Tommaso Padoa-Schioppa Memorial Lecture

Speech by Danièle Nouy, Chair of the Supervisory Board of the Single Supervisory Mechanism

Introduction

I am very happy to give this lecture in honour of Tommaso Padoa-Schioppa. As you may be aware, I knew Tommaso Padoa-Schioppa well. Our career paths crossed on a number of occasions, so I was able to observe first-hand his personal qualities and it was always extremely instructive to work with him, as well as being a great pleasure.

When Tommaso Padoa-Schioppa was the Chairman of the Basel Committee on Banking Supervision, for example, I was in it as well, first as a French representative, then as Deputy Secretary General, and later I became the Secretary General of the Committee.

Through the Basel Committee, Tommaso Padoa-Schioppa ensured that concrete steps were taken to further improve the supervision of large international banks. In particular, he laid the foundations of the market risk framework, accepting internal models for assessing trading book risks because it was the only credible solution. We had very inspiring, high-level discussions under his leadership about the trade-off between a level playing field resulting from more easily comparable, simple frameworks, and the efficiency and safety provided by an adequate level of sophistication. So 20 years ago, Tommaso started a debate that is still on-going in the Basel Committee’s Task Force on Simplicity and Comparability.

Obviously, this framework received new impetus when the financial crisis hit the major banks in 2007.

Tommaso Padoa-Schioppa was as an insightful man. He had a very deep understanding of financial affairs, combined with a real vision for Europe, which came to the fore when he was the rapporteur of the 1988 Delors Report on Economic and Monetary Union. Together with other “wise men”, such as Jacques de Larosière and the late Alexandre Lamfalussy, Tommaso designed the institutional and regulatory landscape in Europe.

These men laid the foundations on which not only European Monetary Union, but also the new banking union have been and are being built. This is important to highlight as the banking union is often described as the European answer to the financial crisis. I would say that the crisis served as a catalyst for further supervisory convergence, because wiseely, when Europe faces problems, it recognises that we need more Europe. However, the foundations of the banking union had already been laid in the vision of Tommaso Padoa-Schioppa. In this sense, the banking union is evolution rather than revolution – it is a further step down the road of European regulatory convergence, a road that Tommaso and the other wise men envisaged long before the crisis emerged.

It is from the perspective of Tommaso Padoa-Schioppa that I will talk to you about one of the main pillars of the banking union today – the Single Supervisory Mechanism, or SSM.

• First I will describe how the European banking union is a further step down the road of convergence, as envisaged by Tommaso Padoa-Schioppa.
• I will then focus on the SSM and talk about our experiences with European prudential supervision so far.
• Last, I will describe what I see as the most relevant future developments.

In doing so, I will try to stand on the shoulders of Tommaso Padoa-Schioppa and show you how we have made his vision a reality.

The European banking union is a further step down the road of convergence

The “TPS perspective”

Current political discussions about the future of the European Union show how complex the creation of the EU has been. The constant tension between national interests and the need for convergence at a European level leads to fierce debates. From a financial sector viewpoint, such debates may seem to belong to the past. Looking at Monetary Union, the harmonisation of financial sector regulations and the recent launch of the SSM, it may seem obvious that further European integration is the way forward. However, from an outside perspective, the degree of convergence that has been achieved in terms of monetary issues and the regulation of financial markets is exceptional.

This is largely thanks to men like Tommaso Padoa-Schioppa, who recognised the political importance of financial integration. Tommaso was the founding father of Monetary Union; in his own words, the common currency was “a political project with an economic rationale” ^[1].

As early as 1982, he presented a crystal-clear argument in favour of a monetary union between the European countries that then made up the European Community. He pointed out that it would be impossible for such a group of countries to simultaneously aim to achieve free trade, capital mobility, independent domestic monetary policies and fixed exchange rates. He then argued that the objective of domestic monetary policies should be abandoned in order to achieve the other three objectives. This argument would ultimately be endorsed in the 1988 Delors Report on Economic and Monetary Reform, which paved the way for Monetary Union.

This union, however, was not accompanied by unified prudential supervision. This led to a unique state of affairs. Never, in any region of the world, had there been a situation where monetary practices were fully harmonised and centralised, but where, at the same time, banking supervision was decentralised and non-harmonised. Tommaso saw this as a major challenge for the euro area. His answer to the challenge was, and I quote: “cooperation among banking supervisors, largely voluntary, but without obstacles in the existing Directives or the Treaty, […], a sort of euro-area collective supervisor […] that can act as effectively as if there were a single supervisor.” ^[2]

From this argument for more convergence, he invented the concept of the “single rulebook” and ensured that it was implemented. With this single rulebook, banks have to deal with only one single regulatory framework throughout the whole of the European Union. More effective cooperation between national supervisors was accomplished thanks to the Lamfalussy reforms that permitted further development of the single rulebook. Lawmakers at both the European and the national level were to define the principles of the regulatory framework. It would be up to the national supervisors to fill in the more detailed and technical parts of the framework; and these national supervisors would be unified through European supervisory authorities – in the case of banking supervisors, the Committee of European Bank Supervisors, or CEBS, and then the European Banking Authority, or EBA.

