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Dealing with diversity – the European banking sector

Speech by Julie Dickson, Member of the Supervisory Board of the ECB, at the 17th Handelsblatt Annual Conference on European Banking Regulation, Frankfurt am Main, 28 November 2016

Henry Kissinger once asked: “Who do I call if I want to call Europe?”

This question reflects two interesting things about the way North Americans see Europe. First, it is indicative of a widespread tendency to think about Europe as a single entity. Second, the tone expresses frustration at the complexity of European national and supranational institutions – where it can be quite confusing to work out who is in charge.

I must admit that before I joined ECB Banking Supervision, I was not at all immune to these views. Indeed, when I received the call offering me a position on the Supervisory Board, I was initially reluctant.

As my experience has been that it is good practice for a bank’s board to have 12-15 members for the benefit of sound decision-making, and as I came from the Canadian supervisory system where there is no supervisory board, and one person – the Superintendent – takes all the supervisory decisions, I was intrigued to see how a board with 25 members representing 19 countries could work in practice. So I accepted to be part of this challenge, because it was all about ensuring tough but fair supervision even within a complex governance framework.

Since then, I have realised that the European banking sector is incredibly diverse. It is composed of a range of banking and supervisory cultures which gives rise to varied governance structures and practices, but also different regulatory frameworks. Some of this diversity is part of the fabric of Europe and will continue to exist, but some aspects of it do not conform to global standards. Since its creation in November 2014, European banking supervision has focused on driving change in these areas.

Today, amid all this diversity, European banking supervision is contributing towards a more stable and more European banking sector.

Let’s take a closer look at what it took to lay the foundations for truly European banking supervision. What have we achieved in the first two years and what challenges lie ahead?

Laying the foundations for European banking supervision: where do we stand?

Today, eight years on from the outbreak of the financial crisis, I can say that Europe has made strides in working towards harmonised banking supervision. We are implementing tough but fair supervision. Perhaps from the outside it might not be so obvious how quickly things are changing within banking supervision in Europe. So allow me to mention two of the major changes we have implemented in the last two years.

Currently, the ECB directly supervises 127 banks. It is now applying the main tool of banking supervision – the Supervisory Review and Evaluation Process, or SREP for short – to all of these banks in a harmonised manner. This ensures that all banks are supervised following a single methodology. Whether a bank operates in Estonia, Germany or Italy, it is subject to the same supervisory expectations, which are based on global standards.

Another step towards truly European banking supervision was harmonising the exercise of “options and discretions” contained in European Union banking law. Such options and discretions offer some leeway to supervisors to take into account national circumstances. In Europe, however, they had been used differently in different countries, and not always for valid national differences. This was particularly damaging in the area of capital, where different definitions and capital quality measures were applied, often out of sync with the Basel standards. These differences were at odds with the idea of equal treatment of banks within a single European banking market.

Harmonising both the SREP and the exercise of options and discretions has allowed us to level the playing field for banks and raise standards. This improves stability, helps to restore confidence and promotes a truly European banking sector.

However, there are still some uneven patches on the playing field. They originate from an uneven transposition of the Capital Requirements Directive into national law. The ensuing regulatory fragmentation continues to prevent us from reaping the full benefits of European banking supervision.

The “fit and proper” assessment is a prime example of this. Anyone who wants to become a member of a bank’s management body has to fulfil certain prudential criteria. We have been able to harmonise many different national practices in this regard, but some differences remain owing to the way in which European rules have been transposed into national law. For example, in some countries candidates must be approved before taking up positions, and in other countries the candidate can take up the position even before any documents are provided to the supervisor. That does not constitute a level playing field for banks. We hope that politicians can commit to removing such unjustifiable differences, which would not only level the playing field, but also help to make European banking supervision more efficient.

The first two years: raising standards and dealing with inherited challenges

But let’s return to banking supervision itself. Establishing European banking supervision was just the first step. The next step was to make it work. And this is where the human factor was crucial: what we needed was a good team of supervisors, and we have built one.

To form our team of European banking supervisors we recruited professional supervisors from across Europe – and beyond. We also recruited former bankers. In my experience, combining the expertise and experience of both bankers and career supervisors enhances our ability to detect risk and act expeditiously. This alone has been quite a change in banking supervision in Europe.

Our dedicated team of highly professional supervisors can draw on a large pool of analytical expertise and take a European perspective, benchmarking banks across borders in order to identify problems early on and to formulate adequate action within diverse banking sectors.

We can, for instance, take advantage of our position as the supervisor of eight of the largest banks worldwide, referred to as global systemically important banks, or GSIBs. This allows us to compare and contrast best practices across GSIBs, which is a huge advantage that European banking supervision has. Many other supervisors around the globe do not enjoy the same advantage.

Once set up, our team of supervisors started its work. Across the euro area, we identified many banks that were not aligned with basic, time-honoured, global supervisory expectations. For example, we identified cases of weak risk governance, insufficient data and IT infrastructure, non-existent internal capital adequacy processes and, as noted earlier, very divergent capital definitions.

These shortcomings are being addressed through the harmonised SREP, which is consistently applied across all supervised banks. This has further contributed to increasing stability, with the core capital ratio of the large European banks having increased by half in just four years – from 9% in 2012 to 13.5% today.

