Single Supervisory Mechanism – Opportunities and Challenges
Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB,
at the Irish Banking Federation’s Banking Union Conference,
Dublin, 23 June 2014
Ladies and Gentlemen, thank you for inviting me to Dublin to address the opportunities offered by, and the challenges associated with, the establishment of the Single Supervisory Mechanism (SSM), one of the key components of the Banking Union.
As you know the SSM is being set up to ensure that strong supervisory standards are applied in a homogenous way across the euro area. This essential reform of the European supervisory system has been driven by the lessons learned from the global financial crisis. In Ireland you have undertaken extensive reform of your regulatory structures in recent years. So you are well aware of the enormity of the task we are facing with the introduction of the SSM. From November 4, the ECB assumes responsibility for supervision of the euro area banking sector. So the SSM needs to be fully functional by that date.
Let me give you an update on the operational challenges associated with such an undertaking and update you on our preparations.
Operational challenges and opportunities
We are already moving into the second half of the one-year transitional period permitted by the SSM Regulation for completing the set-up of the SSM. From 4th of November the ECB will be ready to directly supervise about 130 significant banks and maintain supervisory oversight of all remaining banks in the Euro Area Member States.
In addition to the Comprehensive Assessment of the significant banks required by the SSM Regulation, an exercise of unprecedented magnitude, we are working on establishing the basis of a fully functioning mechanism. To demonstrate the scale of the undertaking, it just requires to outline only some of the issues involved: having in place harmonised, comprehensive and clearly defined supervisory standards and processes; sufficient and also fully trained staff; practical infrastructures such as functional and tested IT systems as well as governance structures that ensure swift decision making.
Looking only at the recruitment process, we have to hire approximately 800 supervisors, and we are looking for the best possible candidates. Most of the recruiting campaigns should be concluded before the end of the summer. This has raised much interest, as we have received so far over 14,000 SSM-specific applications.
This is just a snapshot and I guess you can imagine the challenges we are currently facing to get our “start-up” fully running. Our project management milestone plan is quite extensive. We are working very intensely to meet the objectives and we are well on track with achieving them.
But notwithstanding the evident challenges posed by such a far-reaching process, the opportunities offered are of course significant and, I am sure, worth the effort.
For the first time in the history of the EU, we will have a supervisor with a truly European mandate. This will support the effective application of the single rulebook developed by the European Banking Authority (EBA) and therefore a harmonisation of supervisory standards in Europe. It will reduce regulatory arbitrage and remove national biases. As a result, we will enhance confidence in the supervision of banks and in the whole financial system.
One important objective of the SSM is to improve the quality and consistency of supervision. This is a historical opportunity to build its supervisory approach on the best supervisory practices in Europe and beyond. The SSM aspires to establishing “the” state-of-the-art supervisory standards.
The SSM will ensure that those strong supervisory standards are applied in a homogenous way across the whole euro area, hence providing a level playing field. In addition, given a stronger consolidated perspective, efficiencies with respect to allocation and transfer of intragroup capital and liquidity can be enhanced. This will contribute to reducing market fragmentation, fostering financial integration and reaping the benefits of the single market.
The SSM will provide us with additional opportunities for benchmarking and peer comparisons among institutions and thereby improve the tools of supervisory risk assessments. The SSM will be better placed to assess, monitor, and address the risks faced by banks in a timely fashion. Its micro-prudential view will be further supported by the macro-prudential tasks conferred upon the ECB with respect to the monitoring and addressing of risks from a system-wide perspective. The fact that the ECB has been given powers to directly apply macro-prudential instruments, as well as to play a coordinating role among all Member States, is an important innovation of the SSM Regulation. It will improve financial stability in the euro area.
Additional opportunities relate to the broad experience, knowhow, and resources upon which the SSM can build. The SSM combines the best of the ECB and the National Competent Authorities (NCAs). It builds on the ECB’s extensive expertise regarding macroeconomic and financial stability issues and on the NCAs’ expertise in the supervision of credit institutions within their respective jurisdictions, taking into account their economic, organisational and cultural specificities. Joint Supervisory Teams (JSTs) are being put in place to benefit from such national expertise while ensuring true European Supervision, built on the best supervisory practices. The great opportunity is that we all be learning from each other.
Let me emphasise one aspect: key to the effectiveness of the SSM will be close cooperation between the ECB and the NCAs. But how will supervisory tasks be distributed between the NCAs and the ECB?
The ECB’s new responsibilities under the SSM
The main procedures governing cooperation between the ECB and the NCAs, and the distribution of tasks are laid down in the Framework Regulation. With its publication in April an important milestone has been reached. The Framework Regulation also enables us to determine which of the around 4,900 individual credit institutions in the euro area will be deemed significant.
