Banking union and the United Kingdom in the Single Market
Speech by Ignazio Angeloni, Member of the Supervisory Board of the ECB,
Barclays Annual Bank Capital Conference, London, 9 March 2016
It is a pleasure to be here this morning and to address this conference. I am grateful to the organisers for inviting me. It is actually an honour to stand here, in the leading European financial centre, in front of an audience convened by one of the largest and oldest banks in the country; older, in fact, than the United Kingdom itself.
In choosing my subject for today, I initially thought I should draw on my recent experience to describe the making of the banking union, and especially of its supervisory arm in Frankfurt. These are recent endeavours in comparison: the first anniversary of the Single Supervisory Mechanism (SSM) has just passed. But then I concluded that most of you would already be familiar with this. What is perhaps less known is the contribution that the UK has made to this project, in spite of its decision to stay out. I will come back to this shortly.
However, in doing so I should not lose sight of what lies ahead. European Union, banking union, United Kingdom: diverse as they are, these terms share the notion of unity. They remind us of decisions by large groups of people with diverse aspirations and interests to pool institutions and arrangements, convinced that together they would better achieve their goals. But now, the next step by the UK may well not be one of union, but one of separation. The European Union leaders recently reached an agreement addressing, among other issues, the future relation between the euro area and the UK. Soon the British people will decide. I will not enter into this political debate, but rather focus on the present state and prospects in the relation between the UK and the banking union, which share a single market and common institutions to support it. My point here is that the two banking systems are so closely intertwined, as are their underlying economies, that the success of one cannot easily be delinked from that of the other. The well-functioning of the European banking system as a whole requires constant and close cooperation among the prudential authorities. While such cooperation will be needed in any case, the EU provides a sound and tested basis for it.
Building an open and accountable SSM
Let me start by briefly recalling the initial phases of the banking union and how the UK and British nationals contributed to them in different ways.
In June 2012, the EU leaders asked the European Commission to produce, within a short deadline, a blueprint for an EU bank supervisory authority to be located within the European Central Bank. The summer that followed was an intense and exciting one for the Commission and for the ECB itself, which provided advice. Working at record speed, the Commission issued in September a detailed proposal for the charter of the new supervisor, built on global best practices but tailored to European needs. In retrospect that was a major success for both the Commissioner in charge and the staff involved, whose teams were led, I should mention here, by a Briton.
But that was only the beginning. The second step consisted in making the draft legislation accepted by all Member States. A specific task force was created within the Council. A main focus of the negotiation consisted in making sure that the Single Supervisory Mechanism, which would be hosted by the ECB and have its Governing Council as ultimate decision-maker, would adequately represent also the interests of non-euro countries, all potential members of the banking union. The solution eventually agreed upon is one that guarantees a high level of openness and balance among all participants. Supervisory decisions are fully prepared by a Supervisory Board, composed of heads of supervision of all countries in the banking union plus six representatives put forward by the ECB (including the Board’s Chair and Vice-Chair). The Governing Council adopts the supervisory decisions via a non-objection procedure. Possible divergences of views – which so far have not happened – are settled by recourse to a mediation panel, composed of members of the Governing Council and the Supervisory Board. The UK delegation, with contributions from both the Treasury and the Bank of England, played a considerable role in the agreement. In the end, the regulation was approved, with significant but not radical amendments, by the ECOFIN in December 2012.
The third and final step was the passage through the European Parliament. Lawmakers were naturally concerned, among other things, about the democratic accountability of the new authority. The result of the process was an inter-institutional agreement between the Parliament and the ECB, in which several forms of accountability are foreseen, including regular hearings before the European Parliament's Committee on Economic and Monetary Affairs (ECON), confidential exchanges of views on topical issues and the transmission of the records of proceedings of Supervisory Board meetings to Parliament. In my opinion these provisions constitute, in international comparison, one of the most – if not the most – advanced example of accountability for a banking supervisor. I personally remember some of the intense meetings in which those provisions were discussed and agreed with the ECON. This Committee was chaired at the time – you must have guessed by now! – by another British national.
Clearly, these contributions came in some cases from individuals whose nationality was a coincidence and who were acting within their institutional roles. But I can witness that those individuals brought to the negotiating tables some of the best and most characteristic British traits: openness to debate, respect for valid arguments, pragmatism, and a strong sense of democratic legitimacy.
