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Exchange of views on supervisory issues with the Finance and Treasury Committee of the Senate of the Republic of Italy

Speech by Ignazio Angeloni, Member of the Supervisory Board of the ECB,
Rome, 23 June 2015

Mr Chairman, Honourable Members of Parliament,

It is an honour for me to be here today and report to this Committee. The Single Supervisory Mechanism assumed its functions in November of last year, after a preparatory phase that lasted just over two years. The preparation included a “comprehensive assessment” of the banks likely to be supervised directly by the ECB. In my remarks, I will briefly describe the set-up of the new supervisory authority and the results of the assessment. I will then give you an overview of our priorities for the immediate future, and finally share some ideas on the broader financial regulatory agenda. I will then be pleased to answer your questions.

While these remarks are offered on a personal basis, they represent views widely shared by my fellow members of the Supervisory Board.

Set-up of the SSM

The Regulation establishing the Single Supervisory Mechanism, or SSM [1], stipulates, in Article 1, that its goal is to contribute to the “safety and soundness of credit institutions and the stability of the financial system within the Union and each Member State”. This requires the ECB to apply consistent high-quality supervisory standards to banks operating in all participating Member States (in 19 countries, the same as those using the euro). Financial stability, according to the definition adopted by the ECB, is a condition whereby savings are appropriately channelled to finance productive investment; the ultimate goal, therefore, is a well-functioning real economy. A more specific aim of the SSM, mentioned in the Regulation, is to help loosen the tie between national public finances and national banking systems, a nexus that was the cause of repeated episodes of financial instability in Europe in recent years.

Establishing the SSM in such a short time was an unprecedented task, carried out thanks to the support provided by the ECB. Three lines of work were pursued. The first was the establishment of the governance and the methodology of the new supervisor. This consisted of the creation of the Supervisory Board, the fulcrum of the SSM decision- making process, composed of a representative of each national competent authority, plus four ECB representatives – of which I am one – and the Chair and the Vice-Chair. It also consisted of establishing its internal arrangements (Rules of Procedure and Framework Regulation), and in preparing the “supervisory model” employed for conducting day-to-day supervision. The latter brings together the best practices of the constituent national authorities and is enshrined in a Supervisory Manual, which is being used this year for the first time to conduct the 2015 annual supervisory cycle.

The second stream of work comprised the setting-up of the supervisory structures – the staff and its organisation. More than 1,000 new ECB staff members were recruited, a mix of nationalities, ages and gender, and from different professional backgrounds. Around 800 are supervisors, the rest being other staff providing support services (statisticians, lawyers, IT experts). The ECB’s supervisory staff is organised in four directorates general, plus a Secretariat assisting the Supervisory Board. Two of them directly supervise the 123 “significant” banking groups; the third is responsible for coordinating the national authorities in directly supervising the remaining “less significant” institutions, and the last one provides technical expertise to the other operational areas, guaranteeing the singleness of the supervisory approach and its horizontal consistency.

Finally, the third work stream was the comprehensive assessment – to which I shall return shortly.

The decision-making mechanism of the SSM meets the requirements of the EU Treaty, which stipulates that the Governing Council is the ECB’s sole final decision-maker. In practice, complete draft supervisory decisions are first prepared and approved by the Supervisory Board, and then submitted to the Governing Council for final approval. For this purpose a non-objection procedure is followed: draft decisions approved by the Supervisory Board are deemed adopted unless the Governing Council opposes them, normally within a two-week period. This period can be shortened in case of emergencies.

The ECB enjoys a high degree of independence in the exercise of its supervisory functions. In addition, the SSM Regulation establishes a “separation principle” ensuring that supervisory decisions do not interfere with the conduct of monetary policy, and vice versa. Independence is counterbalanced by democratic accountability, exercised primarily vis-à-vis the European Parliament and the Council. However, as today’s meeting demonstrates, we also have reporting obligations to national parliaments, whose members can submit written questions and invite members of the Supervisory Board to participate in an exchange of views regarding the supervision of credit institutions.

