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Presentation of the ECB Annual Report on supervisory activities 2015 in the ECON Committee of the European Parliament

Introductory statement by Danièle Nouy, Chair of the ECB’s Supervisory Board,
Brussels, 22 March 2016

Mr Chair,

Honourable Members of Parliament,

It’s a pleasure to address you here today and to present to you the 2015 ECB Annual Report on supervisory activities. When I presented the first such report last year, the Single Supervisory Mechanism was not even half a year old; it had a promising future but hardly any history. With this second issue of the Annual Report, we can look back on one-and-a-half years of European banking supervision; the SSM still has a promising future, now it also has an encouraging past.

We have in particular made good progress in ensuring tough and fair supervision within the banking union over the past year. In my presentation today, I will focus on the following themes mentioned in the report. First, some key developments in the banking sector. Second, the advances made in harmonising our supervisory methodology, and with supervisory options and national discretions. Third, I will speak about our contribution to the development of the international regulatory framework and other key projects of ECB Banking Supervision in 2015. Before concluding, I will touch on our supervisory priorities for 2016.

Before I get started, though, let me thank you and Mr Gualtieri as Rapporteur for your very relevant and constructive report on the Banking Union, which represents a very important channel to provide us with feedback about the Parliament’s views on a broad range of issues.

General developments in the banking sector

The general performance of banks directly supervised by the ECB has improved in 2015, largely thanks to stabilising macroeconomic conditions and much-needed efforts to repair banks’ balance sheets hit by the crisis. Still, banks face challenges: low interest rates may add to weak profitability prospects; and the broader balance sheet adjustment is incomplete.

The overall profitability of significant institutions has partly recovered in 2015 from very low levels. Their return on equity was 4.6% on average in 2015, up from 2.8% the year before. The improvement was largely due to lower credit losses, eased by stabilising macroeconomic conditions. Fee income from asset management activities and one-off gains on debt securities portfolios contributed to supporting banks’ revenues.

However, the sustainability of these improvements remains to be assessed. The economic outlook is weak and – by extension – the low interest rates and flat yield curve environment might stay for longer. Last year, banks coped relatively well with low rates, benefiting from easier funding conditions that more than compensated for lower interest rate revenues. The situation could become more challenging over a prolonged period of time.

Low profitability is a concern for supervisors because it may impact the medium-term sustainability of some business models. Certain institutions might struggle to generate capital while having limited access to financial markets. The ECB will carefully assess the sustainability of banks’ business models in the coming quarters, with a view to ensuring that they are able to withstand cyclical developments and structural challenges.

The large stock of problematic legacy assets constitutes a second challenge for SSM banks. Non-performing loans weigh on profitability and capital, hampering banks’ ability to provide new lending to customers. The issue has multiple causes besides general economic conditions, including poor banking practices and ineffective legal and judicial frameworks for insolvency and debt recovery in some countries. In 2015, banks have made substantial progress in tackling bad loans by improving their processes and by increasing provisioning levels. Some Member States have also implemented much-needed legal and structural reforms.

The ECB has worked extensively with banks in 2015 – and continues doing so this year – to develop individual and tailored action plans. While it will take some time to bring down bad loan stocks, good progress over the next few years can be expected.

Harmonisation in supervisory methodology

Let me now turn to the harmonisation in supervisory practices achieved over the last year.

As you know, in 2015 the Supervisory Review and Evaluation Process or SREP was for the first time carried out according to a common methodology for the around 120 largest banking groups in the euro area. Capital and liquidity levels of banks directly supervised by the ECB have been set according to their individual risk profiles. Additional supervisory measures have also been applied where deemed necessary.

The ECB methodology is in line with EU legislation and draws on leading practices within the banking union and on recommendations by international bodies.

We achieved a holistic assessment of institutions’ viability, taking a forward-looking perspective and applying proportionality.

We combined quantitative and qualitative elements through a constrained expert judgment approach. This ensured consistency while taking into account institutions’ specificities.

Extensive peer comparisons and transversal analyses were possible on a wide scale for the first time, allowing all institutions to be assessed in a consistent manner and thus promoting a more integrated single banking market.

Harmonisation in options and discretions

However, the level-playing field also depends on harmonised rules under which the banks operate. As you know, options and national discretions, or ONDs, in prudential regulation are a key source of divergence in supervisory rules. If not harmonised, such options and national discretions to be exercised by supervisors or national governments mean that it becomes impossible to supervise the banks in banking union and the single market in a consistent manner. For supervisory ONDs, the ECB project on options and discretions addressed precisely this situation. The ECB has designed a harmonised policy for 122 of the supervisory ONDs in CRR and CRD IV. These policies have been transformed into an ECB Regulation and an ECB Guide. After taking into account also the feedback received in the course of the public consultation, these were formally adopted last week and will become operational in 2016. This is an important, but not last, step of the ECB’s work towards a truly level playing field. A second and final phase of the project is going on, in order to harmonise seven additional ONDs in 2016. In addition, the ECB is assessing a proportionate way of harmonising options and discretions for less significant institutions, in close cooperation with the national competent authorities. As you know, while the NCAs are in charge of direct supervision of the LSIs, the ECB exercises the oversight over the entire euro area banking system, and we are committed to ensuring a consistent supervisory approach also for LSIs.

