Launch of the SSM – what will change in banking supervision and what are the imminent impacts on the banking sector?

Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB,
at the Third FIN-FSA Conference on EU Regulation and Supervision,
Helsinki, 5 June 2014

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Summary

The idea of the SSM was born at a moment when the sovereign debt crisis threatened the cohesion of the euro area. Since the political decision to set up the SSM during the June 2012 European Council meeting, we have come a long way in building a strong and independent supranational supervisor.

For the first time in the history of the EU, we will have a supervisor with a truly European mandate, and a collective responsibility. The SSM will take an encompassing view of banks’ activities throughout the SSM Member States (and beyond) and remove national bias in supervision. Moreover, the ECB will be accountable to both the European Parliament and the EU Council, two institutions that represent citizens of the European Union and the Member States. By reducing financial fragmentation, the SSM will also facilitate the smooth transition of monetary policy throughout Monetary Union. Money markets will work more efficiently across national borders.

The SSM is rapidly becoming a reality and is set to assume responsibility for bank supervision within the euro area from 4 November 2014. The ECB published and finalised the SSM Framework Regulation on 25 April. The Framework Regulation lays down the main rules for the proper functioning of the SSM. We have largely developed the supervisory model of the SSM. The current SSM core project – the comprehensive assessment – consisting of the asset quality review (AQR) and the stress test, is progressing on multiple fronts. The actual execution of the AQR is on track – more than 6,000 supervisors and auditors are now working on the AQR. If banks face a capital shortfall arising from the AQR or the baseline stress test scenario, they will be asked to restore their capital position within six months; for shortfalls arising from the adverse stress test scenario, they will have up to nine months. The SSM is working on harmonised reporting templates based on Common Reporting (COREP) and Financial Reporting (FINREP) data that will ultimately reduce the reporting burden on pan-European banks, by eliminating different reporting standards across European countries, and will help to foster a level playing field.

From a supranational supervisor’s perspective, the region is certainly interesting. There is much cross-border bank activity among Denmark, Finland, Norway and Sweden, in the form of both subsidiaries and branches. Partly thanks to their experiences of the crises in the early 1990s, the four Nordic countries now have strong national supervisors. Nordic banks are already considered to have good solvency as well as good risk management. But what benefits will the banking union bring for them? Among other things, the additional transparency created by this exercise will further enhance the confidence of investors and depositors. The strong link between transparency and confidence has important positive implications for funding costs.

Each of the most important banks in Finland will be supervised by a Joint Supervisory Team (JST) with members from the ECB as well as members from the Finnish Financial Supervisory Authority. Through the SSM we aim to build on the best practices of all national supervisory authorities.

The Nordic region represents an interesting supervisory challenge for the ECB. For the largest bank in your country we will be the host supervisor. And the home supervisor of one of the largest banks in the region is in a non-participating Member State. The SSM will not create new or artificial borderlines within one banking group in terms of supervision. And as it would not make sense to look at entities within SSM countries in isolation, the role of colleges is key. A host supervisor that takes a European perspective, a perspective across the whole EU, is something new.

Less than two years after the European Commission proposed the establishment of the SSM, we are well prepared to deliver on this mammoth task.

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Ladies and gentlemen,

Thank you for inviting me to this year’s FIN-FSA conference.

The role of the SSM in building a new paradigm for banking supervision

Let me start by recapping the motivation behind the Single Supervisory Mechanism (SSM) and its main characteristics. As you will remember, the idea of the SSM was born at a moment when the sovereign debt crisis threatened the cohesion of the euro area. To help break the sovereign/bank nexus, a direct recapitalisation instrument was added to the toolkit of the European Stability Mechanism. And in parallel to the transfer of the liability for European banks, supervision was also shifted to the supranational level.

Since the political decision to set up the SSM during the June 2012 European Council meeting, we have come a long way. The Council Regulation on the SSM (SSM Regulation) has established the SSM as a strong, independent, supranational supervisor. At the core of the SSM, the ECB will assume responsibility for the direct supervision of the approximately 130 most significant banks. Moreover, the ECB will be responsible for the overall functioning of the SSM as an integrated supervisory system and thus also perform oversight over the supervision of the less significant banks. Those will remain under the direct supervision of the national competent authorities (NCAs), but will also apply common SSM methodologies. Moreover, if deemed necessary to ensure consistent application of high supervisory standards, the ECB will have the right to assume direct responsibility for supervising also the less significant banks.