Cooperation between the ECB and the “national competent authorities” or NCAs, as they are called in technical legal language, takes place at three levels. The first level is that of the Supervisory Board, as I have mentioned. Moreover, for each significant banking group, a “joint supervisory team” (JST) has been created, responsible for dealing with the regular activities of the respective institution (risk analyses, validation of risk models, definition of “Pillar 2” prudential requirements, and so on). Each JST has a coordinator, chosen from the ECB staff and normally a national of a country different from that where the bank is incorporated. For example, the JST in charge of UniCredit is headed by a French supervisor, whereas the JST for BNP Paribas is headed by an Italian supervisor. Other JST members are both from the ECB and from NCAs, to a large extent from the national authority of the country of incorporation of the bank. Around 75% of the JST members are NCA staff members. This organisational set-up satisfies the need for a centralised perspective and the absence of national bias and allows the experience and know-how of the national supervisors to be leveraged. The supervision of “less significant institutions” remains mostly with the NCAs, although the ECB exercises oversight and contributes to the harmonisation of the supervisory practices for all banks, again through a single supervisory methodology.

Comprehensive assessment

The comprehensive assessment (CA) was conducted in close association with the European Banking Authority (EBA) on 130 banking groups, covering together about 85% of the euro area banking sector. It comprised two components, an asset quality review (AQR) and a stress test. These were then brought together to produce a measure of the capital required to satisfy certain prudential criteria. The AQR provided for a risk-based analysis of the main components of the banks’ assets. The stress test calculated the sensitivity of the banks’ balance sheets to two macroeconomic scenarios, a consensus one and an adverse one.

While the main focus of the AQR was on credit exposures, financial market positions were also covered in a dedicated work stream and credit valuation adjustment (CVA) calculations on derivatives were reviewed specifically. Moreover, the stress test included a detailed review of both credit and market risk exposures, in which banks were required to carry out a full revaluation of their trading books.

It is important to realise that the CA was conducted on the basis of the existing banking legislation, which was (and still is) only partially harmonised. I will return in a moment to what the ECB is doing to promote regulatory harmonisation. Nevertheless, the ECB made every effort to make the exercise as transparent and comparable as possible across banks and countries. In particular, the AQR resulted in an improved and harmonised definition of non-performing credit exposures (NPE). The overall impact of the comprehensive assessment (AQR and stress test under the adverse scenario) on the banks’ aggregate capital was equal to €262.7 billion, of which €49 billion was in France, €46 billion in Germany and €47 billion in Italy. The AQR itself resulted in an upward adjustment in the estimated amount of NPE in the SSM area of €136 billion, or 18%.

Capital adequacy was measured for each bank against a threshold of 8% CET1 as a ratio to risk-weighted assets, or 5.5% for the adverse stress test. The capital shortfalls relative to these benchmarks depended not only on the impact of the exercise, but also on how close the initial capital of each bank was to these thresholds. Overall, a shortfall of €24.6 billion across 25 banks was found, of which €9.7 billion was in nine Italian banks. Several banks had already covered the shortfalls in 2014, before the outcome of the exercise was disclosed. In the end 13 banks were asked to additionally replenish their capital for a total amount of €9.5 billion (of which €3.3 billion applied to four Italian banks).

Shortfall banks were required to cover their shortfalls within six or nine months (the latter if the shortfall derived from the adverse stress test). As of now, most banks have completed their recapitalisation; the others should fulfil their capital plan before the established deadline.

International best practices suggest that stress tests are an important part of the supervisor’s toolkit. The ECB intends to continue to use stress tests, both in association with the regular exercises coordinated by the EBA, and for its own internal purposes. The assessment conducted last year constitutes, also from this point of view, a valuable experience.

The 2014 assessment focused only on two specific – albeit important – factors of bank riskiness: asset quality and the sensitivity to shocks. Other factors relevant to determining the soundness and riskiness of the banks, such as profitability, sustainability of the business model, quality of governance, effectiveness of internal controls, were not directly covered. In 2014, these elements were subsumed in the supervisory review conducted by the national authorities. This year, those aspects feature prominently in the regular supervisory review conducted by the ECB.

SSM priorities for 2015

The core of the ECB’s regular supervisory activity is the so-called Supervisory Review and Evaluation Process (SREP), conducted on an annual basis. In the SREP, the ECB assesses all relevant risk factors and relates them to the prudential requirements (capital, liquidity, exposure limits, etc.) that are deemed necessary for each bank to be “safe and sound”. The JSTs carry out the SREP for the respective significant institutions, relying on a common methodology that combines a variety of quantitative and qualitative information. Macroprudential elements – that is, the potential systemic risks generated by the interaction between the banks and the broader economy – are also included.

The 2015 SREP is now progressing swiftly and will be finalised around the end of the year.

Options and national discretions

Another major activity under way this year is directed towards elaborating an ECB policy for the exercise of options and national discretions in European banking legislation.