Contributions to the international regulatory framework

Let me also use this opportunity to report on our engagement with international regulatory fora and the development of the international regulatory framework. ECB Banking Supervision participated actively in the work of the Basel Committee on Banking Supervision, the BCBS, and its oversight body, the Group of Governors and Heads of Supervision.

The finalisation of outstanding Basel III policy reforms was a priority area for us. Our representatives in the various working groups of the BCBS provided expertise and input to discussions leading to the finalisation of some key dossiers. These include the market risk framework, as well as the treatment of banks’ holdings of total loss-absorbing capacity; revisions to the standardised approaches for credit and operational risks; reforms to enhance the comparability of risk-weighted assets calculated using advanced approaches for credit risk; the capital treatment for “simple, transparent and comparable” securitisations, in this dossier you are of course involved as the co-legislator; and the treatment of interest rate risk in the banking book.

ECB Banking Supervision was also involved in other strands of work which are on the agenda of the BCBS over the course of this year and the next, including the revision of the prudential treatment of sovereign exposures.

Other key projects of ECB Banking Supervision in 2015

Let me now briefly touch on four other important projects on which we have worked in 2015, mentioning also our day-to-day supervisory work.

First, ECB Banking Supervision contributed to the development of the EU crisis management framework, based on the BRRD and the Single Resolution Mechanism. In this regard, a Memorandum of Understanding was signed with the Single Resolution Board in order to facilitate cooperation and communication between the ECB and the SRM.

Second, prior to assuming supervisory responsibilities, the ECB has to carry out a comprehensive assessment of the relevant banks. In 2015, such an exercise has been conducted for nine institutions. Five of these banks did not pass the test and their total capital shortfall amounted to 1.74 billion euros. Part of that had already been covered by capital increases and other eligible measures the banks had undertaken since January 2015.

Third, in the first cycle of on-site inspections, around 240 inspections were conducted in 2015. National supervisors contributed 95% of on-site resources while the ECB contributed 5% through its dedicated Centralised On-site Inspections division. This division also monitors inspections in order to ensure a homogeneous application of the relevant methodology.

Fourth, more than half of all significant institutions are using at least one internal model for calculating their regulatory capital requirements. In 2015, work was initiated on a targeted review of internal models. The objective is to promote a uniformly compliant implementation of these models.

Supervisory priorities for 2016

Before I conclude, let me highlight for you in terms of broad focal areas our supervisory priorities for 2016.

These priorities build on an assessment of the key risks faced by banks under ECB supervision. The key risks have been identified in cooperation with the National Competent Authorities, building on the input from the Joint Supervisory Teams, and ECB microprudential and macroprudential analyses as well as reports by external bodies.

Among the key risks identified, business model and profitability risk is ranked the highest, followed by other risks, the importance of which varies across the banking union Member States. These included credit risk and heightened levels of nonperforming loans; a reversal of the search for yield; conduct and governance risk; sovereign risk; geopolitical risk and growing vulnerabilities in emerging economies; IT and cybercrime risk; and banks’ ability to meet upcoming regulatory capital requirements.

To ensure that banks address these key risks effectively, the ECB adopted five high-level priorities to guide its supervision in 2016, namely:

  1. business model and profitability risk,
  2. credit risk with a focus on NPLs,
  3. capital adequacy,
  4. risk governance and data quality, and
  5. liquidity.

For each priority, a number of supervisory initiatives are being carried out. In some cases, their full implementation spans more than one year so they will continue to be relevant in 2017.

Conclusion

Let me now conclude. The SSM is not only about setting up a robust supervisor in order to make banks safer. It is also about contributing to the integrity of the Single Market and ensuring that banks can safely access resources and use them to fund innovation, investment, and growth.

In this regard the harmonisation of supervisory practices is not sufficient if rules differ. This is why we embarked on the project on options and discretions. There is, however, a limit on what the ECB can do to harmonise prudential rules in the SSM.

Indeed Union legislation currently grants options also to Member States, which can be exercised in different ways through national laws. And the ECB is bound by differing national legislation implementing the non-harmonised Capital Requirements Directive where a substantial part of banking legislation is found.

In these cases, there is little the ECB can do to pursue further harmonisation. Here, legislative intervention is necessary to fix the source of the problem.

Against this background, I am grateful for your call for legislative harmonisation in your Banking Union Annual Report, including your call to rely more on regulations than directives for banking union legislation.

Thank you for your attention.

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