A single rulebook and close supervisory cooperation meant that we were just one step away from creating a single supervisory mechanism. That is the legacy of Tommaso Padoa-Schioppa. A legacy that would prove itself most valuable in the wake of the financial crisis.

A European banking union with a Single Supervisory Mechanism

For it was during the financial crisis that we discovered how many more responsibilities would have to be transferred to European institutions. What we learned from 2007 is that an economic, financial or banking sector crisis is never simply a national crisis, especially within a monetary union. The second phase, the emergence of the sovereign debt crisis, was additional proof of this.

The 2007-08 crisis affected the euro area as a whole – the interconnectedness of markets and financial institutions has made national borders nearly irrelevant. Therefore, it is only realistic to say that the financial crisis was a catalyst for the creation of a European banking union, in order to safeguard financial stability in the euro area. This is how the Single Supervisory Mechanism became a reality.

However, as I mentioned earlier, rather than a revolutionary decision this was an evolution, albeit “evolution at the speed of light”. The single rulebook and the existing mechanisms for cooperation between national supervisors through the EBA facilitated the creation of a single supervisor within the euro area – it seems only logical that a European-level supervisor would be responsible for supervision, on the basis of a European-level framework.

That is why I would say that the banking union is much more than a lesson of the financial crisis: it is a further logical and, in my view, inevitable step along the road towards more European convergence. The financial crisis may have accelerated the process – I believe that without it, the euro area supervisors might still be thinking in terms of cooperation rather than convergence. However, eventually the euro area would have opted for a single supervisory, resolution and deposit guarantee mechanism to complement the single rulebook and the single monetary authority.

There is a simple reason for this: national fragmentation within a currency union is not sustainable. National policies alone do not, for the most part, take into account the potential negative externalities generated vis-a-vis other supervisory actions. In the same vein, in the case of cross-border bank failures the supervisors of the countries that will be less affected may be reluctant to participate in the resolution plan. For the euro area, complementing Monetary Union with a banking union would thus have been inevitable.

That is why I see setting up the banking union, and the SSM as part of it, as evolutionary rather than revolutionary. This does not mean it wasn’t spectacular – think only of the very limited time we have had to make the idea of a single mechanism operational, and the way in which the ECB was assigned supervisory responsibilities. In this sense, the revolution is in the details: for the first time, new supervisory powers were conferred to a European institution – the ECB – without having to amend the treaties. What is more, the supervisory mandate of the ECB includes both micro and macroprudential powers. This is another way in which the legacy of Tommaso Padoa-Schioppa lives on: as early as 1990, he stressed the importance of interaction between micro and macroprudential supervision, since both levels influence each other – think, for example, of the impact of setting a macroprudential capital buffer for individual banks.

I am convinced that this creates a framework for the most robust form of banking supervision this continent has ever seen. We contribute to the safety and soundness of the European banking system and ensure financial stability.

Practical experiences with the SSM

One of the most important and earliest practical tests for the SSM was its staffing. The recruitment process sparked huge interest across Europe, and permitted us to be selective, hiring only the very best and most experienced candidates. The majority of the almost 1,000 people hired during the recruitment campaigns are working at the core of the SSM in the joint supervisory teams, or JSTs, which are teams of supervisors dedicated to a specific bank, consisting of supervisors from both the relevant national competent authority (NCA) and the ECB. The concept of JSTs is the cornerstone of the SSM approach to banking supervision. The structure of the JSTs, as well as that of the horizontal services – with the relevant networks of experts at the NCAs – combines the specific in-depth knowledge of national supervisors with the broad-ranging experience of the ECB.

The comprehensive assessment of the banks that were likely to fall under direct ECB supervision was another demanding exercise. It established the basis of the SSM, by covering more than 85% of euro area banks’ balance sheets. We established robust processes early in order to ensure reliable results and a consistent implementation of the outcomes. The exercise brought together in cooperation the European Banking Authority, the European Commission, the European Systemic Risk Board and the European Securities and Markets Authority. In conducting a stress test together with a rigorous balance sheet examination, we have substantially enriched our knowledge of the banks we supervise and gained valuable insights into cross-border trends within the entire European banking system. We have also enhanced transparency regarding the condition of our banks. I am sure that, at the end of this whole process, after taking the appropriate measures to repair the impaired balance sheets where needed, stakeholders will be reassured that our banks are fundamentally sound and trustworthy.

