“Taking a closer look at individual risk drivers”
Interview with Felix Hufeld, Member of the Supervisory Board of the ECB, Supervision Newsletter
12 February 2020
Felix Hufeld, ECB Supervisory Board member and President of the German Federal Financial Supervisory Authority (BaFin), talks about the high-level review of the SREP, the importance of the ICAAP, digital developments and other financial services.
You have been chairing a high-level group to review the core supervisory activity – the Supervisory Review and Evaluation Process – for two years now. What is the group’s mandate and what are you looking at specifically?
The Supervisory Board gave the group an advisory mandate just over two years ago. We prepare the Supervisory Board’s discussions on SREP-related topics. A central topic is how the individual banks’ capital add-ons, the Pillar 2 requirements, should be determined. Within European banking supervision, these requirements are now closely aligned to our overall assessment of a particular bank.
So we take a holistic approach. We are now expanding on that by taking a closer look at the individual risk drivers. That is what we call the risk-by-risk approach. Our main motivation in introducing this additional perspective is that not all of the factors that feed into our overall assessment of a bank have an equal impact on its capital requirements. It goes without saying that we should not allow, say, liquidity risks, or risks that we could more effectively reduce through qualitative measures than through capital add-ons, to feed directly into the determination of Pillar 2 requirements. And it’s worth noting that in taking this risk-by-risk approach we are acting in line with the European Banking Authority’s supervisory review guidelines.
Where do you see room for improvement in the supervisory process and what do you expect from banks?
By introducing a risk-by-risk perspective – meaning the review of individual risks – we also want to give more prominence to the internal capital adequacy assessment process, or ICAAP, within the SREP. This risk-bearing capacity analysis goes well beyond the Pillar 2 requirements. We want to encourage banks to both improve their ICAAPs for internal management and make better use of the information for supervisory purposes. After all, banks generally determine their internal capital requirement by risk type, in other words on a risk-by-risk basis. There are pitfalls here, however, because, at the end of the day, the Pillar 2 requirements obviously also need to be calculated in line with supervisory criteria, albeit with a different objective in mind than for the ICAAP. So we need to avoid a direct interdependence between Pillar 2 requirements and the ICAAP. That would neither benefit the supervisor nor the bank. Unfortunately, the ICAAP data that we receive from many banks still leave much to be desired. We will undoubtedly give top priority to this issue over the next few years.
BaFin has traditionally highlighted the ICAAP’s importance as a valuable risk management tool for banks. Why is that?
True to its name, the ICAAP is an internal process. As a supervisor, we naturally have certain expectations of what this process should look like and we share these expectations with the banks. For example, the banks should undertake a thorough risk inventory using a fixed risk horizon. It is also important that banks directly link their ICAAP to their risk management. Only then can we assume that the banks are correctly capturing, measuring and managing their risks. If it all simply became a box-ticking exercise for us supervisors, we would be defeating our purpose, which is to strengthen banks’ own risk management. A sound ICAAP and sound internal capital management based on it are the first line of defence.
The German banking sector may be moving toward more consolidation – as indicated recently by considerations of Helaba and Deka Bank. Could this start a trend, in particular in the public banking sector?
This trend towards consolidation has been seen for decades and touches all pillars of the German banking sector.
In 1990, the year of German reunification, there were around 4,700 banks in the whole of Germany with some 44,000 branches. Ten years later there were only 2,700 banks. However, the number of branches had increased to 60,000 and reached its peak around the start of the millennium. At the end of 2018 there were no more than 1,600 banks, which operated close on 28,000 branches. I am absolutely convinced that this trend will continue unabated for quite some time to come.
Popular musings about the benefits or otherwise of national or cross-border mergers and acquisitions among very large banks are a very different matter. Preliminary deliberations and more concrete talks have been held repeatedly on this issue – also quite recently. But we should not underestimate the complexity regarding this issue.
It is first and foremost up to the market to decide on the expediency of such mergers, not government agencies. And it goes without saying that the new banks arising from mergers must in turn comply with all supervisory requirements.
BaFin is not only responsible for banking supervision but also for all other financial sectors. How do the supervisory risks facing banks compare with those facing other financial providers?
The risks cannot be put side by side. All financial subsectors – whether they are banks, insurers, asset management companies, payment service providers or other financial service providers – have their own set of risks, all of which need to be appropriately addressed by the supervisor.
One possible distinction between banks and other financial service providers is that in an acute crisis situation at a bank, the time available to us is compressed to a few days, or sometimes even just a few hours. At other financial institutions we generally have more time to deal with a crisis.
But I am basically extremely grateful that, as an integrated financial supervisor, BaFin can keep an eye on all financial sectors and use the entire range of supervisory tools.
In view of the ever stronger interdependencies across the different subsectors, I think it's a huge advantage that we have the ability to take a comprehensive approach.
You are closely observing digital developments in the financial sector, from big tech firms and big data to artificial intelligence. What is the supervisor’s role in this regard?
We need to understand how digitalisation will affect the financial markets so that we can respond appropriately to evolving, or even completely new, phenomena.
At the same time, our task is to act on these insights, to adapt existing regulatory requirements – on risk management, say, with a view to IT security – or to instigate totally new regulations in areas such as cryptoassets.
Besides new challenges in traditional prudential supervision, many new issues are emerging with regard to conduct supervision, particularly consumer protection. Let me just mention deliberate or unintentional discrimination and debates about personal responsibility given the increasing use of computer-aided decision-making processes.
Moreover, the boundaries between traditional financial institutions that fall under our supervision and technology providers are becoming increasingly blurred. This presents the question whether the current range of supervisory competences is appropriate for the market structures of tomorrow or if it needs to be supplemented. I believe the latter to be true.
We need to wait and see the extent to which the financial sector, as we know it today, is fundamentally challenged by trends such as the platform economy, the most far-reaching anonymous blockchain-based networks or the possible emergence of a token-based economy.
In your view, what are the top strengths of European banking supervision and what are the top challenges?
I think the biggest strengths of our single European banking supervision lie in sound analytical capabilities and instruments, extremely well-qualified and high-performing staff and the impressive sense of collegiality and togetherness that has developed between the ECB and representatives of the national supervisors when tackling a common task.
In my view, the greatest challenge lies in moving from the start-up phase of the first five years into a phase of organisational maturity. That covers a multitude of separate aspects. I will just single out human resources management, a stronger risk-orientation and the correct mix of being process-oriented and making case-by-case assessments.