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Safety and progress: an SSM perspective

Speech by Danièle Nouy, Chair of the Supervisory Board of the Single Supervisory Mechanism,
at the FMA supervisory conference entitled “Safety and progress in financial markets – a contradiction?”,
Vienna, 15 September 2015

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Summary

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.

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I am very grateful to the Austrian Financial Market Authority (FMA) for the invitation to speak at this annual supervisory conference, and I am especially pleased to share some thoughts on the main theme of “safety and progress”. I must say the title of my speech – “Safety and progress: an SSM perspective” – sounds quite ambitious, but it should be interpreted as an inclusive and hopeful mission statement.

While we all understand very well why the conference asks the question of a contradiction between safety and progress in finance, this exact association of concepts is actually used harmoniously in other technical areas. In economic terms, safety is often defined as low risk-taking and is associated with low economic output, while progress is a positive function of risk-taking, which generates economic growth. Both notions therefore seem to clash and regulators are often asked to strike the right balance between those opposite injunctions. Yet, as I mentioned earlier, in other areas, safety and progress go intuitively hand in hand: first, in the medical domain where safety is a paramount pre-requisite of progress. In computer sciences as well, where “safety and progress properties” are essential features of software design, checking for bugs and possible improvements in the code of programmes. These ideas of “stabilising one’s state in order to allow for prompt recovery” and “checking for bugs and implementing improvements in a given system” can easily be transposed into the economic environment, where they actually match quite well our mission as prudential supervisors.

Indeed, at the time that the creation of the Single Supervisory Mechanism (SSM) was suggested, in June 2012, the euro area had just experienced its second banking crisis. As you well know, the main goal of the SSM was to break the sovereign debt/bank nexus at the origins of that crisis. As the first of the three pillars of the Banking Union, the SSM was tasked with the direct supervision of the most significant euro area banks to ensure their safety and soundness, to limit the impact of bank failures on public finances and, ultimately, taxpayers, and to foster financial integration. This dual mandate ensures that the SSM will make a key contribution to a sustainable recovery in the euro area, by providing a safe environment, which in turn will encourage sound risk-taking and the diffusion of progress across the area.

With your permission I will therefore explore why and how the SSM embodies safety and progress thanks to one coherent and truly European mandate, using the concrete example of our ongoing work on options and national discretions (ONDs).

To this end, I will first highlight the innovative aspects of the SSM as an organisation. I will then focus on the substance of the project itself and its outcome, showing 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.

First and foremost, the SSM is itself a major innovation, both in institutional and political terms, with a clear mission to ensure the safety and soundness of banks, and to contribute to the financial integration of the euro area.

The legal and institutional innovation surrounding the direct supervision of the most significant banks of the euro area is impressive.

Before the SSM Regulation itself, the Capital Requirements Regulation (CRR) was the first major legal innovation regarding the supervision of the whole European banking sector. Building on the momentum created by high public expectations following the global financial crisis, the CRR was adopted in record time at a moment when fragmentation and national ring fencing burst in the context of the public debt crisis in the euro area. The more than 1,000 pages of text transposes the internationally agreed Basel III reform measures and makes them directly applicable to the thousands of banks established in Europe. On top of the CRR provisions, additional regulatory and implementing acts, the so-called level 2 acts also reinforce what has come to be known as the “single rulebook” since 2013. This single rulebook is the cornerstone of modern prudential regulation in Europe.

The SSM Regulation is the second major legal innovation in the area of financial regulation in Europe since the crisis. European leaders gave, in that regard, direct competence to the ECB for supervising significant banks and for overseeing the functioning of the overall system, including the supervision of the less significant banks in the euro area. This creates an integrated system composed of the ECB and national supervisors, such as the FMA, which are most often designated by the acronym “NCA”, or national competent authority, which assist the ECB in performing supervision of the significant institutions. This fully integrated system is the SSM, so all NCAs are fully involved in the supervision of all significant institutions of the participating countries. By functioning in an integrated manner with the NCAs, the SSM not only makes it possible to better act on the national biases and cross-border interlinkages, it also fosters convergence towards the best supervisory practices and standards.

The European Central Bank (ECB) was the natural home for the SSM in order to meet all of the challenges involved in establishing it. As a long-established and credible supranational authority accountable to the European Parliament, the ECB is in a good position to distance itself from any national concerns, constraints and pressures. In operational terms, no other institution could have absorbed these new functions and integrated so many new staff as efficiently.

As regards the exercise of supervisory tasks under the same roof as monetary policy, we all agree that full separation should apply in order to avoid conflicts of interest and to ensure that each function is executed in accordance with its objectives. The legal framework designed by European legislators in October 2013 is very clear and I have experienced it for close to a year now, and have seen that it guarantees the separation and independence of the functions within the ECB and also shields the SSM from undue external influence.

Since the establishment of the SSM we have been making the best of this new structure by launching projects of an unprecedented dimension such as the comprehensive assessment. In conducting a 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.

