Stable financial markets, stable Europe

Speech by Danièle Nouy, Chair of the Supervisory Board of the Single Supervisory Mechanism,
at the Economic Council in Berlin,
9 June 2015

Ladies and Gentlemen,

Thank you very much for the introduction, and thank you for inviting me to speak at this distinguished event.

The topic of our session here is “Stable financial markets, stable Europe” and I am honoured to have been asked to kick off the session, as I interpret this to mean that there is broad agreement that European banking supervision can meaningfully contribute to this.

Of course, I would be dishonest if I said I disagreed.

But I do owe it to you to explain how unified supervision in the form of the Single Supervisory Mechanism – or SSM – can contribute to achieving stable and well-functioning financial sectors in the euro area, which in turn is a key ingredient for sustainable growth and economic development.

As you know, the SSM became operational last November only three years after the so-called “Four Presidents’ report” outlined the decision to establish a banking union in the euro area to address the increasing fragmentation of the internal market and to put an end to the deep financial crisis. The SSM constituted one of the key pillars underpinning the banking union, along with the Single Resolution Mechanism and the increasing coordination of the national deposit guarantee schemes. Since then, we have taken a giant leap towards ensuring consistent banking supervision in the euro area, and I encourage you to read our first annual report about the remarkable work that has been undertaken in a very short time by the ECB and the national supervisors.

Focusing more specifically on the topic of our discussion today, I will start by highlighting some concrete evidence of the ECB's contribution to financial stability as supervisor, a role clearly separated from its monetary policy function to avoid undue influences while benefitting from evident synergies. I will then expand on our efforts towards harmonising rules, as I consider this to be a clear precondition for harmonised supervision in the euro area.

A comprehensive start

Before we even became fully operational in November, the ECB was tasked with conducting a comprehensive assessment of the banks that were likely to fall under our direct supervision. This in itself was an exercise of unprecedented magnitude, which consisted of an asset quality review and a stress test, and required the close involvement of the ECB, the national supervisory authorities and the private sector.

In conducting the rigorous balance sheet review in combination with a stress test, we substantially enriched our knowledge of the actual financial situation of the banks that we now supervise, and gained valuable and detailed insights into the trends affecting the European banking system. Overall, the comprehensive assessment was one of the key building blocks in renewing market confidence in the euro area banking sector, unlocking bank funding and capital so that banks can carry on lending to the real economy, and promoting financial stability in the euro area.

It gave us a head start in getting to know very well most of the banks that we subsequently began supervising and it was the first step towards establishing a European supervision culture of thoroughly and prudently monitoring, probing and assessing banks. By checking that banks are adequately capitalised, supervisors contribute to stability; and by ensuring that banks are properly managed and have efficient risk management and the right incentives in place, they can contribute to sustainable growth. In other words, our role is to ensure that banks can deliver their tasks in all phases of the economic cycle and provide the economy with the financial services corporations, smaller firms and citizens need. Only a healthy bank can do that, which is why more stringent and sustainable prudential requirements have a positive impact on sustainable growth. We as the SSM take a medium to long-term perspective on this, resisting those who argue for short-term relief.

Under one roof

After the comprehensive assessment, we jumped straight into supervision and it helped immensely that the SSM was part of an established institution: the ECB. We all agree that supervisory tasks should be carried out in full separation from monetary policy to avoid conflicts of interest and to ensure that each function is executed in accordance with its objectives. The separation principle covers, among other things, the separation of objectives, the separation of decision-making processes and organisational tasks, and procedural separation at the level of the Governing Council.

The legal framework designed by European legislators in October 2013 is very clear on this point in that it guarantees the separation and independence of the functions within the ECB and also shields the SSM from undue external influence.

To underline this, ECB supervision is held accountable in its own right: the Supervisory Board submits the minutes of its meetings to the European Parliament, we regularly report to the relevant European parliamentary committee separately from monetary policy operations, and we publish a separate annual report on supervisory activities, which is presented to the European Parliament and the Eurogroup.

The ECB was the natural home for meeting all of the challenges of establishing the SSM. No other institution could have offered a sounder basis for the creation of the SSM and I would argue that no other institution could have absorbed these new functions and so many new staff as efficiently as the ECB. For a new European supervisory authority starting its work, the ECB’s long established services and its credibility as an institution are invaluable assets. For the first time in the history of the EU, we have a banking supervisor with a truly European mandate. We are committed to delivering on this mandate and helping to make the banking sector more stable and better managed in the interest of European citizens. The ECB is truly one house with separate wings.

While we are centred at the ECB, we are also working very closely with the national supervisory authorities and are benefiting from their experience and resources in supervising the largest banks. All these strengths have been combined to create a unique form of cooperation, which could inspire other current and future European bodies.

Toward harmonised rules

As I mentioned, having a sound banking system which operates efficiently during all phases of the economic cycle is a precondition for sustainable recovery and economic growth, which in turn is key for the revitalisation of the European project.

That is why – after a long period of deregulation – governments around the world decided to strengthen regulation and supervision. The ultimate objective of these reforms has been the same since the 1930s: regulators and supervisors have to ensure that the banking sector is resilient and provides the economy and society at large with its key services, even under severe stress.