More specifically, let me start with the so-called ‘common procedures’ applicable to all banks. These are the authorisation processes, meaning the granting of banking licences and the assessment of applications for the acquisition of qualifying holdings. The entry point for applications is always the relevant NCA. The applications are subject to a joint assessment by the NCA and the ECB. The final decision on approval or rejection rests with the Supervisory Board of the ECB.
For all other supervisory tasks, roles and responsibilities are based on the distinctions between “significant” or “less significant” banks. This distinction, reviewed annually is based on the size of the bank, its importance for the EU or any participating Member State, the extent of its cross-border activities, and whether the bank has requested or is in receipt of direct public financial assistance from the ESM. In line with the SSM Regulation, the first list of significant institutions will be published no later than the 4th of September. Work on this is underway and we will shortly begin the process of notifying each bank of our initial assessment.
The ECB is responsible for the direct supervision of up to 130 significant groups, which represent almost 85% of all banking assets in the euro area and which comprise around 1,200 individual credit institutions. The day-to-day supervision will be implemented via the JSTs which are one of the key elements of the SSM. They bring together the experience and know how available in both the NCAs and the ECB.
The less significant banks, in practice the vast majority of the credit institutions, will remain under the direct supervision of the NCAs. Although labelled “less significant”, the soundness of these credit institutions is vital for the entire system, in particular with regard to potential contagion effects, and the SSM is a single system – that is why the direct supervision of the less significant institutions (LSIs) is monitored by the ECB. Moreover, the ECB can take over the direct supervision of LSIs, if need be, to ensure the consistent application of high supervisory standards. The same supervisory principles will be applied, with proportionality, to all credit institutions in the SSM, irrespective of their classification as “significant” or “less significant” banks.
The SSM supervisory model
In addition to the Framework Regulation we have developed the supervisory model of the SSM in a supervisory manual, which will serve as the basis for the supervisory work within the SSM and will create a harmonised supervisory culture across the euro area.
The Supervisory Manual provides a common methodology based on the best supervisory practices in Europe and beyond. For example, it lays down a detailed methodology for the Supervisory Review and Evaluation Process (SREP) including its risk assessment component.
The Supervisory Manual is an internal SSM staff document, but we intend to publish a “Guide to supervisory practices and methodologies in the SSM” before we take on supervision so that both banks and the public understand how supervision will be conducted. The guide will ensure transparency.
The new risk assessment process in practice
Supervisory risk assessment methodologies of the highest quality are essential to achieve efficient and consistent supervisory outcomes.
The ECB has to work according to the EBA’s single rule book and closely cooperates with the EBA to develop it in particular regarding the SREP and risk assessments.
In concrete terms, the common methodology for carrying out the SREP will form the basis for an on-going monitoring of a credit institution’s risks, capital and liquidity situation and will therefore play a key role in the supervision of both significant and less significant banks..
The SSM’s SREP is built on the following two main elements: the risk assessment system used to evaluate credit institutions’ risk levels, and a capital and liquidity quantification methodology which is used to evaluate credit institutions’ capital and liquidity needs, given the results of the risk assessment.
The risk assessment process is also an essential element of day-to-day supervision. It should be understood as an overarching and continuous assessment of the risk profile of a credit institution in a forward-looking manner. It is a quantitative and qualitative analysis based on a wide range of information collected through, for instance, regulatory reporting or via on-site inspections. A key objective is to take into account the broadest possible range of both quantitative and qualitative indicators when assessing a bank’s intrinsic risk profile, its position vis-à-vis its peers, and its vulnerability to a number of exogenous factors.
Based on all the information reviewed and evaluated during the SREP, the SSM will conduct the overall assessment of the capital and liquidity adequacy of the credit institution concerned and determine any necessary corrective actions.
Practically, the monitoring of the quantitative requirements and indicators, as well as the documentation of the full assessment, will be performed by the JSTs.
In this context, designing a multi-module IT system that covers all supervisory needs and serves as interface between the ECB and the NCAs for efficient JST work, and which ensures consistent risk assessments within tight deadlines, is of course a major challenge. For its design, we have selected, as a nucleus, a software solution that is already being used at the Central Bank of Ireland, and we are adapting it to the needs of the SSM. We selected this system as starting point for our adaptation since it has now been active for some years, was built to support a more intrusive supervisory culture and is already free of the so-called “teething problems” that usually accompany new developments. The system’s immediate adaptability because of its “simple" structure, and obviously the language advantage, were also taken into consideration, but the system will be adapted in full to the SSM methodology.
Yet, we need to bear in mind that the approaches used at present differ significantly between jurisdictions and that, even though the SSM methodologies have been designed with due consideration of the best practices available, they are new developments and, hence, are also new for their users, the supervisors. They will need further field testing and they will be subject to on-going improvement. We should therefore not expect fully fledged new harmonised approaches to be applied completely consistently already in 2014. For this year, the assessment methodologies in place in NCAs will still play a major role.
Let me conclude by saying that the creation of the SSM is a major undertaking by the EU, and that we are well prepared to deliver on this task.
Thank you for your attention.