Second ordinary hearing in 2016 of the Chair of the ECB’s Supervisory Board at the European Parliament’s Economic and Monetary Affairs Committee

Introductory statement by Danièle Nouy, Chair of the Supervisory Board of the ECB, Brussels, 9 November 2016

Mr Chair,

Honourable Members of Parliament,

It is a pleasure to be back in your Committee to inform you and exchange views about ECB Banking Supervision. A number of notable developments in the banking sector and single European supervision have taken place since my last hearing in ECON in June. I will first touch on these before turning to the latest reform measures within the Basel framework that are currently under discussion, and which you have asked me to address.

Key developments in the banking sector

The profitability of euro area banks remains low by historical standards. The average return on equity of large euro area institutions stood at 5.9% in the second quarter of 2016, slightly below end-2015 but still double the figure of December 2014.

What I think is important to stress in this context is that singling out low interest rate as the culprit for low profitability is not justified.

This is because low interest rates have a mixed impact on banks’ profits. While they negatively affect interest margins they also help easing credit losses and they support credit demand. It is in particular through this last channel that they support a recovery in the euro area, which improves the overall environment in which banks operate.

At the current juncture we are also facing a number of additional factors which have a downward impact on profitability. These include: competition from non-banks; and the increased need for investments in information technology to keep up with consumers’ demand for digital services and distribution channels that are partly outdated. We also see that there is a case to be made for banks to adjust their business models. However, it is not up to supervisors to prescribe a certain business model or give profitability targets to institutions: it is for banks themselves to make sure they adjust to the new macro-economic and competitive environment.

NPLs

A particular challenge to banks is posed by non-performing loans or NPLs, which have increased significantly since 2008, and in particular in Member States that went through significant economic adjustment processes or are still faced with very sluggish growth.

The ECB is pursuing work on this issue with the aim of fostering a consistent supervisory approach on NPL resolution across the banking union. As I already informed you in writing, the SSM taskforce on NPLs which was created in 2015 has launched in September a public consultation on a draft guidance for banks on NPLs and published a stocktake of national supervisory practices and legal frameworks related to NPLs. The consultation is coming to an end on 15 November and we expect to adopt the final guidance in January 2017.

However, tackling the NPL issue goes beyond the remit of the ECB’s supervisory tasks. Therefore we call on other stakeholders to address structural obstacles that prevent banks from resolving their NPLs, and facilitate the restructuring of distressed debt. Progress is needed with regard to streamlining insolvency frameworks and processes in a number of Member States.

SREP

Let me now briefly touch on the Supervisory Review and Evaluation Process or SREP for 2016. Overall, the exercise revealed that the level of risks in the system remains broadly stable, but euro area banks are still facing a number of challenges. I already mentioned profitability and non-performing loans. In some banks also governance issues need to be addressed. Lastly, supervisory stress tests pointed to additional vulnerabilities in case of possible adverse shocks.

As I had already mentioned in my previous hearing in June, in accordance with several clarifications received from the EBA and the European Commission on the interpretation of EU legislation, we will express our supervisory capital expectation this year in the form of Pillar 2 requirements as well as Pillar 2 guidance. For the significant institutions, the aggregate CET1 capital expectation will remain broadly stable when compared to last year. What we have noticed again during the second SREP cycle conducted under the ECB’s supervision was how important supervisory judgement is when setting Pillar 2 in a consistent and harmonised manner for all significant institutions. We would not be able to address the specific risks associated to individual business models appropriately by using a purely mechanistic Pillar 1-like approach constraining supervision to a ‘one-size fits all’ perspective. The relevance of such an institution-specific approach was recognised by the post-crisis regulation, which provided European supervisors with tools to impose risk-commensurate requirements under Pillar 2. This understanding should be preserved in the forthcoming review of EU banking regulation.

Basel Reforms

Let me now turn to the finalisation of the reforms of banking regulation currently being discussed in Basel. First of all, it is important to note that excessive variability in calculating risk through internal models undermines the credibility and effectiveness of the Basel capital framework, and it creates unhelpful uncertainty for banks’ investors. There is widespread agreement among supervisors and the market that not all credit risk exposures can be modelled sufficiently reliably or consistently in a way that forms a good basis for determining regulatory capital requirements. Acknowledging these problems, the Basel Committee has embarked on possible repair options. These include:

  • A revision of the internal ratings-based approaches for credit risk, which envisions constraining modelling of certain risk parameters where appropriate, or removing modelling altogether for those exposures where there are no sufficient data to produce accurate estimates. The Basel Committee is assessing different combinations of approaches to finalise these revisions.
  • A revision of the standardised approach for credit risk, whose main goal is to strike the right balance between risk sensitivity and simplicity, and a revision of the framework for operational risk, which includes the option of replacing the current modelling approach with a new, risk-sensitive standardised approach.
  • Where appropriate, adjustments to the frameworks proposed in the relevant consultation papers are being considered. Discussions are also under way on the appropriateness of a capital floor on internal models based on the revised standardised approaches.
  • At the same time, final modifications to the leverage ratio are being undertaken. These are important to calibrate a potential G-SIB surcharge and to ensure that the exposure measure captures relevant activities appropriately.

Finding the balance between risk sensitivity and simplicity has not proven easy. We need to understand both the contribution of policy changes to the reduction of unwarranted variability and the impact of changes on jurisdictions to come up with a good overall package.

Let me say a few words about our role in this process. The ECB places great importance on this work. It engages with other euro area representatives ahead of the meetings to discuss the issues that concern particularly the SSM countries. More generally, at the Basel level, the ECB is actively involved in the technical work on the remaining open issues and in the BCBS quantitative impact studies. It is crucial to ensure that the final calibration of these reforms will not result in a significant overall increase in capital requirements, in line with the Group of Governors and Heads of Supervision (or GHoS) commitment made in January 2016 and reiterated in September 2016. But it is still too early to confirm the outcome at this stage.

Securitisation

As you are currently debating your report on the legislative package regarding securitisation, I would like to recall that the ECB very much welcomed the original proposals put forward by the Commission, as they generally strike the right balance between the need to revive the European securitisation market and the necessity to maintain the prudent nature of the regulatory framework. Securitisation can contribute to a well-diversified funding-base for banks. Especially at the current juncture where banks are capital constrained, enabling a well-functioning securitisation market is key.

By putting in place well-calibrated regulations, the two legislative acts avoid repeating the mistakes of the past that led to the financial crisis, while ensuring that relevant European securitisation markets, which proved overall relatively safe during the crisis, are revived in a responsible manner.

Conclusion

Let me conclude by saying that we are making good progress on a number of dossiers which are of vital concern for the banking union, including on NPLs. However, our efforts will need to be complemented by regulatory and policy action at the EU and national level. ECB Banking Supervision stands ready to provide its support.

I thank you for your attention and am now available for your questions.

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