Savings banks in the European banking landscape
Speech by Ignazio Angeloni, Member of the Supervisory Board of the ECB,
at the Financial Meeting of the Confederación Española de Cajas de Ahorros,
Madrid, 18 June 2014
It  is a pleasure to be here today to address the Financial Meeting of the Confederación Española de Cajas de Ahorros. I wish to thank you, Mr President, the organisers of this event and all those present this morning for the interest you have expressed in my participation.
There are several reasons, besides seeing again the beautiful city of Madrid, why I was glad to accept your invitation. The first one was to have an opportunity to reflect again, with you, on the restructuring of the Spanish Cajas. This is one of the most radical and broad-ranging operations of its kind ever enacted in an advanced economy, comparable in its proportion only to the crisis that preceded it. It is too early to draw conclusive lessons from this experience, but I have no doubt that the reform of the Spanish Cajas will long be considered, an event of historical importance and a rich case study for economists, historians and policy makers.
Another reason is more personal. I still remember being impressed in my school days by the presence, in my home city of Milano, of the local savings bank, the Cassa di Risparmio delle Provincie Lombarde – an institution that later merged into Intesa San Paolo. With its imposing stone building located, not by coincidence, in a street named Monte di Pietà – a reminder of its origin as a charitable institution – it was regarded as one of the most influential and respectable institutions of the city. Long before I even suspected that banks would one day be at the centre of my professional life, I reflected on the meaning of the word “cassa”, (“casket”) and why it differs from the name of other institutions called “banca”, (“plank”, or “table”), although they perform very similar functions. I found intriguing that the first name suggests the idea of a box, in which money is collected and stays idle, whereas the second alludes more to a desk, where money is exhibited and exchanged. Whatever the value of these intuitions, I believe that the historical origin of savings banks, from which, as we shall see, their name derives, is worth revisiting today because it can tell us something about why so many of those banks, after thriving for over a century, have entered into a deep crisis more or less at the same time, and for comparable reasons.
Therefore, I will first look at this historical evolution before turning to more present-day concerns, specifically to the changing regulatory and supervisory landscape in Europe – especially the establishment of the banking union and its impact. I will describe the functioning of the prospective Single Supervisory Mechanism (SSM) and the current preparations by the ECB for assuming its new responsibility. This includes the comprehensive assessment on the banks that, because of their significance, the ECB will supervise directly. Finally, I will elaborate on how the SSM, as well as the Single Resolution Mechanism (SRM), should contribute to a more robust banking sector, also to the benefit of savings banks.
Origin and crisis of the savings bank model; some lessons
Saving banks have a long tradition. When, near the turn of the 18th century, the British philosopher Jeremy Bentham proposed the establishment of thrift banks in England in order to make retail savings safer and more attractive, the first savings banks had already been founded in northern Germany. Interestingly, in England, after being collected, often in churches, deposits were actually stored in special boxes. In subsequent years several similar institutions appeared throughout Europe; in Paris in 1818; the Cassa in Milano that I mentioned dates back to 1823; and the Caja Madrid, ancestor of all Spanish Cajas, was established as a saving bank in 1838, having operated mainly as a charity up to then. This almost simultaneous origin is not a coincidence, but rather the result of a combination of historical influences. On the one hand, the new middle class, rising from industrial and political revolutions, was becoming capable of saving and investing, and required appropriate financial arrangements. On the other, the egalitarian ideas of the Enlightenment, together with the Christian influence, suggested that the pools of funds generated by those savings should be used, among other things, for social and charitable purposes.
This blend of functions – collection of retail savings, lending for productive purposes and a social and altruistic component – all with a distinct local and mutualistic flavour, has characterised savings banks throughout their history. And it was also the reason for the special treatment, in the form of public guarantees and special regulatory and tax regimes, that savings banks have enjoyed almost everywhere for most of their history, until recent times. It also helps us to understand the constant proximity, throughout history, between savings banks and political power.
I wish to emphasise that a distinct mission of savings banks was, originally and subsequently, to educate the lower-middle class about the importance of saving and its fruitful use, both privately and socially. During the turmoil of the 19th century, those aims contributed to stabilising the social order.  The importance of those banks continued to grow with the size and the wealth of the middle class; after the Second World War, savings banks were a well-established presence in all major countries. In Europe, in the early 1980s, the sector included approximately 1,400 savings banks with around 35,000 branches, and its assets represented about 14% of the overall banking sector.
