We aim to improve the resilience of banks and reduce system-wide risks

Joint interview with Danièle Nouy, Chair of the Supervisory Board of the ECB, and Sabine Lautenschläger, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, published in Supervision Newsletter (Autumn 2016) on 16 November 2016

Two years after the creation of ECB Banking Supervision, Supervisory Board Chair Danièle Nouy and Vice Chair Sabine Lautenschläger talk about key issues for banks in the euro area and how supervision is doing so far on the European level.

What are the most important issues that still need tackling with regard to banks under your direct supervision?

Danièle Nouy: Over the past two years, we have already seen European banks addressing risks more forcefully, although some more so than others. Banks are certainly more robust than they were two years ago. But much remains to be done as they face a number of challenges, including legacy assets, non-bank competition and new regulation in an economic environment of low growth. In our view, banks should focus on three overarching issues. They need to assess and, if necessary, rethink their business models to remain profitable, and they need to address credit risk, especially non-performing loans and potential risk concentrations in sectors such as real estate and shipping. And finally they need to improve their risk management, including their models to assess credit, market and counterparty risks, their internal processes to assess capital and liquidity adequacy as well as their compliance with data aggregation and risk reporting principles.

How should banks adjust to ensure their profitability?

Danièle Nouy: It is not up to us as supervisors to prescribe strategies, but banks could, for example, increase their efficiency to reduce costs, and they could expand their non-interest business operations to secure revenues. Digitalisation, for instance, provides a great opportunity to streamline processes, develop new products and unlock new sources of revenue. But these are just general observations. As supervisors we challenge the assumptions underlying banks’ strategies. This helps banks judge whether their business models will remain viable in a changing industry and makes them reflect on what they have to do to stay competitive.

Can you understand why banks are uneasy about what they refer to as Basel IV?

Sabine Lautenschläger: What is currently being discussed on the global level is the completion of Basel III, which is a set of reforms to improve the banking sector’s ability to absorb financial and economic shocks, enhance risk management and governance, and strengthen banks’ transparency and disclosures. Upon completion, Basel III should not, on average, significantly increase capital requirements further. As regulators and supervisors, we aim to improve the resilience of banks and reduce system-wide risks. We are keen to do this in a way that creates and preserves a global level playing field for banks.

What is the ECB doing to ensure greater consistency in the supervision of banks that that are under national supervision? And how do you ensure consistency with respect to business models that cut across banks under national supervision and those supervised by you?

Sabine Lautenschläger: Our objective is to ensure harmonised banking supervision throughout the euro area, not only of the largest banks, the significant institutions (SIs), but also of the smaller ones, the less significant institutions (LSIs). To that end, we are working closely together with national supervisors. So far, we have developed a number of joint standards for supervising LSIs, and are currently working on a harmonised Supervisory Review and Evaluation Process (SREP) for them, based on the model used for the SIs. Applying that process in a proportionate manner will ensure a level playing field as well as continuity in the assessment of SIs and LSIs. We are also developing a consistent approach to specific business models which are relevant for both SIs and LSIs, such as car financing. The same is true for our approach to institutional protection schemes, which comprise SIs and LSIs. And we are about to extend the application of harmonised options and discretions in European regulation to LSIs.

Will banking supervision as practised by the ECB become more transparent, for example, in respect of determining SREP scores?

Sabine Lautenschläger: In supervision, there are two types of transparency; we take both very seriously. The first type involves our direct interaction with the banks we supervise. Here, feedback shows that we have made good progress in communicating effectively and clearly. In addition to bilateral exchanges with banks’ representatives, we have set up dedicated workshops with, among others, CEOs and CROs to inform them about new methodologies and processes. We address linguistic and procedural differences, which inevitably arise when working at the European level.

The second type of transparency is more wide-ranging and entails communication with other stakeholders and the public. Regarding that type of transparency, we have increased our engagement with banking associations, market participants, economic and financial committees in parliament and the media. We brief these groups on our processes and methodologies, and we provide detailed information on our website. We hold public consultations on a number of key issues and actively seek input and feedback from the industry. And of course, this very newsletter, which also announces our new statistics series on supervisory data, is another case in point.

But the supervision of individual institutions is a sensitive matter and detailed information about a bank’s situation needs to be handled discretely and prudently. It is therefore unlikely that we will venture into publishing rankings or scores of banks. The banks themselves are, of course, free to disclose any information about their own situation.

Considering the rapid pace of technological change, also in the banking sector, should the ECB also start supervising shadow banking?

Sabine Lautenschläger: For us, shadow banks are certainly relevant because they often have ties with regulated and supervised banks. But because they are, by definition, non-bank entities, we don’t supervise them. Nevertheless, the principle of “same business, same risks, same rules” should also apply to shadow banks. That’s why we support global and European initiatives to properly regulate them – even though it is not our job to supervise non-bank entities.

Has European banking supervision put an end to the sovereign-bank vicious circle, and when do you think banking union will be completed?

Danièle Nouy: European banking supervision certainly helps to decrease the feedback loop between banks and sovereigns. It makes the banking sector more stable and crises less likely. And if a bank gets into trouble, the Single Resolution Mechanism and the new bail-in rules limit the recourse to taxpayers’ money. However, to really break the sovereign-bank vicious circle, we also have to rethink the regulatory treatment of sovereign bonds so that their true risk is reflected in adequate capital requirements. That would help to shield banks from deteriorating public finances. More generally, the most important things are, of course, prudently managed banks and responsible fiscal policy. As for banking union, it currently consists of European banking supervision and the Single Resolution Mechanism. In order to complete it, the proposed European Deposit Insurance Scheme has to be set up as soon as possible.

Is ECB Banking Supervision a good example for deeper European integration?

Danièle Nouy: The creation of European banking supervision represents the biggest step towards financial integration in Europe since the euro was introduced in 1999. Today, this supervision consists of the ECB and 26 national central banks and supervisory authorities. The Joint Supervisory Teams (JSTs), which directly supervise the significant institutions, are both a cornerstone and a symbol of Europe-wide banking supervision. We have a JST in place for each banking group we supervise. JSTs comprise staff from the ECB and national supervisory authorities, and are managed by a coordinator located at the ECB in Frankfurt. These JSTs are essential for maintaining close contacts with the banks. Nevertheless, cooperation reaches beyond the JSTs. We have, for instance, started to use mixed teams for onsite inspections. And the common methodologies we apply have also been developed by joint teams that comprise staff from the ECB and all the national authorities.

You therefore have people from across Europe who work together and pursue a common objective. Each day they grow closer together, develop a European spirit and even become friends. So, yes, I think that European banking supervision is indeed a model for European integration, both from an institutional and a personal point of view.

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