Interview with LETA
Interview with Danièle Nouy, Chair of the Supervisory Board of the ECB, conducted by Inguna Ukenabele and published on 5 September
The Single Supervisory Mechanism (SSM), a part of European banking union, has been operating for four years now. What is your assessment of it at this point? Where is it functioning well and where is there still room for improvement?
There is still much to be done, of course, and not everything has been completed. However, a lot has been achieved; among other things, a lot of work is being done in relation to non-performing exposures –NPEs for short. Such exposures amounted to around €1 trillion when European banking supervision began. We started by issuing qualitative guidance on how to address non-performing loans, the way in which they should be managed. And then, with the addendum to the qualitative guidance, we expressed our quantitative expectations regarding the provisions needed for new non-performing exposures (the flows). We are currently working on the implementation of the addendum also for the stock of NPEs. Banks still have non-performing exposures totalling €680 billion. So we still have some way to go. But every day we hear from banks about the significant steps they are taking and the good progress they are making, which is promising.
We want banks to tackle this issue before the next crisis comes. We don't want the banks under our supervision to enter the next crisis with the legacy of the previous crisis.
Another thing to point out is the lack of harmonisation of European legislation. The single rulebook is not so single after all, and in some areas we are a long way from full harmonisation. This is the case with regard to the fit and proper rules, for example, which are part of the Capital Requirements Directive. We need more regulations, which can be implemented directly, rather than directives, which are transposed in 19 different ways into national law. Moreover, we should have fewer national options. We would be more efficient and would do a better job if the legal framework in Europe was more harmonised.
Does this mean that national parliaments and governments are creating problems by being slow to take decisions?
I wouldn't call them problems. Establishing a legal framework at the European level requires time. For example, in order to introduce changes into the SSM framework, there needs to be a consensus among all European countries, and that is not easy.
It is unfortunately true that, as we move out of the crisis and the economic environment becomes more benign, it seems that improving the supervisory framework ceases to be the key priority. There is rather a temptation to introduce some deregulation. We see this not only in Europe but also in the United States and other countries. We are humans and people tend to forget the lessons that were painfully learnt during the crisis.
What is the ECB's cooperation with national supervisors like?
At lightning speed we created a new institution which requires cooperation between the centre in Frankfurt and the 19 supervisory authorities at the national level. It was a huge challenge, but, in my view, we have achieved our goal. The cooperation is getting better and better. A European supervisory culture is growing every day and bringing us closer together. So I would say that cooperation is functioning well and getting better with time.
There were recently two scandals related to money laundering in the Baltic States involving ABLV Bank in Latvia and a branch of Danske Bank in Estonia. Does this also point to problems in supervision and "gaps" in the whole system?
Combating money laundering is hard work and it also requires a sound legal framework. In Europe, this area is also governed by a directive, which means there is a risk of it being implemented in 19 different ways in the euro area.
I personally think that combating money laundering requires a common European framework, hence a regulation rather than a directive. I also think that it would be better to address the money laundering issue through a European institution. I am sure that my colleagues are doing the best they can. But in this relatively small country, compared with the rest of the euro area, which has correspondingly small supervisory institutions, it is difficult to obtain enough staff with the required expertise and experience to focus on this issue. This is all the more critical since the geopolitical risks in this region, in the Baltic and Scandinavian region, I would say, are not negligible.
I personally think that we would be more successful in this task if we had an institution performing a role similar to that of the ECB in the area of supervision, with people in the central body working with the national institutions. It would enable us to work on the prevention of money laundering and to take the relevant decisions from a European perspective, which would be much more powerful. I have talked to European legislators about this too, and I am convinced that it will happen in the future as this, together with a fully harmonised legal framework, would provide powerful solutions to the problems faced by certain countries. But when we had those discussions, the development of the new directive had already reached its final stages, so it was probably a bit too late to transform it into a regulation.
Some steps are now being taken to compensate for the fact that, up to now, we have not been as ambitious as we should have been in this area. I would reiterate that this is not a matter that can be addressed exclusively at the national level; the discussions should take place at the European level. The Vice-President of the European Commission, Valdis Dombrovskis, has now set up a group which includes representatives from the European Banking Authority, the European Insurance and Occupational Pensions Authority, the ECB and the European Commission. All these institutions that can play a role in combating money laundering – even if it does not fall directly under their tasks – have to sit down together and agree on the most appropriate way of implementing the new directive and cooperate more closely, to be certain that we have done all we can under the current legislation. It is a good turning point. It is not widely known, but not all European countries – I am not talking about the euro area here – have even transposed the previous anti-money laundering directive into their national law. So we are not just talking about directives not being transposed into national legislation in the same consistent way, we are talking about them being ignored altogether in some cases. But that is not the case with Latvia.
The cases of both ABLV Bank and the Estonian branch of Danske Bank will be investigated, but will the ECB subsequently asses the local supervisory authorities and their ability to keep money laundering under control?
