The ECB and national supervisory authorities: cooperation and common challenges
Speech by Ignazio Angeloni, Member of the Supervisory Board of the ECB, at the XXXI Convegno “Adolfo Beria di Argentine”, Courmayeur, 22 September 2017
It is a pleasure to be here today, and I am grateful to the organisers for inviting me. The Foundations sponsoring this event have a long tradition of promoting studies on social and economic issues that have a European dimension. Perhaps, the proximity of the national border is a source of inspiration. The audience today, which includes representatives from the banking sector, the legal profession and the regulatory authorities, as well as academics, covers a broad mix of perspectives, all relevant to debate the working and the challenges of the new European banking supervision.
The program assigns to me the task of explaining the relationship between the ECB and the national supervisory authorities, which together form the Single Supervisory Mechanism (SSM). I will do so in the first part of my remarks. Following that, however, I would like to take the opportunity to touch upon two other issues, which, while related to our general theme, are also particularly topical today. The first is the state of the legal framework of banking supervision in the European Union, which is now undergoing a thorough review under the aegis of the European Commission. The second is the crisis management framework of the banking union, which, as you know, has been put to test this year for the first time. On both issues, the time is right to reflect and possibly draw lessons for the future.
How the ECB and national authorities cooperate
The ECB and the national supervisory authorities (in legal texts often referred to as the national competent authorities, or NCAs) work closely together on supervisory matters. I can describe how this happens rather quickly, since a number of other sources (speeches of ECB Supervisory Board members, our Annual report, and other material published on our web pages) have covered it extensively.
From a legal viewpoint, the cooperation between the ECB and national authorities in the SSM is disciplined by the SSM regulation. Articles 4 and 6 give the ECB direct competence for day-to-day supervision of significant banks (broadly speaking the larger ones, around 120 in number, accounting for about 82% of total euro area banking assets) and also a general oversight responsibility for the well-functioning of the system. Whereas the day-to-day supervision of significant entities is with the ECB, that of less significant entities (around 3500 in number, accounting for the remaining 18% of euro area banking assets) is retained by NCAs. Together, the ECB and national authorities are responsible for the supervision of 26 trillion euros of banking assets (or 2.6 times euro area GDP) in 19 euro area countries, with a combined workforce of some 6000 staff (of which the ECB accounts for around 1300). These figures give a first idea of the magnitude of our challenge, also from a logistical point of view. There is no supervisory authority with such broad mandate.
Cooperation between the ECB and NCAs is structured on different levels. At the higher decisional level, there is the Supervisory Board. The Board includes members from 19 NCAs, normally the heads of the national supervisory authorities. The ECB is represented by the Chair, the Vice Chair, and four other members. It is important to keep in mind that all members, including the national ones, are bound by statute to serve the European interest; hence they do not represent their national institutions, or their countries, when they sit and vote in the Board.
The second level is constituted by the Joint Supervisory Teams (JSTs), the groups in charge of day-to-day supervisory assessments and actions. There is one JST for each significant banking group, chaired by an ECB staff member. Staff members from NCAs, with their knowledge and experience, provide an important input here.
Furthermore, staff structures cooperate in numerous dedicated projects, with NCA staff actively participating in ad-hoc working groups as well as in on-site inspection missions.
It is worth emphasising that notwithstanding the clear allocation of responsibility that I have described, the SSM works as an organic system. NCAs remain involved also in the supervision of significant banks, as well as in the less significant ones. This approach allows for the achievement of higher supervisory quality and efficiency, by making use, to the extent possible, of the resources and knowledge available with national supervisors.
This organisational structure of the SSM was conceived time ago, during the preparatory phase that spanned between 2012 and 2014. Having been closely associated with that phase, I sometimes go back in my mind and compare our expectations at that time with today’s reality. The comparison is not disappointing. The objective of building the SSM as an organic and cohesive structure, combining the strengths of its European and national elements, has been achieved. The Supervisory Board has grown into an effective forum for debate and decision-making. The JSTs, the true operational core of the system, overall run smoothly, in spite of the considerable complexities inherent in managing teams whose members come from many different institutions and countries. There are, as one would expect, occasional divergences of views, with some NCAs and the ECB sometimes taking different positions. What is important is that objectives and responsibilities are clearly defined and understood. Different perspectives are fruitful if channelled within accepted rules and orderly processes that help identify common lines of action.
