In its first year in operation ECB Banking Supervision exceeded expectations, but work is underway to bring the single supervisor of the euro area to ever higher standards. Mr Angeloni emphasises that harmonisation of the way supervision is conducted across the euro area is key. Otherwise there cannot be a level playing field which enables fair competition, a precondition for growth and prosperity. In this context the ECB Supervisory Board has identified around 120 “options and national discretions” in Union law which can be exercised by a supervisor, for which a single approach has been agreed upon. In a public consultation ECB Banking Supervision is currently seeking comments from stakeholders on two documents, a Guide and a Regulation, in which this agreement is spelled out. Mr Angeloni encourages the banking community to submit questions and suggestions during this consultation, which ends on 16 December, using the contacts on the website of ECB Banking Supervision.
Regarding day-to-day supervision, Mr Angeloni explains that business models and profitability will be key priorities in 2016. Another priority is credit risk, considering that a number of institutional credit segments exhibit a persistent high stock of non-performing loans (NPLs). Other objectives are the fostering of comparability and the quality of internal models as well as capital adequacy. Governance and risk propensity will remain a priority in 2016. These priority areas for the SSM will be further refined and will eventually be published.
Mr Angeloni underscores the importance of transparency in the way supervision is conducted. Investor decisions need to be supported by adequate information on the returns and risks involved. Some knowledge of supervisory requirements can help in this respect. To that end, an appropriate degree of disclosure on the annual supervisory exercise known as Supervisory Review and Evaluation Process (SREP) could be helpful. So far, the SSM has disclosed a broad description of a common methodology for the SREP in its Guide to Banking Supervision. Going forward, as the SREP methodology becomes more established, steps towards greater transparency will be possible.
The SSM has been operating for 11 months and all national authorities contribute, but none is predominant. Three features of the SSM receive less attention than others: with the SSM the ECB has been given both micro- and macroprudential responsibilities; the coexistence of national and European components in the legal basis of the SSM is a source of asymmetry, which conflicts at times with a level-playing field; and the founding regulation of the SSM – the SSM Regulation – gives it extensive powers over the banks under its direct responsibility, covering all supervisory tasks.
Mr Angeloni then highlights five areas in which research could benefit supervisors. The first area concerns financial stability – how to define it and how to measure it. Good measures of financial stability remain elusive. In contrast to monetary policy, where an extensive literature on the definition and measurement of price stability exists, no quantified objective is available for supervisors. Financial stability is multidimensional and hard to enshrine in a single notion or measure.
The second area relates to how much capital should banks hold. Answers are required for how much capital is needed in “normal” conditions, how it depends on preferences and other factors, at what point capital should be considered excessive, and why. These dilemmas are routine for banking supervisors because of their responsibility in setting Pillar 2 requirements.
The third area concerns the diversification and optimal mix of capital. As hybrid instruments are inherently complex, their use may add uncertainty to the financial system. The question is whether the additional complexity is outweighed by benefits in terms of added flexibility, better incentive structure, or lower costs.
Another question relates to what role there is for other prudential requirements. A framework is needed on how liquidity and capital requirements interact. In principle, the distinction between insolvency and temporary cash shortages is clear; but in practice, it is blurred because temporary illiquidity may lead to premature asset liquidation in stressed market conditions, and hence to losses.
A final question has to do with where – specifically, in which sub-entity of a banking group – should capital and liquidity be located. For the SSM, the problem is important because of the presence of large cross-border groups. The SSM has launched a project on harmonising national options and discretions in the CRD IV and CRR, which will increase the flexibility to manage capital and liquidity for banking groups, while still respecting basic prudential requirements.
Mr Angeloni concludes that some of these issues are very complex, and that understanding is still incomplete and evolving; which is why more research is needed.
Julie Dickson gives a keynote address at De Nederlandsche Bank (DNB) in Amsterdam. At a conference focussed on supervision of behaviour and culture at financial institutions, she says that DNB has taken a leading role in emphasising the role of behaviour and culture in financial institutions.
Ms Dickson then explains the importance the Single Supervisory Mechanism (SSM) places on corporate governance, noting that a key priority in 2015 was a thematic review on risk governance and risk appetite in the 123 banks directly supervised by the SSM which, she confirms, is now close to completion. She says the review is providing valuable insights, which are important for this year’s Supervisory Review and Evaluation Process process; and also for providing a basis for planning next year’s supervisory cycle.
She points out that the review has been a new experience for many banks, some of which are not used to answering the kind of questions the SSM is asking, such as why boards believe their risk appetite framework is appropriate, or why they believe the information they are getting from their management teams is appropriate. She says the review also touches on incentives, by asking questions regarding the consequences for employees within an institution of not respecting the risk appetite framework and by exploring whether the risk appetite framework encouraged the desired risk-taking behaviour.
She says that though the review is an initial one, over time, as its knowledge of each bank grows, it is to be expected that such assessments by the SSM will go deeper.
She then underlines the huge opportunities that bringing together supervisors of 19 different countries can offer and notes that the SSM is consulting the DNB to explore how to make optimum use of their staff and to better understand their approach.