Regular forms of microprudential and macroprudential cooperation
Let me now describe how supervisory cooperation between the SSM and the UK authorities works in practice. I will limit myself to European arrangements, leaving aside global groupings like the Financial Stability Board and the Basel Committee on Banking Supervision, which however also offer frequent occasions of encounter and exchange.
The financial crisis has taught, among other lessons, that banking supervisors should look beyond national boundaries. The development of the single rulebook and the creation of the European Supervisory Authorities (ESAs) and the European Systemic Risk Board (ESRB) was the European response to this challenge. The single rulebook, in particular, is the foundation of the European Single Market for banking services. Much has been done in the past years to develop it. This effort continues, as there are still elements of the regulatory agenda that need completion.
Among the ESAs, the European Banking Authority (EBA), seated in London, plays a special role on the micro-prudential side. The EBA fosters convergence of supervisory rules and practices, by issuing guidelines and technical standards that contribute to the single rulebook. It also produces regular assessments of risks and vulnerabilities in the EU banking sector, notably through pan-European stress tests. Importantly, the EBA provides a regular venue of high-level contact among European supervisors, something that facilitates familiarity and cooperation. Now that the SSM exists and has established frequent and systematic interactions among its representatives, the EBA has taken on more relevance in providing a link with the other EU supervisors.
The EBA also plays a role in the working of the bank supervisory colleges. In this way, it facilitates the adoption of joint Pillar 2 decisions; it promotes best practices; and it also occasionally makes use of its mediation powers to resolve disagreements in cross-border situations.
The EBA’s activity is complemented by bilateral cooperation. So far, the ECB has stepped-into the existing Memoranda of Understanding between the banking union supervisors and those of non-euro area countries, notably including the UK. Over time, new ECB-specific agreements will replace the existing ones, so as to foster a more coherent and efficient cooperation.
In the macro-prudential sphere, the ESRB performs regular analyses of systemic risks relevant for the EU as a whole, and by issuing warnings and recommendations addressed to the authorities in charge of macro-prudential policies, national and European. The UK is a prominent contributor to this Board in many ways, most notably through the Governor of the Bank of England who is Vice-Chair of the ESRB.
My conclusion on this subject is that, now that the SSM has been established and has set-up its own internal arrangements, it is vital for the survival of the Single Market that channels of contact and cooperation with the supervisors of non-participating Member States are preserved and actually enhanced.
I now move to three specific areas: (1) supervision of cross-border entities between the banking union and the UK, including specifically the treatment of subsidiaries, (2) cross-border crisis management, and (3) macro-prudential policies.
Banking and supervisory integration across the channel
Let me start with a few facts regarding economic and banking integration across the channel. At current prices, the UK economy is about one fifth of that of the euro area by GDP (a bit less by population). More than half of the UK’s imports come from the euro area, especially in vehicles and machinery. Conversely, the euro area relies on the UK for about one tenth of its exports. The EU is also the biggest investment partner accounting for around half of all foreign direct investment (FDI) in the UK.
By asset size, the UK’s banking sector is between a third and a half of the euro area’s. Bank balance sheets amount to about three times of GDP in the euro area (at end-2014), whereas they account for more than six times of GDP in the UK. In the last years, both banking sectors have undergone a rationalisation process. In the case of the euro area, this consolidation is largely due to pressures to achieve cost containment and restructuring in a context of enhanced financial integration. The financial crisis has put additional pressure on banks to deleverage and consolidate.
The UK banking sector is much more open to foreign presence. Foreign banks (via branches or subsidiaries) represent 37% of total bank assets in the UK, and about 14% in the euro area. The two banking systems are closely interlinked. Euro area banks are exposed to the UK for about 5% of their assets (or €1.1 trillion). The United States is the only single country to which the euro area is more exposed. Analogously, about 5% of total assets (or €631 billion) of the UK banking sector are exposures to euro area bank counterparties; again only second to the United States. Most of the direct exposures to the UK are concentrated in banks domiciled in France and Germany (mainly derivatives) and in Spain (mainly retail loans); these banks together account for almost 80% of all euro area significant institutions’ UK exposures. In relative terms, compared with the size of their balance sheets, Irish banks and some Spanish banks have higher exposures to the UK.
The UK is a major host for EU bank sub-entities – often hosting wholesale operations - with approximately €1 trillion of assets. Around 10% of all branches or subsidiaries of euro area banks operating outside the area are in the UK. Conversely, about 15% of all branches and subsidiaries of non-euro area banks in the banking union are branches or subsidiaries of UK banks. Based on data at the end of 2014, these branches and subsidiaries account for at least €750 billion of total assets. Five subsidiaries are significant according to SSM criteria and hence are supervised by the ECB.
