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Banks are not overregulated”

Interview with Sharon Donnery, Member of the Supervisory Board of the ECB and Deputy Governor of the Central Bank of Ireland, Supervision Newsletter

15 February 2023

Since your last interview with us five years ago, a lot has changed. How has the Single Supervisory Mechanism (SSM) evolved since then? 

Firstly, I think the SSM has gone from strength to strength. As we approach the anniversary of our first decade, we all have a lot to be proud of. One thing that has really struck me is that we see deeper integration across the SSM, embracing a common supervisory culture, with an emphasis on outcomes. The sense of community and belonging has developed, which I am very happy to see, with staff in the national authorities and the ECB all central to so many of the SSM’s core responsibilities and projects. This common culture, co-operation and collaboration is something we will continue to build on in the coming years.

The pandemic, Russia’s war on Ukraine and high inflation have created a challenging macro environment. What does this mean for banks and supervisors?

Unsurprisingly, this is one of the main features of my discussions at home and abroad. It is heartening to see the people of Europe welcome so many Ukrainian refugees as a result of this awful war and the humanitarian crisis it has caused. The war continues to create considerable uncertainty for the economy and financial system. In terms of supervisory concerns, asset quality has continued to improve in recent years. But prevailing inflationary pressures and lingering effects from the pandemic will pose challenges to borrowers’ repayment capacity and will require a robust approach to provisioning. While some institutions may experience short-term positive effects from rising interest rates, the wider effects from asset re-pricing and from cost drivers will put pressure on profitability. Liquidity risk, somewhat muted over the last number of years when monetary policy was more accommodative, will also require more supervisory attention.

But stepping back for a moment, our job is fundamentally about stability for European citizens. Given the external challenges, I think it is essential we remain focused on the core elements of our job. I am pleased that, as with the pandemic, the SSM has quickly focussed its attention on the key elements of these risks, and we will continue to prioritise them this year.

You spearheaded the ECB’s work on non-performing loans (NPLs) and the 2017 NPL guidance to banks. NPL ratios have decreased significantly since then, but current developments may result in higher NPLs again. Are banks better prepared nowadays?

Banks are much better prepared today than they were in the past. I think our work on the NPL guidance, the supervisory follow-up and targeted work on issues like leveraged finance and CRE puts us in a good place. The strengthening of the framework more widely, including higher levels and quality of capital are also central to the increased resilience. We cannot however be complacent, and the supervisory engagement will be important this year.

Banks’ advancements in complying with the Basel Principles for effective risk data aggregation and risk reporting (BCBS239) have been slow and unsatisfactory. Why is that, and what can be done to address the banks’ inertia in this area?

It is true, progress here has been slower than expected. For me, the governance element is key. The commitment of management bodies in banks to giving this the attention and resourcing it needs is crucial to making progress. For our part, this area will continue to be a focus of supervisory attention, given the importance of this issue to the prudent management of banks. Better risk aggregation delivers enterprise-wide benefits, in terms of effective governance and risk management, and the robust financial planning which delivers sustainable business models through the cycle. This allows banks to better play their role in the wider functioning of the economy and society. As long as this is seen as a “box-ticking exercise” and regulatory initiative, banks will not reap the possible benefits. More broadly, this issue underlines the importance of us having a clear escalation framework for how we engage with banks to ensure there is the required level of focus and oversight.

The FinTech sector is growing rapidly, especially in Ireland, and thus challenging supervisors. What can European regulation and supervision learn from Ireland to oversee these new and often complex entities?

Across the euro area the financial system continues to become more diverse, with certain sectors experiencing rapid change. In Ireland, innovative technology-driven businesses are targeting aspects of “traditional” financial services. We are seeing significant growth in the payments and e-money sector, for example. We are also seeing the digital transformation of the business models and products of incumbents. The way I look at it, these changes provide significant benefits to consumers and the wider marketplace, including in relation to competition, convenience and innovation. But while it is important to harness the benefits of innovation, we also need to ensure the risks are managed. 

A lot of these firms come into the regulatory perimeter without previous experience of being subject to regulation. And this presents a different challenge, particularly in the authorisation process. What we have learned to date is the fundamentals of authorisation and supervision remain the same. Our core work is about ensuring firms are well-governed, have sustainable business models, are financially and operationally resilient and that they operate in the best interests of their consumers.

Many of these developments are being seen across Europe too, which is why our supervisory priority on digital transformation is so important. We really want to see that banks are embracing sound digital transformation which will contribute to ensuring they have sustainable business models in the longer term.

On the same topic, do you think that some sectors in the financial industry are overregulated – such as banks, while others are underregulated – such as non-banks? How can that gap be closed?

I approach conversations around whether banks are overregulated with caution. Questions like these are often not about how regulation and supervision can best ensure safety and soundness into the future. Of course, our frameworks will need to continue to evolve. But, to answer your question directly, banks are not overregulated. This is not about a regulatory pendulum swinging one way or another. Proportionality is built into the system, with judgement and pragmatism being features of how we execute supervision. We will continue to adopt a risk-based approach to supervision, adapting as the risk environment changes.

Whether banking is more regulated than other sectors running similar risks is a different question. There are gaps outside the banking sector and the Central Bank of Ireland has been a strong voice in the calls for developing a framework that tackles the systemic risk that certain non-bank actors pose to the wider financial system. For example, I currently co-lead work at the Financial Stability Board on open-ended funds, which as we know exacerbated shocks to market functioning during the pandemic. But that is only one of a number of areas which require attention given how recent events have exposed vulnerabilities to the stability of the wider financial system.

The Central Bank of Ireland showed in a recent study that better bank communication increases mortgage refinancing, meaning borrowers can manage their mortgage burden better. Do you think supervision should include more guidance to banks to make good and clear communications part of their toolbox?

The importance of good and clear communications can be often underestimated. As an integrated supervisor across the entire Irish financial sector, we, in the Central Bank of Ireland, have seen how targeted and timely communication can really make a difference in achieving supervisory outcomes. Through our supervision, data analytics and research, and policy interaction, we have been able to identify and communicate areas of regulatory and supervisory focus to regulated firms to ensure that our expectations are understood. In the same way, banks need to utilise their existing tools to identify and communicate issues affecting their customers in a proactive and timely way to mitigate any potential harm to consumers and the reputation of firms and the wider system.


European Central Bank

Directorate General Communications

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