She also speaks about the ECB’s position on supervisory participation in regular bank board meetings. She says that the ECB’s current view is that supervisors should meet with boards as needed to deliver supervisory messages, and may also attend part of a board meeting from time to time to watch and to see what information is being provided and what questions are being asked; but that it will not attend as a general rule.
Finally, she touches upon the challenges confronting the ECB in its work to harmonise differing transpositions of the Capital Requirements Directive. She says that when the ECB has to assess the suitability of new bank board members, it is confronted with very diverse national rules and practices. And that although it can go some way towards harmonising rules on suitability of the management body, it cannot harmonise specific items laid down in national law. She says that in areas like fit and proper assessments, it is therefore not easy to spread best practices across the 19 SSM countries. And that the ECB is seeking more changes to bank regulation in Europe.
Daniele Nouy, Chair of the Supervisory Board of the ECB, speaks to an audience at the Austrian Financial Market Authority’s Supervisory conference in Vienna on the theme of safety and progress in finance and banking supervision.
Ms Nouy explains how the Single Supervisory Mechanism (SSM) has a clear mission to ensure the safety and soundness of banks, and to contribute to the financial integration of the euro area.
She highlights the innovative aspects of the SSM as an organisation, pointing to the SSM and the SSM Regulation as key advances. Then she focuses on the substance of the work the SSM is undertaking to harmonise the different supervisory options and discretions (ONDs) available to banks and supervisors at national level. She points out that the SSM can only be a credible provider of safety and progress, if its actions are supported by structural initiatives at both the European and national level.
She says that SSM combines a bank-specific approach with a cross-sector view and has a better knowledge of how banks are linked to the rest of the financial system, drawing also upon the excellent analysis prepared in other units of the ECB while respecting the separation principle between supervisory tasks and monetary policy.
She stresses that supervised banks should be subject to consistent prudential requirements based on their inner characteristics regardless of where their business is located. Ultimately, equivalent economic and financial conditions must receive the same regulatory and supervisory treatment.
She says that approximately eight months after the start of a project to tackle options and national discretions, the Supervisory Board of the ECB adopted in mid-July a policy package on close to 100 ONDs. This policy package is being translated into a legal package, composed of an ECB regulation for general ONDs, and internal guidance laying down stances and specifications for case-by-case ONDs. Ms Nouy adds that the resulting draft regulation will be subject to a public consultation, to be launched at the beginning of November.
As a supervisor, she says the SSM’s most valuable contribution to economic growth is to do its job: by implementing regulation consistently, by closely monitoring supervised institutions in a forward-looking, risk-based and proportionate way, and by taking timely and determined action when needed.
She says that the SSM wants safety and progress to serve sustainable growth and that the SSM helps in creating the right environment for it, fostering intense competition, but on fair grounds, encouraging risk-taking, but in a transparent and responsible manner, and ensuring financial stability, but not at the expense of taxpayers. This, she concludes, is the SSM’s contribution to the well-being of the people of Europe.
The implementation of rules by supervisors matters just as much as the rules themselves, Julie Dickson, member of the Supervisory Board of the ECB, tells an audience in London at an event organised by the Centre for European Reform.
She highlights that the emphasis being placed by the ECB on the quality of supervision in Europe is refreshing and that the day to day efforts of supervisors in addressing bank risks are key to contributing to the safety and soundness of credit institutions and the stability of the financial system.
She points to four key areas of focus: the ECB’s aim for consistent supervisory practice in the area of non performing loan recognition, coverage and write-offs; conducting a public consultation in the autumn to work towards harmonising over 150 options and national discretions available at national level; the unified application of the 2015 supervisory review and evaluation process methodology which she says, will become more robust over time as the ECB’s knowledge of the banks it supervises increases; and finally a targeted review of internal models at banks that will aim to ensure that capital held reflects underlying risks - a task she says is complex and will take several years to complete.
Ms Dickson also acknowledges that improving the quality and consistency of supervision requires not just supervisory convergence but also convergence on European bank regulation. She identifies areas where harmonising some approaches hold more challenges than others. In the area of consistently applying fit and proper requirements for members of the banks’ boards and senior management, she says the ECB is confronted with very different national rules and practices. She also cites a German draft law on banking regulation that delegates to the German Federal Ministry of Finance certain competences to issue regulations which would replace the administrative guidelines issued by the competent German authority, BaFin. She emphasises that if such practices increase, the harmonisation and the establishment of uniform conditions would be hampered significantly.
She concludes that through the Single Supervisory Mechanism, Europe is moving quickly to harmonise supervisory approaches. ‘The ECB is taking banking supervision very seriously’, she concludes. ‘It’s a challenging, full time job and we’re doing everything possible to make banking union a success.’
Supervisors can contribute to sustainable economic growth by ensuring that supervised entities are resilient to plausible shocks, properly managed, adequately capitalised and subject to an efficient risk management and the right incentives. The European Single Supervisory Mechanism takes a medium to long-term perspective on this, resisting those who argue for short-term relief. The SSM ensures that banks can deliver in their tasks in all phases of the economic cycle and thus are able to provide the economy with the financial services that corporations, smaller firms and citizens need.