After less than three years of operation, we can safely conclude that the introduction of the single supervision in Europe was a success – although there is still progress to be made in many areas, to which I shall return. This achievement – which was not granted at the outset – owes to many factors, the main one being precisely the cooperation between the ECB and the national supervisors. Each component of the system has strengths and weaknesses relative to one another. The complementarities are being effectively exploited.
Reviewing the legal framework of European banking supervision
I move now on to a topic that should be familiar to the many of you with a legal background, namely the legislative framework in which the SSM operates.
Let me stress at the outset that a strong legal basis is essential for a good supervision. More than in other policy areas, banking supervision touches upon a wide array of interests that are well protected by legislation. Banking supervisors are naturally cautious in exercising their powers unless the legal basis for acting is clear. This is even more the case for a multinational authority, where the relevant legal basis is made more complex by a combination of European and national law; for the SSM, this means considering as many as 19 different legal systems. The SSM applies European law if this is directly applicable, as, for example, is the Capital Requirements Regulation, or CCR. National law becomes relevant when European law does not cover certain areas, or when European law consists of Directives, like for example the Capital Requirements Directive IV, or CRDIV. Directives operate through national transposition laws. Transposition and other national laws leave space for differences across jurisdictions. Often, as one would expect given their national origin, such differences alter the level-playing in favour of domestic priorities. As a result, there are limits to the extent to which a level-playing field in banking supervision can be established, even in presence of a single authority. To mitigate this problem, the boundary of European law needs to advance over time, in favour of European norms that are directly applicable to the subject concerned. To some extent this is happening, but the process takes time and can, at times, face considerable resistance.
The EU institutions are currently engaged in a thorough review of the EU banking legal framework, following proposals tabled last Autumn by the European Commission. This review is important for many reasons. First, the current legislation was introduced before the start of the banking union, so the review provides an opportunity to adapt to the new reality. Second, since most of the legislation was introduced or revamped in response to the financial crisis, it is useful to take stock of progress since then, keeping in mind the goal of making banks sounder and safer.
The Commission proposals are helpful in several respects. The proposed amendments implement important international regulatory standards in European legislation which rightly push the prudential approach further in the direction of being more risk-sensitive. Among them are the net stable funding ratio, the leverage ratio and the fundamental review of the trading book. The transposition of international standards on total loss-absorbing capacity (TLAC) and the review of its European counterpart, the minimum requirement for own funds and eligible liabilities (MREL), is also envisaged. Incorporating such elements in the legal framework is a further step to ensure that banks have resources to absorb losses when they reach the point of non-viability, thereby minimising the use of public funds in managing banking crises.
The proposals also introduce innovations designed to make the banking system’s structure more resilient. These include moratorium powers for the SSM, allowing it to impose a temporary suspension of payments if needed in the course of a bank’s crisis in order to safeguard financial stability and protect certain classes of creditors. They also suggest creating a new category of non-preferred senior bank debt, junior relative to other senior liabilities, so as to make deposits safer in case of a bail-in of liabilities in resolution. In our view the Commission proposals could go one step further, establishing a generalised preferential regime for all depositors. This would help preserve the special economic and social role of bank deposits, reducing the risk of contagion.
Third, the Commission proposes to regulate the presence of non-EU headquartered banks with subsidiaries in the euro area, an issue which is especially important in the prospect of Brexit. Those outside entities would be asked to establish within the Union an intermediate parent undertaking (IPU), which would ensure that supervision is enacted by a single authority.
Fourth and final, the ECB fully supports the proposal to grant capital and liquidity waivers within banking groups operating on a cross-border basis in the EU. We see this proposal as consistent with the aims of the banking union project, by promoting the efficient management of resources within the group and fostering banking integration.
In contrast, there are areas in which the Commission’s proposals could be improved.
One relates to supervisory discretion. The Commission proposals frame the supervisor’s ability to set capital requirements under ‘Pillar 2’ in a manner which is excessively tight in our view. The proposal to frame Pillar 2 decisions in technical standards issued by the European Banking Authority (EBA) may prove too restrictive, limiting supervisory flexibility. The proposal also restricts the supervisor’s ability to collect information beyond regular statistical reporting. Ad-hoc gathering of statistical and other information remains essential, especially for a new authority like the SSM. In our experience, this has been invaluable to conduct thematic reviews in less-explored areas of supervision, like for example governance and business model comparison.
