A lot of things have happened in the meantime. Will there be banks that technically fail the assessment on the basis of those figures, but in the meantime will have taken action before the outcome?

A We will publish a template with the shortfall and what has already been done, after end of December 2013, to cover it. It will be very clear what remains to be done. From the information we have , the capital position of the banks in the CA has been improved by more than E100bn during the last 12 months. We are now collecting from national supervisors the exact information.

We welcome those steps. But we’ll have to wait for the outcome of the CA to see what is still to be done.

Q To hear some national governors, each claims that his banks are fine. Do you think this disrupts what you are trying to communicate in terms of needed action?

A They are human and hope their banks will do well. Some are right. The outcome remains to be seen.

Q From November, the eurozone will move closer to a banking union. How will the system develop after that? You have said it will be stress-tested every year. But there are the longer term issues of low profitability, deterioration of the loan portfolio, even overbanking, according to a report by the European Systemic Risk Board.

A I personally believe that a new banking world will emerge in Europe from the financial crisis. We have new regulation coming in, Basel 3/CRD IV and CRR, meaning more capital of better quality, The Bank Directive on Recovery and Resolution - BRRD. The price to use public support will be pretty high. State aid rules implemented since last summer state very clearly that if you use public money there will be burden sharing, with the bail-in of junior debt, hybrid capital instruments. This will change the landscape. The bail-in of senior debt from 2016 is also a powerful new element. Banks and supervisors have to draw conclusions from this new environment. The business models of banks will be challenged.. There may even be other regulations, such as the separation of retail banking and trading, as was proposed by the European Commission. Profitability, sustainability of profitability, sustainability of the business models will all be very important. It is very good that we can address these questions for banks after a transparency exercise has been done, provisions have been made and there is no unidentified forebearance.

Q Europe has too many banks. Will it have less banks, not just different banks, as you say?

D The situation is different in different countries. We should not generalise too much. Each market has to be considered. For the large banks, the euro area is their domestic market, for smaller bank it is the national market. There is no lack of banking services and this gives some flexibility to supervisors to recognize that if some banks have no future, if they have to close certain banks, others will provide banking services. I see this as a positive element.

Q The closure of banks will happen. But it has costs and the credibility of the exercise depends on the credibility of the backstop. It worked in the US, where the backstop was provided upfront. In Europe, it was not done that way and now it’s too late. But are you comfortable with the backstop system in place now?

A There were very clear statements form the European Council and the Ecofin in 2013 about a clear commitment to provide the necessary backstop. Maybe not all countries have realized, but I believe it was made clear at the last Eurogroup and Ecofin meetings last Monday and Tuesday, that to benefit from public support either to continue in business, or to go to resolution in an orderly fashion, there need to be national legal arrangements that permit bail-in of junior creditors. If some countries were lagging behind in putting in place these burden sharing arrangements they have been strongly reminded.

Q Breaking the link between sovereigns and banks was seen as essential to the solution of the crisis and the way to do that was through the direct recapitalisations from the ESM, as decided in the European summit of June 2012. That seems now in a limbo.

A Markets are benign right now. Banks that need capital do not seem to have difficulties in getting it. In countries that have done national stress tests, even without waiting for the outcome of the ECB comprehensive assessment, banks were able to recapitalise themselves with private money. We think this is the way it should be done. Private funds should come first, and only if this is not possible, there is the question of the backstops. They are expected to be national. In a sense we are at the end of “the old world”, as the conclusions of the CA will come before the SRM. But the coverage of the shortfalls will take place in 2015, when we will be at the beginning of “the new world” in terms of rules with the BRRD. Indeed, it is a last resort possibility to use the ESM. Based on current market conditions, it is not expected to be needed. I repeat, based on current market conditions. I do not know what the conditions will be in October. That is why I am telling the banks to start covering the possible shortfalls now.

Q You are going to visit Italy and meet the supervisors at the Bank of Italy. Italian banks are often in the spotlight of analysts and international media, although they have been quite resilient so far and needed little public money. What are the critical issues there?

A I am not talking to the banks on this visit; and I do not know enough yet about the other banking systems to have a precise view on their situation. I will have a better view in October, November. I am going to give supervisors a very simple message: I need you to do my job. A very significant part of the supervisory teams will be national. For significant banks, about 90%. . In some countries, some of my colleagues are a bit concerned about their future work, what kind of job they will do: "primary", not sophisticated work? This is not at all the case. Recommendations will go to the ECB, instead of national directorates. But some responsibilities, like anti-money laundering or consumer protection, will remain at national level. And in prudential supervision national supervisors still have a lot of work to do in a similar fashion to what they do now. The manual will change, but it has been changing constantly. We always need to adapt to the new reality, banks and supervisors.

Q Recently there was the case of BNP Paribas being fined by the authorities in the US, possibly Commerzbank. Beyond the specific cases, will this conflict of jurisdictions hamper your work?

A I do not comment on individual cases. But indeed, we have to spend time on how to better assess and mitigate conduct risk, for example liability risk triggered by FX or Libor wrongdoings, by the ban on operations with certain countries. Banks must be better equipped to deal with risks and liabilities arising from operating in different countries. Definitely it is a matter of concern. The ESRB has created a working group on such conduct risk.

Q Doesn’t this show the need for better international coordination?

A For sure. These risks are materialising more for internationally active banks. We need to get warnings from our colleagues when there is a risk of that happening. And thanks to the SSM, there is an opportunity for us to have closer interaction with the supervisors of the other large markets. We will be the largest supervisory authority in the world. I have spent a lot of time in international circles. I think I am well placed to play a role in this cooperation. Sabine Lautenschlaeger also worked in the Basel committee and other international fora for quite some time. It will be easier for the US authorities to talk to one supervisor than 18.

Q The ECB-appointed members of the Supervisory Board are almost all female, except for Mr Ignazio Angeloni. This seems to be an exceptrion in a male dominated work. You were selected for your competence, not for your gender, but do you think it will make a difference?

A I would not like to have been selected on gender. It would be the first time in my career. We should select people on competence. But it is true that we have a number of women in the SSM and in banking supervision. It’s a work that women do well.

Q One member is still missing on the Board, in spite of the urgency and the amount of work you are undertaking. When will he or she be appointed and what is the reason for the delay?

A Frankly, I don’t know. The Governing Council decides. It’s a question you should ask Mario Draghi and Vitor Constâncio.

Q To sum up, President Draghi said some time ago that one should not expect major surprises from the CA. What is your judgement, now that your work has progressed?

A It depends what you mean by major surprises. Supervision is a job in which sometimes you do have surprises. I’d wait until I see the outcome of the AQR and the stress test, which is quite tough. It’s not just a matter of provisions possibly too weak. We’ll have to see what the adverse scenario of the stress test is doing to the balance sheets of the banks. I’ll be cautious on that. Probably we won’t have major surprises: the more banks are taking care of the possible problems before, putting their houses in order, the less likely that we have surprises.