The relationship between the ECB and the Prudential Regulation Authority (PRA) is very constructive and collaborative: our Joint Supervisory Teams (JSTs) and PRA staff hold regular exchanges to discuss strategic supervisory topics and plan coordinated actions. The degree of involvement of each authority depends upon the relative “impact” of the entities on the group they belong to and their interconnectedness with other market players. Cooperation includes joint Supervisory Review and Evaluation Process (SREP) decisions, extensive information sharing, on-site visits and quarterly risk-specific calls.
Regarding the SREP, we work together on the supervision of UK-based global systemically important banks (G-SIBs) to exchange information on capital and liquidity requirements at consolidated and subsidiary level. We focus on key risk drivers, such as market risk, business models, profitability and governance. Communication with the banks is closely coordinated so as to convey a coherent supervisory message. On these activities, guidance is provided by the EBA’s guidelines on the SREP, applicable as of January 2016.
This dialogue is further supported by cooperation in the college process. With support from the EBA, progress has been made to improve the efficiency of this process. Both SSM JSTs and staff of the PRA participate in the colleges. This means that, for the relevant cross-border groups, the risk assessment and the decisions on capital and liquidity requirements are the result of a joint effort.
A key issue I wish to mention here is the cross-border consistency of the approach followed to set Pillar 2 requirements and capital buffers. The implementation of the Basel standards and the rules on capital buffers are not fully consistent around the globe, and this may distort the level playing field for internationally active institutions. Even at the EU level there is legal ambiguity on how to treat Pillar 2 requirements when determining the point at which restrictions on distributions apply, should a credit institution fail to meet the overall capital requirements, i.e. the maximum distributable amount (MDA) threshold.
Although the EBA Guidelines on the SREP and a recent EBA Opinion provide more clarity, differences in practices still remain in Europe. As a result, the MDA trigger point depends on where an institution is located. Since such trigger affects the pricing of bank’s AT1 capital instruments and the possibility to pay variable remuneration, the level playing field is at risk. Ensuring consistency in the hierarchy of these requirements should rank highly in the priority list of future cooperation. This is relevant for both micro and macro-prudential authorities.
Cross-border crisis management and resolution
Let me move to crisis management and resolution.
Crisis management is inherently complex: time is short, information is incomplete, and an agreement must be reached among a variety of stakeholders, whose interests typically conflict. When the entity operates across borders or includes non-bank activities, such as insurance or pension funds, complications increase. National authorities often have different objectives and are subject to pressure. Different national legal frameworks and insolvency regimes (often not specifically tailored to banks) must be taken into account. As one moves to resolution, a variety of public interests must be balanced: continuity of the bank’s critical functions, minimal disruption to the real economy, no or limited use of public money, balance and fairness in cost sharing.
Supervisors and resolution authorities work together to develop effective solutions. In this respect, the Crisis Management Groups (CMGs), established following guidance by the Financial Stability Board in 2011, play an important role. CMGs bring together home and key host authorities (supervisory and resolution authorities as well as central banks and finance ministries) of all Global Systemically Important Financial Institutions (G-SIFIs) to enhance their cooperation. Today, 30 CMGs have been established globally. Banking union authorities act as coordinators in 8 cases.
During the recent crisis, no major instances of disorderly or otherwise risky bank failures in Europe materialised. But this is because national authorities have intervened with public support measures, including bail-outs and nationalisations. These interventions have been very costly: between 2008 and 2013, Member States granted aid for more than 5% of EU 2013 GDP, for recapitalisation and asset relief measures; the amount of state guarantees is a multiple of this figure.  Since then, major steps have been taken in setting up a pan-European crisis resolution framework. We have now a new legal regime, the Bank Recovery and Resolution Directive (BRRD) , and a delegated authority, the Single Resolution Board. In this framework, banks have to build up sufficient loss absorbing capacity to meet resolution costs with own balance sheet resources. In addition, a Single Resolution Fund (SRF) has been set up, funded by the private sector. National resolution funds contribute gradually to the fund and Member States provide bridge financing to the SRF. The new framework introduces also Resolution Colleges for cross-border banks, to strengthen cooperation amongst authorities involved in cross-border resolution.
While CMGs and Resolution Colleges are major steps, important obstacles to consistent cross-border resolution remain. First and foremost, insolvency regimes are not harmonized. In resolution, no creditor should be worse off than they would have been had the bank been liquidated under normal insolvency proceedings. The resolution authority must respect the creditor hierarchy as set out in national insolvency laws.