It is in this context that the first major crisis of this sector took place: that of the US Savings and Loans Associations (S&L). In the early 1980s the S&L represented about 22% of the total US banking system, and 50% of mortgage lending. Undercapitalised and weakly regulated, overgrown and overly reliant on short deposits to finance illiquid investment (largely in real estate), weak in their governance and internal controls, those banks were hit, in sequence, by the rise of short-term interest rates and by the economic downturn. In the end, the crisis lasted ten years and resulted in the closure of half of the previously existing institutions and in an estimated cost for the US taxpayer of 3% of GDP.
The crisis of the Cajas in Spain exhibits some similar characteristics. Savings banks were leading players on the credit side well before the crisis.  Following the removal of geographical barriers in 1988, in the period from 1992 up to 2004, the number of branches increased threefold and loans increased fivefold, well more than in the rest of the banking sector. In 2004, savings banks had the largest network in Spain, and were still growing. Massive risk-taking in real estate, facilitated by structural and governance weaknesses in many ways comparable to those that had marred the S&L twenty years earlier, brought the Cajas very far away from their traditional business model, let alone from their original social and charitable mission.  You know how the story ended: most institutions were restructured and merged; their number declined from 45 to 13; branches were cut by one- third; employees by a quarter. The eventual cost for the public sector, while difficult to determine precisely, is probably similar, relative to the size of the economy, to that in the earlier US case.
From these two examples I draw the following lessons. First, liberalisation and deregulation must be accompanied by a corresponding strengthening of governance, transparency and controls within the banks, lest these forces fuel financial and economic instability. Second, in our modern, open and globalised financial sector, there is no longer room for niches of regulatory protection or forbearance: banking is a powerful and delicate function requiring solid and pre-emptive prudential supervision, without exceptions. Third, by implication, the blend of financial, social and charitable purposes, with related political influence, which is part of the long and proud tradition of savings banks everywhere, cannot and should not survive in its earlier form. Strong and transparent safeguards must be built to separate these functions. Guarding them should be one of the priorities of banking supervisors.
But I would like to propose yet another reflection, perhaps less obvious than the preceding ones. Leaving charity aside (an essential function which, however, I believe belongs mainly to a different sphere), a key original aim of savings banks, that of facilitating the collection, channelling and wise use of individual savings, especially by low to middle income earners, is not only still relevant, but has become even more important after the recent experiences. This function includes helping customers in their savings and investment decisions, by providing the necessary information, knowledge and advice. Without adequate information and, on occasion, guidance, decisions can be driven by herding and become destabilising . We have learned from Bob Shiller, winner of the Nobel Prize in economics last year, that financial instability derives also from individuals not possessing the right information and knowledge, as well as instruments, to assess and manage the risk they take.  We have learned from Daniel Kahneman, who was earlier awarded the same prize, that individual behaviour can be misled by false perceptions and intuitions.  Proximity to clients makes banks natural providers of financial advice. Moreover, we know from research on credit markets that stable relations between lenders and small borrowers can resolve informational asymmetries, increasing investment and growth . In their relations with customers at all levels, banks have a clear responsibility in all these respects, a responsibility that doesn’t belong to savings banks alone, but rather to all banks. And again, banking supervisors should be there to remind banks of the importance of this function and to protect it, ensuring it is performed honestly and transparently to the benefit of all users of bank services, and avoiding conflicts of interest.
Strengthening the European regulatory and supervisory framework
Let me now turn to the important changes that are taking place in the European regulatory and supervisory landscape.
European banking underwent a complete regulatory overhaul recently. In the last four years, new rules to calculate and establish capital buffers were introduced (the Capital Requirements Directive and Capital Requirements Regulation – known as the “CRD IV package”); national rules to restructure or resolve ailing banks were harmonised (the Bank Recovery and Resolution Directive); a new area-wide banking supervisor, the SSM was set up; a single restructuring and resolution authority, the SRM was established and will be provided with its own resolution fund as soon as it is approved by the European Parliament. In preparation for assuming its new supervisory function, the ECB is conducting a balance sheet review of all major euro area banks, known as the comprehensive assessment, to be completed by October.