Definitely not. We are not mandated to investigate money laundering. When the SSM was set up, the legislators decided that combatting money laundering should stay at the national level. We can only act (in particular to withdraw the banking licence) on the basis of the information shared by the national supervisors. If such information is not provided to us, or if it is incomplete, we cannot move. Withdrawing a bank's licence is a very serious step, so we need convincing evidence. If we are concerned about a bank's business model, for example because the bank is too focused on collecting non-resident deposits and doesn’t serve the national economy, we can only consider assigning a low score to its business model during the supervisory evaluation. This may result in additional capital requirements, but it is not very efficient because, for the most part, such banks are well capitalised, have no non-performing exposures and have good liquidity. If they were assessed by a machine rather than the judgement of a supervisor, these banks would get the highest evaluations. So this is a pretty complicated issue for a prudential supervisor.
Will the ECB be involved in the liquidation of ABLV Bank given that the bank was under the ECB's direct supervision?
No; but no-one can prevent us from saying what we expect.
The Latvian authorities proposed that the bank should be allowed to undergo self-liquidation. We would have preferred a liquidation via the courts, but that was not possible in this case. So, we expressed two expectations. First, before the self-liquidation, an independent valuer, such as a consulting or accounting firm, needed to assess whether there were enough assets in the bank to reimburse the investors. Those who invested in the bank knew that it was supervised by the ECB and that has a certain value. So it would be unacceptable if, all of a sudden, they found out that the bank was being self-liquidated and they were not properly reimbursed. This assessment was carried out before the self-liquidation, and the bank was judged to have enough assets to satisfy investors' claims. Second, we asked the Latvian Office for Prevention of Laundering of Proceeds Derived from Criminal Activity to be very careful with regard to the reimbursed money to investors so as to make sure that money possibly tainted by money laundering schemes does not flow to other banks in the country or region. We have been assured that this will be the case. So we are not involved in supervising the liquidation, but we can rest assured that it will be done in an appropriate way.
What is the situation elsewhere in Europe? Can we expect cases similar to that of ABLV Bank?
My view is that we won’t be totally safe until we have both sound harmonised regulation and European-level supervision. We are doing all we can under the current legislative framework, but we have limited options and power. Much of this has been addressed in the new directive which came into effect in July. But, for the time being, there are still national laws which do not permit the transmission of money laundering-related information to the SSM. As a result, we are expected to revoke banks' licences when national supervisors notify us of money laundering problems, although some national supervisors are not even allowed to provide us with information related to money laundering concerns. But that is not the case with Latvia.
After the ABLV Bank episode, decisions were made in Latvia that significantly affect banks servicing non-residents. What future do you see for Latvia's banking sector?
There are different kinds of banks in Latvia. The largest banks in Latvia belong to big banks operating in the Baltic and Scandinavian region, including Swedish banks. Those banks are part of large groups which serve the national economies of the region. With regard to the smaller Latvian banks that are more involved in providing services to non-residents, the Latvian authorities have decided that this business has to be scaled down because conducting such high shares of their business with non-residents is a source of money laundering concerns and does not serve the Latvian economy. Now that they have been forced to reduce the volume of services to non-residents, rightfully so in my view, these banks are currently reviewing their business models. Some mergers might take place, and some banks might cease to exist. This will certainly trigger changes for the Latvian market. The events and changes experienced in recent months are a major challenge for all players.
According to those involved in the industry, some of the non-resident money is being transferred back to Russia, and some to other European countries such as Cyprus and the Czech Republic. Does it not raise concerns that non-resident money is simply flowing to other EU Member States and will create problems there in the future?
That is exactly why I recommend setting up a single European institution, because we are stronger together; and this is an international business. If we want Europe to be well protected, it makes sense to improve supervision at the European level. In the euro area we are doing all we can together with our colleagues from the national supervisory authorities. And we cooperate with the other European countries outside the euro area. Moreover, since the crisis, tax havens and similar structures/jurisdictions have come to be addressed more appropriately and it is becoming more difficult to use them to evade taxes or hide income. So I would say: let’s at least do a good job in Europe; and let us cooperate with the other regions of the world, which will have to look after themselves.
Do you see potential risks in any of the banks in the Baltic States?
Looking at the banks in the Baltic States from our perspective, we are interested in the developments in the real estate market and mortgage lending. And from a supervisory point of view, “interest” means that there are certain concerns. Growth in the real estate market, the commercial property market, is very substantial in terms of both price and volumes of transactions. In my opinion, the use of variable interest rates poses a risk, as there is no guarantee that, when interest rates go up, companies’ profits or people’s wages will increase; but payments on their loans will do so. We will closely follow developments in the real estate market. This affects not only Latvia and the Baltic States, but also other countries. Subsidiaries of large Scandinavian banks operate in the Baltic States; and, of course, if a bank is not doing as well as expected in its home country, that has an effect on the situation of its subsidiaries in other countries. So it is good that Nordea has chosen Finland for its headquarters; that will help the SSM to better understand what is taking place in the whole Nordic region regarding real estate.