The EU Capital Requirements Directive [2] and Capital Requirements Regulation [3] grant Member States broad discretion in applying a wide range of norms. Such flexibility was given by the legislator partly to facilitate the transition to a new regulatory regime, partly to accommodate different supervisory approaches, at a time when the creation of a single European supervisor was not foreseen. The discretions now leave room, in the SSM area, for significant cross-border differences in a variety of regulatory provisions, many of which, for example those regarding the calculation of capital and liquidity buffers, or the treatment of large exposures, are of key importance from a prudential viewpoint.

In order to establish a more level playing field among its supervised banks, the ECB has launched a project involving all the national competent authorities in the SSM, in close coordination with the European Banking Authority, to identify, assess and where possible address these regulatory asymmetries. Overall, we have identified over 150 options and national discretions, most of which are exercised by the supervisors (the others are exercised by Member States through national legislation). The project aims to establish a consistent framework to handle these options and discretions, which are now the competence of the ECB. The ultimate aim is to foster convergence towards the highest prudential standard consistent with international rules, while providing also legal certainty and stability to banks, investors and supervisors.

As I just mentioned, a smaller number of options and discretions are enshrined in national legislation, over which the SSM has no power. I am convinced that the broader objectives of supervisory effectiveness and consistency are shared by national parliaments as well. I hope that you and your colleagues in other countries will follow closely the work of the ECB in this area, and that you may consider, at a later stage, the possibility of adaptation to national laws to foster those objectives further.

Monitoring quality of capital and liquidity: non-performing exposures

Even though European banks generally increased the quantity and quality of capital in 2014, many SSM banks are still burdened by high non-performing exposures (NPEs). The ratio between NPEs and total credit exposures for SSM significant banks, according to the new harmonised definition used in the CA, is equal to about 8% in the SSM area a whole; in Italy the level is 17%. The share of NPEs which banks already have provisioned for (the coverage ratio) is equal to 50% in the SSM as a whole, and to 48% in Italy.

High levels of NPEs absorb banks’ precious resources that should be dedicated to support lending to the real economy. Institutions should carefully assess the development of their non-performing assets and undertake actions to reduce them. Some countries have successfully adopted schemes to separate and subsequently liquidate their NPEs. Measures to facilitate a rapid reabsorption of NPEs are under study in Italy as well.

In its realm of competence, the ECB is using its supervisory powers to improve the credit screening and monitoring processes of its supervised banks, so that the volume of NPEs can be gradually reabsorbed.

Review of internal models

According to principles established by the Basel Committee on Banking Supervision, translated into European legislation, banks with given characteristics can use internal risk models to quantify their capital requirements. This practice, introduced by the Basel II Capital Accord, is retained in Basel III. In the SSM area, there exists at present a wide variety of different internal models. Analyses have shown that the heterogeneity of models leads to significant differences in the amounts of capital held by banks, not justified by the underlying risks.

Against this background, the ECB is now launching a multi-year targeted review of internal risk models used by its directly supervised institutions, which will be followed by an effort to harmonise those features which display differences not clearly justified by prudential considerations. Here as well, the broader goal is to promote a level playing field and a sounder prudential treatment.

Financial reform agenda

Let me now briefly discuss some key issues on the international financial reform agenda. I will limit myself to those of more direct relevance for supervision: bank recovery and resolution, including loss-absorbing capacity, structural separation of banking activities, the prudential treatment of sovereign exposures and macroprudential policy.

Recovery and resolution framework

Recent experience has shown that banks deemed too big, too complex or too important to fail exacerbate the risks and the costs of crises. In the lack of a credible resolution strategy for ailing credit institutions, governments often felt obliged to bail out banks using public money.

This notion is behind the creation in Europe of the Single Resolution Mechanism, the second pillar of the banking union. Its aim is to ensure that banks can be resolved in an orderly fashion and that costs for taxpayers and the real economy are minimised. The Bank Recovery and Resolution Directive (BRRD) [4] provides a toolkit to deal with failing banks, including loss-sharing procedures. The BRRD provides for shareholders and creditors to bear the risks first and foremost, with some well-identified exceptions (depositors covered by insurance, and to a large extent other deposit holders as well).

I would like to emphasise the importance of transposing the BRRD into national legislation as quickly as possible. Implementation of BRRD is essential to ensure effective crisis management. This is even more important considering the imminent start of the Single Resolution Mechanism. This authority, located in Brussels, is currently preparing to start operations and is already in contact with banks for the preparation of their resolution plans. Transposing BRRD into national law is also in the interest of Member States because it allows them to access the common public backstop provided by the Single Resolution Fund. A credible and robust backstop is essential to safeguard financial stability in the banking union.

