“Things are moving along the right path”

Interview with Pentti Hakkarainen, Member on the Supervisory Board of the ECB, Supervision Newsletter, 14 February 2018

Pentti Hakkarainen, ECB representative member on the Supervisory Board since February 2017, talks about the challenges ECB Banking Supervision is facing, including in his focus areas of budgetary issues, auditing, and technological advancement.

What do you see as the main challenges for ECB Banking Supervision?

The strategy for the entire ECB, including banking supervision, sets goals for the years to come and provides a roadmap for the future. Ultimately, our most important output is our contribution to society, which is to support financial stability and integration. Given the importance of our tasks, it is crucial to continually foster good performance and to ensure we have the most effective processes and systems possible.

It is also important to recognise that some developments cannot be predicted. Indeed, one thing that makes our work so interesting is the need to constantly change our focus to meet the new issues posed by changes in the banking industry. Our strategic plans are designed to be a guide for how we expend resources; nothing is set in stone.

How do you see the current health of the European banking sector, and how successful has the Single Supervisory Mechanism (SSM) been so far in enhancing banking stability?

We still face important challenges. However, we should remember the SSM was born out of widespread concerns about the state of the European banking sector at a time when people also feared that things might get even worse.

Now, bank capital buffers are far healthier. For example, fully-loaded CET1 ratios rose from 11.6% in the last quarter of 2014 to 14.3% in the third quarter of 2017. Non-performing loans are still a major issue, but the trajectory is clearly downwards and people can see that many banks are getting a grip on the problems. We see confidence levels beginning to rise, and market participants see that things are moving along the right path.

Of course, macroeconomic improvements are part of that story of improvement. However, the role of ECB Banking Supervision has also been significant. The market can see that there is a well-resourced supervisor in place, with the cutting-edge expertise needed to successfully deliver on the tasks.

What is your assessment of internal audits in the euro area banks? Are auditors doing a good job?

The success or failure of banks is determined, more than anything else, by the quality of their management and corporate governance. This aspect of banking is more important than any capital adequacy ratio, buffer requirement, or liquidity metric. My experience is that the internal audit function is critically important for ensuring effective corporate governance.

In 2015, ECB Banking Supervision undertook a thematic review on corporate governance, which specified various expectations regarding banks’ internal audit functions. For example, it pointed out that internal audit functions should be fully independent from business lines – and that they should have direct reporting lines to the board or audit committee.

The banks we supervise are making good progress in ensuring that internal audit practices reflect the highest supervisory expectations. For instance, internal audit departments are increasingly integrated in the definition of banks’ risk appetite frameworks. In addition, banks’ internal auditors are increasingly active in ensuring that actions requested by supervisors are properly implemented.

That said, there is still progress to be made in pushing banks further into line with international standards. For example, the scope of scrutiny by internal audit departments should encompass all the potential risks that may occur in a bank. That is not yet always the case and we must keep our eyes on the ball to ensure that the scope of internal audits is sufficiently broad.

There have been claims that you are not sharing enough information with auditors, for example with the European Court of Auditors (ECA), so they cannot make a proper assessment. What is your explanation?

The external scrutiny we receive from auditors such as the ECA is important for us. We are open to constructive feedback as it provides us with opportunities to reflect on how we can better perform our remit.

We have made every effort to cooperate with the ECA while respecting both our confidentiality obligations and the ECA’s mandate to assess the operational efficiency of the ECB’s management.

In the case of the ECA’s recent audit of the ECB’s crisis management for banks, over 500 documents were shared – amounting to almost 6,000 pages of material. There were also 38 meetings and teleconferences with the ECA audit team, where the ECB provided further detailed explanations and answers to questions. Given our legal duties to protect confidential data, bank-specific information had to be anonymised.

When you read the ECA report you see that their auditors were able to develop an external perspective on the processes through which crises are managed under the SSM. The audit has been beneficial for us. We accepted the bulk of the ECA’s recommendations and work is already under way to implement them.

You recently led a project aiming to develop the role of cross-border missions across the SSM. What was the purpose of this work, and what was the outcome?

Cross-border missions are missions where the inspectors are taken largely from outside the national supervisory authority of the country where the inspected bank is located. Such missions are an important part of our work to grow a single supervisory culture across the Banking Union. They also help to ensure there is a level-playing field in the way supervision is implemented across the euro area.

Given the benefits of this type of mission, the Supervisory Board tasked a High Level Group, which I chaired, to assess how to increase their number. Through good collaborative work, and with the strong support of the Supervisory Board, changes have been agreed that will double the amount of cross-border missions in 2018.

This will be achieved in a way that utilises the expertise that already exists in national supervisory authorities. Implementation will also be sensitive to differing environments as national authorities are given various options for the way that they support the staffing of these missions in the future.

What is your assessment of how ECB Banking Supervision currently uses its resources, and what are its resource needs going forward?

My view is that the work of successfully setting up ECB Banking Supervision is now drawing to a close, as we have matured quickly into a credible supervisor. I expect that based on the lessons we have learned, we will focus on opportunities to improve effectiveness and further increase our skills.

In ensuring the right balance in our resourcing, we must reflect on what the public expects of us: for example, that we keep the biggest European banking risks under control. We must ensure that our decisions on resource allocation are consistent with those expectations. That also means ensuring that our collective supervisory resources in the euro area, meaning those of the national competent authorities and those of the ECB, are cooperating fully.

How do you see technology shifting the way we do business in the banking industry in coming years?

Technology is already moving fast in transforming the banking sector. Indeed, the modernisation of the way that banking services are delivered to tech-savvy consumers is transforming our concept of what a bank is. Now we increasingly see institutions moving to business models that make them look more like tech companies and less like traditional banks.

Artificial intelligence is expected to replace a big part not only of routine work, but also of more complicated professional tasks in many sectors. As in other workplaces, this will have a major impact on the work of bank supervisors.

Technological advancement is to be encouraged where it results in innovations that improve the quality of services to customers and citizens. I am personally optimistic that such improvements are under way, and that the market will deliver technological solutions that offer meaningful benefits to us all.

Nonetheless, it is the role of supervisors to worry about untested developments. New ways of doing things imply new risks, and this forces us to innovate in the way we supervise and mitigate those risks. Cyber security is just one element of that, and I can assure you that we take cyber threats very seriously. Substantial supervisory resources and talent are being invested in cyber security, and progress is being made in developing the system’s resilience to threats of this kind.

But whatever consequences technology brings, we need good people to make the best use of it. In the ECB we are lucky to have attracted a range of skilled and talented colleagues – from highly experienced veterans to young and technologically oriented people at the outset of their careers.

We are well-placed to find innovative ways to perform effective supervision in this shifting environment.

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