For the first time in the history of the EU, we will have a supervisor with a truly European mandate, and a collective responsibility. The SSM will take an encompassing view of banks’ activities throughout the SSM Member States (and beyond) and remove national bias in supervision. Moreover, the ECB will be accountable to both the European Parliament and the EU Council, two institutions that represent citizens of the European Union and the Member States.

To ensure homogeneity, the SSM will apply the same standards across all banks in the SSM Member States. Every bank in the SSM will be supervised according to a single supervisory model codified in the Supervisory Manual and will use the same data reporting templates. We will thus ensure high quality supervisory standards and a harmonised and consistent implementation of prudential regulation throughout the SSM. This uniform approach to supervision will effectively put an end to the “compartmentalised” supervision of the past. It will ensure a level playing field throughout the SSM, reduce the supervisory burden for banks operating in several SSM Member States, and increase market confidence. The common standards will also greatly foster financial integration and help us to reap the benefits of the single market.

By reducing financial fragmentation, the SSM will also facilitate the smooth transition of monetary policy throughout Monetary Union. Money markets will work more efficiently across national borders. For instance, in crisis times, we will no longer see national supervisors requiring banks to match national assets with national liabilities. Hence, the SSM will greatly facilitate the conduct of monetary policy.

What is the state of play of the SSM?

The SSM is rapidly becoming a reality and is set to assume responsibility for bank supervision within the euro area from 4 November 2014. Let me give you a brief update on the preparatory work of the SSM at the ECB.

First, the ECB published and finalised the SSM Framework Regulation on 25 April. The Framework Regulation lays down the main rules for the proper functioning of the SSM. It sets out the procedures governing the cooperation between the ECB and NCAs and the methodology for the assessment of the significance of institutions. For the supervision of significant banks, the Joint Supervisory Teams (JSTs) will build the backbone of supervision. The JSTs will consist of local experts from the NCAs of participating Member States, under the overall coordination of the ECB, which will ensure that JSTs take a European perspective.

Second, we have largely developed the supervisory model. We intend to publish a guide to supervisory practices and methodologies in the SSM targeted at the public, mainly the supervised banks. The guide will ensure transparency.

Third, the current SSM core project – the comprehensive assessment – consisting of the asset quality review (AQR) and the stress test, is progressing on multiple fronts.

Let me emphasise that the actual execution of the AQR is on track. Overall, more than 6,000 supervisors and auditors are now working on the AQR. The data integrity validation is close to being finalised. Work on the collateral and real estate evaluation, the collective provisions and the level 3 fair value review is ongoing.

Turning to the most recent developments in the subsequent stress testing exercise, on 29 April, the European Banking Authority (EBA) published the stress test methodology and scenarios. While the extensive process of banks' balance sheet repair is already under way, the test – designed to assess banks' resilience to hypothetical external shocks – will identify remaining vulnerabilities in the EU banking sector and will provide a high level of transparency on EU banks' exposures.

The common methodology and underlying assumptions cover a wide range of risks including: credit and market risks, exposures towards securitisation, sovereign and funding risks. The adverse scenario, designed by the European Systemic Risk Board (ESRB) in close collaboration with the ECB and the EBA, reflects the systemic risks that are currently thought to represent the most pertinent threats to the stability of the EU banking sector. These include (i) an increase in global bond yields amplified by an abrupt reversal in risk assessment, especially towards emerging market economies; and (ii) a further deterioration of credit quality in countries with feeble demand.

If banks face a capital shortfall arising from the AQR or the baseline stress test scenario, they will be asked to restore their capital position within six months; for shortfalls arising from the adverse stress test scenario, they will have up to nine months. Consequently, as of the release of the comprehensive assessment results in October 2014, some banks will have to build up capital buffers, thereby leading to more resilience in the financial system.

Fourth, the SSM is working on harmonised reporting templates based on Common Reporting (COREP) and Financial Reporting (FINREP) data. Ultimately, these will reduce the reporting burden on pan-European banks, by eliminating different reporting standards across European countries, and will help to foster a level playing field. Every effort is being made to coordinate the data collection requests efficiently, and to avoid duplications and overlaps with other data exercises. In particular, the principle of proportionality will ensure a meaningful set of data without overburdening the smaller banks.

Finally, let me highlight that the new SSM vacancies have attracted great interest and that, as part of the top-down recruitment process, the recruitment of the middle management is mostly finalised.

What change will the SSM bring for the Nordic banks?

Now, to a question that is probably on most of your minds: how will the SSM affect the Nordic banks?