In any case, it is essential that banking groups have a transparent and credible mechanism to upstream losses from subsidiaries to the parent and to downstream fresh capital to subsidiaries in case of need. Implementation of the new standard for Total Loss Absorbing Capacity (TLAC) for G-SIBs, which also includes “internal” TLAC allocation, will help in this direction.
Macro-prudential coordination and reciprocity
Let me now comment on a third area where intra-European cooperation is of the essence: macro-prudential policy.
As you know, the recent financial crisis has awakened many of us to the reality of contagion and systemic risks. “Putting your banks in order”, while still a valid supervisory objective, is generally not sufficient for maintaining financial stability on a durable basis. System interconnections and feedbacks must be considered and allowed to influence prudential requirements.
Following guidance provided by the FSB, the EU responded in two ways: first, by instituting the ESRB, as I already mentioned; second, by issuing legislation clarifying the attribution of policy responsibilities in this area and defining the available policy instruments . Among banking union members, macro-prudential powers are shared between the national authorities and the ECB. The ECB can adjust the macro-prudential instruments specified in European legislation, but only to tighten the stance set by the national authorities. In the UK, macro-prudential powers belong to the Bank of England and are exercised by its Financial Policy Committee. The European legislative framework is common to both.
In conducting macro-prudential policy, international cooperation is required for two reasons. First, systemic risks, even when originating domestically, easily transmit across borders. The policies that aim to control them should therefore be based on a holistic analysis, and may require more than one country acting in a concerted way. Second, international leakages call for a form of “reciprocity”. When national authorities apply macro-prudential measures to their jurisdiction, or to a specific sector, analogous measures should be taken by other EU countries to bank exposures to that country or sector, to prevent offsetting cross-border flows. For example, if an EU Member State requires stricter risk weights or higher minimum LGD (loss given default) values for exposures to real estate , other Members States shall recognise and apply the same measure. Recognition is also mandatory for the countercyclical capital buffer, when it is set at a level of up to 2.5% . As regards the systemic risk buffer and measures such as stricter requirements for large exposures and for liquidity , Member States can ask the ESRB to issue a recommendation inviting other Member States to reciprocate the national measures.
Macro-prudential policy coordination in the EU has made some encouraging progress in recent times. The ESRB has adopted  an approach including a systematic assessment of the cross-border effects and a coordinated response in the form of voluntary reciprocity. That said, the European macro-prudential framework is still far from having reached its potential. The dialogue and cooperation among EU members within the ESRB needs to be developed further. The contribution of the UK in this endeavour has been, and will remain, essential.
Let me conclude.
Banking union countries and the UK face common challenges, some stemming from the business environment and the uncertainty on the economic outlook and others from the evolving technological environment which will have far-reaching implications for financial intermediation and banks’ business models. There are also regulatory challenges, as I have already mentioned: since the crisis new banking and financial frameworks have been adopted, and banks need time to adjust.
For all these reasons and in all the areas that I mentioned, exchange and cooperation between the respective banking supervisors is and will remain essential for the well-functioning of European banks and ultimately for the prosperity of the European economy. While such cooperation will be needed in any case, the UK’s membership in the EU provides a sound and tested basis for this cooperation. Relations between the UK and the rest of the continent are at a crossroad; the future is open, as rarely in the past. The ultimate goal, that we all share, is to preserve and develop an open and competitive market for financial services, to the benefit of all our citizens.
Thank you for your attention.
I am grateful to Malte Jahning, Johannes Lindner, Cécile Meys and Frank Smets for valuable contributions and comments. The views expressed here are personal and should not be attributed to the Supervisory Board or the ECB.
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).
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 (SSMR); 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 (CRDIV); 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).
See Articles 124(5) and 164(7) of the CRR. This mandatory reciprocity ensures that the same amount of capital requirements is set for exposures secured by real estate located in the same Member State, and hence contributes to preserving the EU Single Market.
The ESRB also recommends recognition of CCB rates for domestic exposures even when these rates are higher than the 2.5% threshold (see Principle 6, Recommendation A, ESRB/2014/1).
See Article 458 of the CRR.
The ESRB has published two recommendations: 1) ESRB/2015/1 ensures that the same CCB rate for exposures to a particular third country would typically apply across the Union. 2) ESRB/2015/2 covers all macroprudential measures, and sets out the framework for dealing with the cross-border effects and establishes a mechanism for voluntary reciprocity.