For meeting all of the challenges in establishing the SSM, the ECB was a perfect fit and the natural home, an option which I am sure Tommaso Padoa-Schioppa would have fully supported. No other institution could have offered better support for the creation of the SSM. The ECB’s credibility and the experience that had been accumulated across all sections of the Bank were extremely strong assets for a new European supervisory authority as it began its work. I am also convinced that the integration of micro and macroprudential tasks in one institution – the ECB – paves the way for enhancing the safety and stability of the European banking system in the euro area.

The road ahead

After the introduction of the common currency, Tommaso Padoa-Schioppa used to stress in almost every interview he gave that the euro was here to stay. I will tell you the same thing about the SSM. I would even like to go further: we will have to take additional steps to ensure more convergence.

Although we now have a single rulebook, there are parts of European prudential regulation (the Capital Requirements Directive and the Capital Requirements Regulation) where some room for discretion remains for supervisors or national governments to decide on concrete implementation. We have counted over 150 such provisions, ranging from the progressive phasing-in of new supervisory treatment and definitions to more permanent exemptions from general rules. It is important to distinguish these options and national discretions from uniform provisions, introduced to accommodate specific features of the European economy, including for instance “the preferential treatment for 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 rulebook is implemented at the national level. We are aiming to create a true level playing field, and to improve the comparability of capital ratios, so we will do our best to apply options and national discretions wisely. This work is an unprecedented step toward financial integration through setting higher standards. 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 fall under the authority of national legislatures.

Discrepancies also arise from the national transposition of rules established by EU directives. Again, we do not have direct command and can only encourage national legislators to reflect in good faith the objectives of the directives, mindful of the fact that every national exception that is not fully transparent obstructs the work of supervisors and curbs investor confidence. Ultimately, the single rulebook should really live up to its name and we should strive for full harmonisation of the regulatory framework.

Furthermore, we still have a lot of work to do to develop a truly European “supervisory culture”. The joint supervisory teams are key. By design they are pan-European, in the sense that they consist of supervisors from numerous euro area countries. The dialogue within these JSTs about ongoing supervisory issues enables different supervisors, with different national backgrounds, to learn from each other’s perspectives. For this reason, we encourage exchanges of staff among NCAs and between NCAs and the ECB. We are also developing networks for horizontal functions, such as the fit-and-proper assessments for candidate members of the board of a bank. In these networks, the ECB and NCAs share information and experiences on all aspects of our tasks. We will thus ensure that the best parts of different national practices are merged into a single approach.

The third of our three main goals is prioritisation. Given the scale of our undertaking, this is of utmost importance. We have identified clear and strong supervisory objectives for the first year of operation of the SSM. Our priorities build on the outcome of the comprehensive assessment and a careful evaluation of the main risks facing the European banking sector, such as the effectiveness and robustness of banks’ credit risk management, the viability of business models and profitability drivers, as well as governance and the quality of management information.

The general goal of further European convergence is also key for the other pillars of the banking union. The establishment of the Single Resolution Mechanism (SRM) and the increasing coordination of the national deposit guarantee schemes will further reinforce the SSM. The new crisis management framework, as set out by the Bank Recovery and Resolution Directive and the SRM Regulation, directs the SSM and SRM to cooperate closely, providing each other with all information necessary for the performance of their tasks. With the SSM and the SRM Board established, and the European Deposit Guarantee Scheme in the making, the banking union is taking shape, fulfilling the promise of European leaders to better ensure financial stability.

Concluding remarks

Ladies and gentlemen,

Achieving single supervision in Europe is by no means an easy task – as much as I have been enjoying my first year at the SSM, I must admit that I would not like to establish a new pan-European supervisory body every year. However, I am fully convinced that the SSM – and the banking union of which it is part – are necessary and suitable institutions to ensure financial stability in the euro area.

In describing some of the challenges we have faced, as well as our plans for the future, I have tried to show how the banking union has its origins in the vision of great men like Tommaso Padoa-Schioppa. It is our responsibility not only to remember their legacy, but also to build on it. In Tommaso Padoa-Schioppa’s case, I think we clearly have.

I mentioned earlier how Tommaso Padoa-Schioppa turned the inconsistent quartet of free trade, capital mobility, independent domestic monetary policies and fixed exchange rates into a viable trio of free trade, capital mobility and monetary union. With the banking union established, we add the element of financial stability to this trio.

Although I cannot promise that the SSM will eliminate every chance of another financial crisis, I do believe that single European supervision helps to ensure that banks are safer and more stable. This is our contribution to the well-being of the people of Europe, and our way of living up to the vision of Tommaso Padoa-Schioppa.