This broad ranging set of reforms responds to an overall logic. In the highly interconnected euro area financial system, systemic risks originating in any of the member countries tend to spread easily to the entire area. This in itself suggests that banking policies – regulation, supervision, safety nets – should be conducted with regard to the area as a whole, and with a view to the stability of the entire financial system. In the initial part of the recent crisis, insufficiently coordinated measures undertaken at national level have on occasion tended to exacerbate risks, generating contagion and fragmentation of Europe’s single financial market. Until recently, supervisory and regulatory cooperation was limited to cooperation agreements, too weak to be effective.
A major factor of financial instability, in the recent euro area experience, consisted in the negative loop between the weakness of banking sectors and the weakness of public finances at the national level. The experience of Spain in 2011-2012 is a clear illustration of this more general problem. Before the crisis, Spain exhibited an apparently strong fiscal performance, with a sustainable level of public debt and low deficits. But then the crisis hit, with the downturn of the real estate sector and its impact on the banks that were exposed to it, mainly Cajas. Once this crisis erupted, it quickly became clear that public finances were vulnerable as well, due to their explicit and implicit commitment to support the banks; sovereign borrowing costs increased, which in turn drove the funding costs for banks upwards. Moreover, once public finance trends became clearly unsustainable, confidence in the banks eroded further, as it became apparent that a solid public safety net was no longer available. The ensuing economic recession exacerbated both problems, reinforcing the loop.
Eliminating this inherent flaw in the euro area and ensuring a robust crisis management and prevention framework, was the pressing policy objective that led the European Commission to propose, and the political leaders to support, the creation of a European banking union in 2012. The banking union provides the necessary European dimension to banking supervision and resolution and the sufficient degree of coordination to national deposit insurance schemes.
I will now briefly explain the functioning of all these three elements, starting with the Single Supervisory Mechanism, the SSM.
Single Supervisory Mechanism: one system based on cooperation
The establishment of the SSM constitutes the main milestone; by creating a supervisor with a genuine European mandate, it will already this year change the supervisory framework in the euro area. Let me briefly explain how the mechanism will work in practice.
The SSM is composed of the ECB and the national supervisory authorities, with the ECB acting as decision-maker with responsibility for the effective functioning of the overall system. The ECB has been entrusted by the legislator with an extensive set of micro- and macro-prudential powers. Its supervisory remit will cover all credit institutions within the scope of the SSM; this means, initially, all banks in the euro area and, subsequently, banks of non-euro area Member States that wish to opt-in. In its decisions and operational functions, the ECB will be assisted by the national supervisory authorities, which will contribute their long-established expertise. Their assistance includes the on-going day-to-day assessment of a bank’s situation, participation in the supervisory teams, as I shall explain, related on-site and off-site activities.
While the SSM is a single system, with the ECB ultimately responsible for its functioning, different modalities will apply depending on the size and systemic importance of the banks.
The ECB will supervise directly only those banks that are considered significant because of their size, presence in the national economy, or cross-border activities, according to criteria spelled out in the SSM regulation. These are up to 130 banks, covering about 85% of assets held by banks in the euro area. All other, less significant banks will be supervised on a daily basis by the national competent authorities. The ECB will oversee their actions through a general oversight framework, based on data and other information received from banks and national authorities. Should the ECB consider that there is a need to directly supervise a less significant bank to maintain high supervisory standards, it may decide to supervise that bank directly. The list of banks that are deemed significant will be published soon.
The supervisory processes will follow guidelines, specific regulations and a Supervisory Manual approved by the ECB. They will conform to the single rulebook developed by the European Banking Authority (EBA). The application of harmonised regulatory and supervisory standards, including methodologies and definitions, will create a real level playing field for banks and decrease compliance costs and risks.
Importantly, day-to-day supervision of the significant banks will be carried out by specialised groups of supervisors, the Joint Supervisory Teams (JSTs). Their responsibilities will include performing the supervisory review and evaluation process; preparing the supervisory examination programme and ensuring its implementation; liaising with national competent authorities where relevant. These JSTs will consist of experts from the ECB and the national competent authorities of participating Member States, under the overall coordination of the ECB. This close cooperation within the JSTs will help maintain knowledge and understanding of pertinent issues at a national level.