An effective resolution strategy requires banks to have sufficient resources to absorb losses when they are restructured or resolved, so that their failure does not put other banks at risk or involve an excessive use of collective resources. The BRRD and the Regulation establishing the SRM [5] specify that the resolution authorities will, in consultation with the supervisors, determine for each bank a minimum level of own funds for this purpose.

At global level, the Financial Stability Board (FSB) is finalising a proposal for a minimum standard for “total loss-absorbing capacity” in the resolution of global systemically important banks (G-SIBs). These banks will have to hold enough capital and eligible liabilities to be effectively and credibly written down or converted into equity during resolution, enabling the institution to continue providing critical functions and to return to long-term viability after resolution. The ECB broadly supports these plans, in particular the inclusion of this requirement in Pillar 1 and the relevance assigned to non-risk-weighted assets (alongside risk-weighted ones) in its calculation. The exact design and calibration is subject to an ongoing impact assessment, conducted by the FSB and the Basel Committee on Banking Supervision with contributions from the ECB.

Bank structural reform

The ECB welcomes the Commission’s legislative proposal on structural separation of banking activities, which prohibits proprietary trading and separates certain trading activities from the deposit-taking entity. The supervisor should require separation of trading activities if there is a threat to the financial stability of the core credit institution or to the financial system as a whole. While the separation can be beneficial from a stability perspective, the ECB considers it important to preserve banks’ market-making activities, as they have a vital role in maintaining market liquidity, moderating volatility and increasing market resilience. The supervisory decisions on separation should be supported by quantitative criteria, but should not be triggered automatically by quantitative thresholds; an element of judgement must remain.

The prudential treatment of sovereigns

One lesson of the recent financial crisis is that sovereign exposures, like other types of exposures, are risky. Such risks have not so far received adequate prudential treatment in bank regulation.

In view of the global nature of the issue, the Basel Committee on Bank Supervision has started a review of the regulatory treatment of sovereign exposures of banks. A range of options are being considered, such as applying risk weights or risk concentration limits. The ECB supports this approach and its underlying reasons. Preliminary discussions are taking place also in the European fora. It is important that any revisions to the existing framework take into account the potential impact on banks, financial stability and monetary policy operations. Sufficient time should be given to the analysis, and implementation should be gradual.

Macroprudential supervision

Before I conclude, let me consider briefly the macroeconomic perspective. As now broadly recognised, individually sound financial institutions do not guarantee the stability of the financial system as a whole. Micro-prudential supervision needs to be complemented by macroprudential policies to limit excessive credit growth and to leverage and smooth out the financial cycle.

In the new EU framework supervisors can impose, in addition to microprudential requirements, macroprudential margins as part of the Pillar 2 process. The Capital Requirements Directive and Regulation detail which instruments can be used, and the way in which the national authorities – which maintain a competence in this area – should interact with the ECB, to which the SSM Regulation has attributed new powers in the same area.

In this context, the issue has been raised as to whether capital requirements enforced in the context of the new supervisory framework may adversely affect the supply of credit to the real economy, especially in some countries where the economic recovery is still feeble. This argument, plausible in principle, should however be reversed. Weakly capitalised banks tend to curtail their loan supply more than others – weak bank capitalisation was a contributing factor to financial fragility before the crisis. Hence, strengthening capitalisation should be one of the objectives of the ECB as a supervisor. But this should be done in a measured way, taking into account possible systemic considerations and the risk profile of each bank. The ECB is aware of the need to avoid adverse effects on lending to the real economy, and has adequate information (including a detailed Bank Lending Survey) and analytical tools to monitor and control the process. The ongoing economic recovery and the restarting of bank lending offer favourable conditions for extending this process.

Conclusion

Much has been achieved in building the banking union, but many challenges still lie ahead. The ECB is rapidly building its capability; it already provides high-quality supervision and fosters supervisory harmonisation. It does so by leveraging two strengths: the quality of its human resources and the cooperation with national authorities.

An open dialogue is necessary between the ECB, which has recently been entrusted with new powers in the interests of the people of Europe, and national public opinion, and its representative bodies. Transparency is a precondition for effective action. This is another reason why I am pleased to be here with you today.

I thank you for your attention and look forward to your questions.



[1]Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions.

[2]Directive 2013/36/EU of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (CRD IV)

[3]Regulation (EU) No 575/2013 of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 Text with EEA relevance (CRR)

[4]Directive 2014/59/EU of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012 (BRRD)

[5]Regulation (EU) No 806/2014 of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010 (SRMR)

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