However, other inherited challenges have proven more difficult to address, such as non-performing loans, or NPLs. What strikes me in that regard is the extreme diversity. Across the euro area, the percentage of banks’ balance sheet made up of NPLs ranges from 1% to nearly 50%. Other supervisors do not face this kind of variation in NPL levels. For instance, in a country like Canada, where there is a single insolvency law and a single supervisor that has been enforcing global standards for a long time, one sees more homogeneity across banks in terms of NPL levels.

Indeed, one explanation for the diversity here is the fact that the national legislative frameworks differ considerably. In some Member States, it can take years to collect a bad loan, while in others it takes much less time. The very fact that we are facing extremely diverse insolvency regimes means that we will not be able to make equally rapid progress in all Member States.

So we are being ambitious, but realistic. In September 2016 we launched a public consultation on guidance to banks regarding best practices for dealing with NPLs. We also published a first stocktake of national practices concerning NPLs; this is also helping to show countries how insolvency laws differ, and why these differences matter. We had a public hearing on the entire package on 7 November. We are now considering the input received. The idea is that banks with a high level of NPLs establish a clear strategy to ultimately reduce their NPL stock in a credible, feasible and timely manner.

Finally, while European banking supervision has come a long way in two years, there are some areas that are entirely out of reach for supervisors. Nevertheless, they too affect our work. I am referring to a single deposit insurance scheme in Europe – in order to finalise banking union, policymakers need to agree on such a scheme.

The global financial crisis showed the importance of maintaining depositor confidence in the banking system, and the key role that well-defined and well-designed deposit protection plays in maintaining that confidence. Given this, the Core Principles for Effective Deposit Insurance are included within the Financial Stability Board’s Compendium of Key International Standards for Financial Stability.

A strong, single deposit guarantee scheme is an important basis for stable cross-border banking across the euro area.

With an enhanced resolution environment, our job as supervisors becomes more straightforward. When bank failure scenarios arise, we need to have full faith in the resolution machinery in order to avoid any tendency to keep banks alive merely out of fear of what will happen if they are allowed to fail.

Spotting newly emerging risks

Ladies and gentlemen, dealing with inherited challenges is one thing. Another thing is to look to the future and to identify emerging risks that can lead to problems. That is another crucial part of our supervisory work. Today I will briefly cover three such risks: bank profitability and business models, cyber risk and leveraged finance.

The low profitability of European banks has been discussed extensively. It is true that recently we have been seeing some tentative signs of improvement – for example, in the generally positive third-quarter results for euro area GSIBs, supported by trading profits. In general, however, profitability still remains low.

Low profitability reflects a range of factors, including the challenging macro environment, high cost structures, some overbanked markets and legacy assets. In such an environment, banks need to rethink their business models. Choosing a business strategy is one of a bank’s board’s fundamental responsibilities. However, we often receive business plans which assume that interest rates will suddenly increase and restore margins. This might be more of a case of wishful thinking than of sound analysis by boards.

Some banks are making major announcements regarding costs, but there is still significant variation in cost-income ratios across Europe. And banks must fight the impulse to adjust the wrong way. The solution cannot be to embark on a search for yield without commensurate controls.

Cyber risk is another emerging area on which banks and supervisors need to focus. At its inception, European banking supervision identified IT and cyber risks as being among its priorities. Consequently, we have been stepping up our efforts in this regard, and banks and their boards need to be very active on this front as well.

We have consulted other supervisors around the globe regarding what they are doing, and we have zeroed in on the practices of banks under our direct supervision. Furthermore, we have launched a pilot cyber-incident reporting database this year, which helps us to detect cyber threats early on and will thereby support early action to mitigate cyber risks. The scope of the database will be expanded next year, further enhancing our capabilities.

The banks we supervise will be hearing more from us on this topic in the future. We will be enhancing the way we assess banks’ controls in the area of IT, and we will develop supervisory expectations for banks’ IT risk control, which will apply to all of the banks subject to European banking supervision.

A third emerging risk is leveraged finance.

In 2014 euro area banks accounted for no more than about 15% of all leveraged loans that were arranged worldwide, and leveraged finance accounted for just 1% of their assets. Nonetheless, the prolonged period of very low interest rates and resulting search for yield strategies has led us to be concerned about potential exuberance in this market.

As a forward-looking supervisor, we have therefore stepped up our monitoring of credit quality and leveraged finance exposures in general. We have looked for any weakening in deal structures (such as the import of covenant-lite structures into European markets); the degree to which banks define their risk appetite for underwriting and syndicating transactions; the quality of their monitoring; and the triggers they have for enhanced due diligence on deals.

This work culminated in the publication of draft guidance on our expectations, which was issued for public consultation on 23 November.


Ladies and gentlemen, over the past two years, I have been impressed by the ability of the Supervisory Board to act quickly and take decisions. While European banking supervision is young, I have been struck by the value it adds and the changes it is bringing. This is very visible to individual banks, even if it is not so obvious to the outside world.

Still, the European banking sector is incredibly diverse in terms of banks, legal systems, accounting standards and supervisory cultures. And some of this diversity will continue to exist.

Increasingly, however, when it comes to oversight of significant banks in Europe, we are painting a more harmonised European picture. And now you know who to call!

Thank you for your attention.


Europese Centrale Bank

Directoraat-generaal Communicatie

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