The preparation of all decisions is entrusted to a Supervisory Board, composed of a Chair, a Vice-Chair, four ECB representatives and one representative from each national competent authority. In total, there are now 24 members, all of whom are bound by law to act in the interest of the EU as a whole.
Preparing for the operational start of the SSM
The preparation at the ECB to assume this new responsibility started soon after the establishment of the new authority was announced by political leaders, in mid-2012. The work is organised around a strict and detailed time schedule, so that operations in the ECB can start on 4 November 2014. As we are reaching the final phase now, let me give you an overview of the current state of progress.
The Supervisory Board has been operational since January this year, meeting twice a month. In addition, the SSM governance structures, including the rules of procedure and other arrangements of the Board, have largely been completed. A Framework Regulation laying out the main rules for the proper functioning of the SSM was adopted and published in April, after a public consultation.
The recruitment of staff in the ECB is well underway. The recruitment campaign is attracting a tremendous amount of attention. More than 14,000 applications have been received for the positions advertised so far. The staffing is taking place in a top-down fashion, starting from the higher managers and cascading down. We have recently passed the mark of 500 recruited staff, which is about half of the total being planned, including support staff (mainly in the statistical, legal and IT areas). JST coordinators are being appointed and we expect them to be at work in the ECB by the end of the summer.
The Supervisory Manual covering all supervisory operations of the system has nearly been completed. In order to ensure transparency, we intend to publish all essential parts of it in a guide to supervisory practices, clarifying the features, tasks and processes of the SSM.
The ECB is also working on developing harmonised data templates based on Common Reporting (COREP) and Financial Reporting (FINREP). Every effort is being made to coordinate data requests efficiently. In the design of the data framework for the less significant institutions, we are aiming at the right balance between a meaningful coverage and not overburdening banks, particularly the smaller ones.
The comprehensive assessment
I turn now to the comprehensive assessment, an exercise that, understandably, is generating much interest and expectation. As you know its main aims are to provide transparency to bank balance sheets and to identify cases where balance sheet strengthening may be needed, hence helping build confidence in the banks. As a cornerstone of the on-going preparations, the assessment includes an asset quality review (AQR) and a stress test. The outcome of the overall exercise will be communicated in October.
Let me underline that banks have already undertaken a lot of effort to clean and strengthen their balance sheets. Since the start of the global financial crisis, euro area banks have issued some EUR 267 billion of quoted shares, in addition to other forms of capital strengthening, such as retained earnings, convertible bond issuance and State aid. At the end of 2013, the median Tier 1 capital ratio for euro area significant banking groups reached 12.8%. This is five percentage points higher than before the crisis, in 2007. In addition, banks have also made progress in improving their funding profiles by reducing the reliance on wholesale funding from high pre-crisis levels. The median loan-to-deposit ratio for significant banking groups declined from 141% in 2007 to 119% in 2013. These steps, undertaken by banks previously and sometimes in anticipation of the results of the exercise, are a sign of its credibility and will help a smooth implementation of its outcome.
The exercise covers 128 banks in the SSM participating Member States; 16 are located in Spain, of which 10 are former savings banks. Overall more than 6,000 supervisors and auditors are working on the AQR. The total risk-weighted assets of the banking book portfolios selected for the review amount to about €3.7 trillion, 58% of total credit risk-weighted assets across the relevant banks. In addition, banks with material trading book exposures are subject to a specifically tailored AQR of the trading book. This component consists of a qualitative review of core trading book processes combined with a quantitative review of the most important derivative pricing models.
By now we have completed the collection of credit files for the banking book and the processes review for the trading book. With all the data collected, we expect to have the findings of the credit file review in the coming weeks.
The second component of the comprehensive assessment is the stress test. On 29 April, the EBA published the stress test methodology and scenarios. The stress test has a horizon of three years and, as a starting point, it will include the results of the AQR. Furthermore, the stress test will cover a wide range of risks, including credit and market risks, securitisation exposures, as well as sovereign and funding risks. The methodology follows a common approach agreed within the EBA, including static balance sheet assumptions, prescriptions regarding the calculation of the impact on market risk and securitisation as well as caps and floors on various sources of income.  The capital threshold for the baseline scenario has been set at 8% Common Equity Tier 1 (CET1), whereas for the adverse scenario, a threshold of 5.5% CET1 will apply.