Going forward, one of the most important assets of European banking supervision is indeed its capacity to compare banks’ situations across countries and across many different business models. We can do this by benchmarking, through peer reviews and with the support of our strong horizontal functions. In a nutshell, we combine a bank-specific approach with a cross-sector view and have a better knowledge of how banks are linked to the rest of the financial system, also drawing upon the excellent analysis prepared in other units of the ECB while respecting the separation principle.

The impressive improvements in the institutional framework and the in-depth analysis they have allowed have nevertheless helped to reveal further hurdles to the proper conduct of our operations as an integrated banking supervisor.

Both the outcome of the comprehensive assessment and the swift take-up of our supervisory responsibilities have led the Supervisory Board members to look closer at discrepancies in the way the European regulatory framework has been implemented across the euro area.

Indeed, CRD IV and the CRR provide Member States or competent authorities or both with the possibility to choose whether and how to apply different prudential treatments to banks. These provisions are called options and national discretions, or ONDs. Importantly, neither the Directive nor the Regulation discusses the rationale of such provisions or requires Member States to converge; discretion is full and unconstrained within the boundaries specified by the legislation. The strong presence of ONDs in the legal framework clearly undermines the level of prudence, comparability and the level playing field that all of the initiatives and innovations that I mentioned earlier strive to achieve.

This is why the Supervisory Board has agreed that the harmonisation of ONDs is “an issue for the SSM to address as a matter of priority”.

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.

The ECB, as the competent authority for significant institutions within the SSM, has launched a project involving all of the national competent authorities of the SSM, in close coordination with the EBA and the Commission, to identify, assess and, where possible, address the fragmentation and level playing field issues arising from a heterogeneous implementation of EU law.

The ultimate objective of the project is to determine how to exercise the ONDs within the prudential framework in the best interests of the banking union and in a fully harmonised way.

We have counted more than 150 such provisions, ranging from the progressive phasing-in of new supervisory treatment and definitions to more permanent exemptions from general rules.

Taken collectively, these ONDs have material effects on the level of prudence of the framework and on the comparability of capital ratios, which make it harder for markets and the public to gauge banks’ capital strength. Moreover, the SSM cannot supervise banks efficiently, on a level playing field and from a truly single perspective, if significant divergences effectively remain in the way EU laws are applied nationally.

Of course, harmonisation cannot be a goal in its own right. Exactly the same is true for national specificities: if national specificities contribute to a more stable banking system, the SSM will be eager to preserve or even promote them. This is why the design of the common prudential policy has been based on the guiding principles of:

  • prudence;
  • harmonisation; and
  • consistency with European and international standards set at the EBA and Basel Committee levels.

One final principle is a rather legal one, as the policy design obviously needs to take into account legitimate expectations set by previous decisions by national authorities on the affected banks. One response to this issue of legitimate expectations has been to allow, where necessary, a period of transition to the new prudential regime.

What has been the outcome of our efforts?

Overall, careful analysis of the current national implementation and practices has shown that convergence should not be too difficult to achieve for the majority of the ONDs. Indeed, national treatments are sometimes only the result of unquestioned traditions, or implementation is already quite harmonised thanks to EBA standards, but further specification is needed in order to ensure full harmonisation. Also, many of these ONDs taken individually are immaterial, so the cost of converging is much lower than the benefit in terms of overall consistency and simplification of the prudential framework.

Yet there are a number of ONDs which are of notable importance and have actually required further discussion based on a targeted impact study that was performed in June. Material and controversial ONDs include, for instance, the treatment of insurance holdings within conglomerates for the purpose of calculating the CRR capital ratios (Article 49(1) of the CRR), as well as the longer phasing-in of the deduction of deferred tax assets (‘DTAs’) relying on future profitability that existed prior to 2014 (Article 478(3) of the CRR).

Still, approximately eight months after the start of the project, the Supervisory Board 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. The draft regulation will obviously be subject to a public consultation, to be launched at the beginning of November.

But the work on ONDs will not stop with the adoption of the SSM policy package. The SSM only has direct power over two-thirds of the existing options and national discretions, while the remainder fall under the authority of national legislatures. To deliver consistent supervision and a level playing field, we need fully harmonised regulation at the level of regulations and national laws. Hence, the support of the legislator is also key in this process.

Conclusion:

As a supervisor, our most valuable contribution to economic growth is to do our 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. The SSM has the responsibility and privilege to go a step further. By harmonising supervisory practices, we contribute to a level playing field and improve the comparability of capital and liquidity ratios. This work is an unprecedented step towards financial integration through setting higher standards.

Although I cannot promise that the SSM will completely eliminate the chance of another financial crisis, I do believe that single European supervision helps to ensure that banks are safer and sounder. To come back to the title of this conference, we want safety and progress to serve sustainable growth. We help 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 is our contribution to the well-being of the people of Europe.

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