From a supranational supervisor’s perspective, the region is certainly interesting. There is much cross-border bank activity among Denmark, Finland, Norway and Sweden, in the form of both subsidiaries and branches. This is particularly true of the largest bank in the region, which has been identified as a global systemically important financial institution in the Nordic Region. In fact, its subsidiaries in Finland and Denmark are larger than the Swedish parent. ^[1] So, the cross-national dimension of bank supervision will not be new to you.

Banks in these countries have withstood the recent financial crisis quite well compared with banks in many other European countries. And, almost a quarter of a century ago, three of these countries demonstrated how major banking crises could be handled very effectively. Partly thanks to their experiences of those crises in the early 1990s, the four Nordic countries now have strong national supervisors.

Nordic banks are already considered to have good solvency as well as good risk management. So you may ask: is there any benefit for those banks in creating a new European supervisor?

My answer is: Yes, there will be both positive immediate effects and positive effects that will play out over the longer term.

Let me first mention an immediate positive effect. All banks that will be directly supervised by the ECB, including the Nordic banks, are now undergoing a comprehensive assessment. For the Nordic banks, the additional transparency created by this exercise will further enhance the confidence of investors and depositors. The strong link between transparency and confidence, and its important implications for funding costs, are a key reason why we think banks generally benefit from the application of harmonised standards, methodologies and definitions across countries. This is particularly true for banks which rely to a substantial extent on market funding, such as several of the large Nordic institutions.

Moreover, for Nordic banks operating in international markets beyond their own region, being supervised by a supranational European supervisor should also add to the confidence from markets. And this is something which will also play out over the longer term.

Each of the most important banks in Finland will be supervised by a Joint Supervisory Team (JST) with members from the ECB as well as members from the Finnish Financial Supervisory Authority. The work of our Finnish colleagues and their supervisory resources will continue to be of crucial importance for the effective conduct of supervision, not least given their long experience of supervising these institutions and their specific national expertise. But bringing people with experience from other countries outside the Nordic region into these supervisory teams can also bring new insights into the supervision of your banks. Through the SSM we aim to build on the best practices of all national supervisory authorities. It will be a constant learning process and we will all learn from each other.

The Nordic region represents an interesting supervisory challenge for the ECB. For the largest bank in your country, we will be the host supervisor. And its home supervisor is in a non-participating Member State. I would like to stress that the SSM will not create new or artificial borderlines within one banking group in terms of supervision. We consider it crucial to have a holistic understanding of how a group operates and how its individual entities are linked, also from a risk perspective. It would not make sense to look at the entities within SSM countries in complete isolation. For this reason, the role of colleges is key. The JST supervising the largest bank in Finland will of course take part in the supervisory college for this group. It will be represented by the JST coordinator and will be fully committed to strong cooperation. The EBA has done important work in building and improving the framework for such cooperation and the SSM is committed to playing a very constructive role. In the long run, bilateral home-host cooperation between the SSM and supervisory authorities from non-participating Member States will also be based on Memoranda of Understanding, or MoUs. Those MoUs will be key instruments in setting up a good framework for efficient and fruitful cooperation.

The ongoing comprehensive assessment that I mentioned earlier already provides a good example of how cross-border coordination between supervisory authorities can work in practice . The ECB is conducting the assessment for a number of cross-border banks. And in this process we coordinate, for example, a number of relevant aspects with the Swedish and Danish home authorities – in fact they attended another meeting at the ECB last week to discuss the link between the comprehensive assessment and the 2014 Supervisory Review and Evaluation Process (SREP). Here we are clearly benefiting from the long-established well-working home-host cooperation for these groups.

A host supervisor that takes a European perspective is something new. Now, let me emphasise that a European perspective does not simply mean a euro area perspective. It is a perspective across the whole EU, a collective responsibility. The first paragraph of Article 1 of the SSM Regulation explicitly provides that the ECB in its supervisory policies shall contribute to “the stability of the financial system within the Union and each Member State.” And this has practical implications for us. We will supervise large cross-border banks with significant operations in several Member States. In our supervisory decisions regarding such banks we will take into account potential impacts in all Member States where the bank operates. And we will do this to a larger extent than a national supervisor tends to do, or is able to do.

Let me conclude by saying that the creation of the SSM is a major undertaking by the EU. Less than two years after the European Commission proposed the establishment of the SSM, we are well prepared to deliver on this mammoth task. I look forward to cooperating with the Financial Supervisory Authority, FIN-FSA, in supervising the banks in the SSM area.

Thank you for your attention!