If capital shortfalls are identified, banks will be asked to submit a capital plan. The shortfalls will be expected to be covered within six months for those identified in the AQR or in the baseline scenario, or nine months if originating from the adverse scenario.
The preparatory work that I have just described lays the foundation for robust supervisory standards and processes, and also sets the tone for the cooperative way of working within the SSM, ensuring a single system with a European perspective and an independent decision-making process.
Link between the SSM, the Single Resolution Mechanism and deposit guarantee
Before closing, a few words on bank resolution and deposit insurance, the other elements of the banking union.
As I highlighted earlier on, the lack of tools to effectively deal with bank failures and the lack of an appropriate framework to deal with cross-border bank failures exacerbated the crisis and increased the costs of bank resolution. The absence of a European mechanism for bank resolution further intensified the destabilising link between banks and sovereigns.
This problem is addressed by the Bank Recovery and Resolution Directive, which provides a harmonised framework to prevent banking crises and allows for early intervention and resolution of banks if they are failing or likely to fail. Furthermore, the introduction of bail-in of shareholders and other creditors should help ensure that the costs of bank failures remain in the private sector.
Moving beyond this, the Single Resolution Mechanism will provide an appropriate European framework to deal with bank failures. It complements the SSM by ensuring an orderly resolution of non-viable banks. Bringing the responsibility for supervision and resolution up to the European level should avoid potential distortions and conflicts of interest between the two functions.
The revised Deposit Guarantee Scheme Directive ensures that all depositors in all Member States have the same rights as regards the coverage of eligible deposits – up to EUR€100,000 – including deadlines for pay-outs and ensuring that deposit guarantee schemes are funded in the same way. These measures should ensure better depositor protection.
In ending my remarks, I do not feel the word “conclusion” would be appropriate. Banks and authorities are in a transition phase, moving forward step by step, focused on the goals to be achieved.
Let me just remind you of the extremely high stakes we face. After the creation of the euro, the banking union is a next logical step in the construction of our common European house, and a major one. Financial markets, public opinion, the international community are all watching us with understanding and encouragement, but also with a critical eye. We cannot afford to fail.
The SSM and the assessment of the banks are cooperative undertakings where the success of each of the actors involved – the banks, the Member States, the national authorities, the ECB – requires and in turn implies the success of the others. The ECB has put its reputation on the line and is fully committed to making them work. We urge support from all sides, first and foremost from the banking industry.
We count also on your support.
Thank you very much for your attention.
- I thank Cécile Meys for her contribution, and the Confederación Española de Cajas de Ahorros and the European Savings and Retail Banking Group for providing data and other information.
- European Savings Banks Group, History of the European Savings Banks (http://www.esbg.eu).
- Cardenas, A.,”The Spanish Savings Bank Crisis: History, Causes and Responses”, Internet Interdisciplinary Institute, Open University of Catalonia, 2013.
- Altman, M., "Behavioural Economics Perspectives - Implications for Policy and Financial Literacy", Research paper prepared for the Task Force on Financial Literacy, February 2011; Gerardi,K., Goette, L. and Meier,S., "Financial Literacy and Subprime Mortgage Delinquency: Evidence from a Survey Matched to Administrative Data", Federal Reserve Bank of Atlanta Working Paper 2010-10, April 2010.
- R.J. Shiller, Finance and the Good Society, Princeton University Press, 2012.
- Kahneman, D. (2011). Thinking, Fast and Slow, Allen Lane, London. Recent research by Hackethal suggests that sound financial advice can help resolve some of Kahnemann’s pitfalls and improve financial decision making; see A. Hackethal, “Financial Advice”, in E. Faia, A. Hackethal, M. Haliassos and K. Langenbucher (eds.), Financial Regulation: a Transatlantic Perspective, Cambridge University Press (forthcoming.).
- A seminal paper on relationship lending is M. Petersen and R. Rajan, “The Benefits of Lending Relationships: Evidence from Small Business Data”, Journal of Finance, 1994. See also A.N. Berger and G.F. Udell, “Small Business Credit Availability and Relationship Lending: The Importance of Bank Organisational Structure”, The Economic Journal, February 2002, 112 pp. 32-53.
- The static balance sheet assumption is not applicable to banks subject to a restructuring plan approved by the European Commission before end-2014.
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