The design of the ambitious regulatory agenda resulting from the last crisis is slowly becoming more stable, and the focus is increasingly turning to the interplay of the many new standards, implementation and supervisory practices.

Right now we are very busy establishing common methodologies, a joint culture and a shared reputation, which will ensure that we have the right instruments and incentives to effectively carry out our supervisory tasks. This foundation has already been successfully tested, as the comprehensive assessment shows.

Nevertheless, the comprehensive assessment also shed light on parts of the European prudential regulation (the Capital Requirements Directive and Regulation), where some discretion remains for supervisors or national governments to decide on its concrete implementation.

We have counted over 150 such provisions, ranging from the progressive phase-in of new standards and definitions to more permanent exemptions from the general rule. Regulators usually refer to these as “options” and “national discretions”.

It is important to distinguish them from uniform provisions introduced to accommodate specific features of the European economy, including, for instance, the preferential treatment of exposures to small and medium-sized enterprises. Contrary to this type of support measure, where all banks in Europe are treated equally, options and national discretions create significant discrepancies in the way the Single Rule Book is implemented nationally.

These options and national discretions are often the result of long negotiations in the Council and Parliament concerning how to take account of different market structures and legal environments. But many of them have significant material effects on the level of prudence of the framework and on the comparability of capital ratios which make it hard for investors to price capital and funding for the banks. They also add an additional layer of complexity as well as a source of regulatory arbitrage. They create competitive disadvantages for banks in euro area countries that have chosen the most virtuous standard and can thus pose a risk to the financial sector. Last but not least, they make our job as supervisors much more difficult, as we need to take this uneven playing field into account in daily supervision.

Identifying best practices and then harmonising supervision accordingly will help foster fair competition and promote efficiency in the banking sector, as banks will compete based on their inherent capacities, rather than on unjustified differences in the regulatory framework. This should benefit all customers, individuals, small companies and corporates in their efforts to finance their activities throughout the economic cycle.

We aim to create a true level playing field and improve the comparability of capital ratios, so we will do our best to apply options and national discretions wisely. In the medium to long run, this will permanently increase the resilience and service capacity of banks.

Of course, harmonisation cannot be a goal in its own right. Exactly the same is true for national exceptions: if they contribute to a more stable banking system, we will be eager to preserve or even promote them. But if they are only the reflection of unquestioned traditions, pure national interest and regulatory capture, they should be removed. We expect the positive outcomes in terms of the prudence, consistency and stability of the framework to far outweigh the adjustment costs that each national banking system will face when converging to the high standards.

Financial integration

As you can see, by setting higher standards, the work on options and national discretions is an unprecedented step towards financial integration. But we cannot fight this battle alone: the SSM only has direct power over two thirds of existing options and national discretions, while the remainder falls under the authority of national legislatures. Nevertheless, we support the work of the European Commission, the European Council and Parliament and the European Banking Authority in their endeavour to strengthen the Single Rule Book.

Discrepancies also arise from the transposition of the rules laid down in the EU directives into national law. Again, we do not have direct authority and can only encourage national legislators to reflect in good faith the objectives of the directives, mindful of the fact that each national exception that is not fully transparent obstructs the work of supervisors and curbs investor confidence. This ultimately hampers the smooth allocation and flow of capital and liquidity within the euro area, which we all agree are key to ensuring stable financial markets.

But let me also note a more general and, from our perspective, most welcome trend, which is one of improving the simplicity and comparability of the existing framework. I mentioned earlier that in the near future the regulatory agenda will focus more on interplay and implementation issues. This will include all reforms that have occurred in the past five years since the adoption of Basel 3. Simplifying the current framework will help harmonisation but will also make rules easier to understand and to follow. Instruments such as the leverage ratio and non-risk based measures designed to balance the uncertainty of banks’ internal models are part of this trend. We also actively contribute to the work of European and international supervisory forums, such as the Basel Committee’s work on balancing risk sensitivity, simplicity and comparability, or the benchmarking exercises carried out at European Banking Authority level.

All these initiatives feed into our efforts to harmonise standards, also in close coordination with the other EU countries as well as countries outside Europe. This cooperation is important, as a level playing field within the euro area alone will indeed not be sufficient if we want to ensure conditions for stable financial markets and a stable Europe. We need to work with other key players in Europe and beyond.

Concluding remarks

In conclusion, let me emphasize that, especially in the context of this severe financial crisis, European citizens have the right to demand that European and national institutions do everything in their power to restore economic conditions that foster sustainable growth and economic development. For ECB supervision, this means implementing harmonised supervisory practices to the highest standards in the euro area. Only when banks are prudently and responsibly managed with the right incentives can the financial sector provide citizens, small and medium-sized companies and corporations with credit and financial services at all phases of the economic cycle. This in turn will help weather economic downturns, spur economic growth and generate the high-quality jobs that we all are interested in seeing again in Europe. For this reason, I consider our firm determination to deliver on the clear mandate provided by the EU legislators to promote financial integration and financial stability to be our most significant contribution to the European project.