In Latvia the ECB currently directly supervises Swedbank, SEB and Luminor. Is the ECB planning to take over direct supervision of any other bank?
At the end of each year, we receive an assessment of the next largest market participants. That is when we decide on further action.
It is also possible that the national supervisor would ask us to take over direct supervision earlier. That was the case with Luminor, because after the merger of DNB and Nordea operations, it immediately gained an influential position in all the Baltic States. So it made sense to take over its direct supervision.
Otherwise we have to take over direct supervision whenever a bank becomes one of the three largest banks, whether we like it or not. We cannot do any cherry-picking. The same applies when a bank's assets exceed €30 billion or 20% of the country's GDP.
Every now and then we are warned about the possibility of a new crisis. Would the European banking system be ready for that?
The only thing we know for sure is that there will be a new crisis. But we don’t know when or why it will emerge. We can be almost certain that it will be different from what we expect. For example, before the last crisis, many of us feared that a crisis might be brought about by hedge funds, as their behaviour in financial markets was sometimes risky. But supervisors followed the recommendations of the Basel Committee and supervised them indirectly, through the activities of the supervised banks, since hedge funds conduct leverage activities that require bank loans.
What could cause the next crisis? I don't know, but I suspect it could be the real estate market. Many of the previous crises have been related to the real estate market, even if not directly.
But, in any case, we need to stand ready for a crisis, and there is only one rule, one thing that has to be done: banks need to be safe and sound. That means they need to have enough capital and good quality capital. At present, the average CET1 ratio of euro area banks stands above 14%, which is much higher than before the crisis. The same goes for liquidity. We will nevertheless carry out liquidity stress tests next year. Although liquidity is ample and money is cheap, some banks have not been successful enough in mobilising collateral and acquiring additional liquidity in the market when under pressure. Banks have to be ready for possible liquidity constraints.
We also have the Single Resolution Mechanism in place, which helps a lot. This means that we are much better prepared for a crisis because the crisis management mechanism is fairly strong.
I would also like to say that, thanks to Latvia, we underwent a good test, as the ABLV Bank incident came out of the blue. Nobody was expecting a crisis of this kind. It all happened in a relatively small country and we were not experts on the nuances of its national legislation. So it was a good test of our capacity and ability to take the right decisions within a short time frame. In no more than a few days, all the necessary actions had been accomplished. So I would indeed say that we are much better prepared now.
What is still lacking is a European deposit insurance scheme – EDIS. I know that some northern and eastern European countries want to see a more pronounced reduction of risks in euro area banks before further moves are made. I personally think that the risks have already been reduced significantly. So, we now have to move forward.
Will Brexit bring about changes in European banking supervision, given that a number of London-based financial institutions are talking about moving to Paris or Frankfurt?
Brexit means a lot of additional work for us. To be honest, we had enough work to do and we didn’t ask for more, but we do not decide what we do, we have to do whatever needs to be done.
First of all, I would like to say that it is sad when a country leaves the European “family”. But this also gives us an opportunity to think about how we would like international banks to be set up. In the euro area, we are both “home” and “host” supervisors; so we are obliged to take balanced approaches, while the United Kingdom is mostly a host supervisor. That means that what we prescribe for non-SSM banks relocating to the euro area, other supervisors can prescribe for SSM banks; so our decisions need to be reasonable. We need to be balanced, reasonable and fair; and at the same time we need to be effective. We have strict principles for relocating banks, which were introduced within the SSM framework, meaning also for the SSM banks. This is the case, for example, with regard to empty shell companies. This refers to the prohibition on banks registering risks in the euro area but setting up workplaces and carrying out actual operations in a third country.
We want to make sure that banks that supposedly move to the euro area actually do move to the euro area. This means that their capacity for trading, hedging, risk management and so forth in the euro area has to be commensurate with the size and the risk of the relocated operations. We can accept a transition period but it should not be too long. They should move within two or three years at the most, and they will have to start with resources that are proportionate to the risk they are moving over.
To start with, we had discussions with banks that wanted a longer transition period and did not want a fully proportionate presence in the euro area, but now the conditions are clear.
What are the main challenges for the European banking system in the future?
I would say that profitability is the major issue. There are a number of banks in the euro area that are not earning their cost of capital, and have not done so for the past few years. This cannot go on for long. Banks have to be able to make enough profit either to generate capital internally or to raise capital from the market, with investors expecting a certain return on equity. It is a major challenge for a number of banks, in particular the ones that are burdened with NPEs.
Profitability is a challenge and we see that some consolidation is needed both in the European banking system in general and in the euro area banking system, which is covered by the SSM.