Another area relates to harmonisation. As I mentioned already, establishing a level playing field is impossible if the single supervisor needs to apply different legal frameworks in different countries. The legislator can help either by expanding the scope of directly applicable norms, or by placing the in-built margins of flexibility of the legislation in the hands of the supervisory authority; in this case, the ECB can at least harmonise rules at the SSM level. This was done last year, in part, in our policy on options and discretions, which you may be familiar with.
Recent lessons in managing bank crises
Let me move now on to my final point, which relates to crisis management. The experience here is very recent and reflection still ongoing, so I will propose only a few tentative remarks.
My first observation based on this year’s experiences is that, from an operational point of view, the new crisis management framework has worked. The actors involved (ECB, SRB, Commission and national authorities at various levels) have put in place effective and rapid cooperation modalities that have performed well under stress. This was not obvious ex ante, especially on account of the complexity of some of the procedures, the extremely tight time constraint (the resolution was, in one case, conducted overnight during the week, instead of in the weekend as is the norm) and the large number of actors involved.
Importantly, contagion risks have not materialised. Some observers have suggested that the rules of the banking union, involving creditors in the burden sharing and protecting taxpayers more explicitly than in the past, could weaken market confidence and be a source of systemic risk. What we have observed instead so far is that, in general, a loss of confidence in the banks perceived as weak was accompanied by a strengthening, not a weakening, of their direct competitors, indicating that market discipline has been functioning.
That being said, there are a number of points which merit close attention by supervisors going forward. Let me mention three of them, among those that may be of more interest to this audience.
First, the recent cases have confirmed that risk correlations across different segments of the balance sheet can be heightened in times of crisis. Just as there are risks of contagion across banks, there may also be transmission of risk within the bank, among different segments of the balance sheet. This type of risk correlation can be exacerbated in banks that have a strong local or regional imprint. The reason is that in these banks, the pools of investors, borrowers and depositors are more limited and often tend to coincide. This blurs distinctions of roles among stakeholders and potentially gives rise to conflicts of interest. In this environment, governance problems are more pervasive and their effects more difficult to control for. Irregular practices, such as for example financing of own shares, are more likely to arise.
In general, as we have noted in several cases, weaknesses that eventually led to crises originate from long-standing and deep-seated governance problems within the bank, whose effects become more apparent when the bank operates in difficult conditions. For supervisors it is difficult to intervene in this domain; the classic tools of supervision, like capital and provisioning requirements, tend to address problems at a later stage, sometimes too late, when they have already generated sizeable risks in the balance sheet. In the SSM we have prepared one specific tool, as you know, our ‘fit and proper’ policy for managers and administrators, consisting of specific criteria to conduct the assessments. Here again, however, the effectiveness of our action is limited by the divergent array of national laws that we have to apply. In Italy, the national authorities are now, after some time, in the process of establishing secondary regulations that will permit the full transposition of CRDIV, which has, in this area, clearer and more stringent norms. This is a due step in the right direction.
My final point regards the coordination of crisis management. As I mentioned, the recent cases have been handled smoothly; operational or procedural gridlocks have not occurred. But we may, in the future, find ourselves facing even more complex crisis situations. In those circumstances, the crisis management coordinating function at the European level is of key importance. The coordinator needs to have the overall view and bring the perspectives of all stakeholders together in a balanced way. It needs to make, at record speed, the correct synthesis of disparate priorities: financial stability, taxpayer protection, property rights, legal certainty, credibility of the framework and of the institutions involved. When state aid has been provided, such role has naturally been played by the competition arm of the EU Commission. But not all crisis cases involve state aid, and besides, state aid control is not the only consideration that matters when dealing with impending bank risks. It may be worth reflecting on ways to give European bank crisis management a more established format, also looking at international best practices.
In less than three years, the ECB has established itself as a credible and independent supervisor. This being said, much progress is still needed on a number of fronts. Let me mention some of them as I conclude.
Within the European supervision, further efforts should be made to promote higher staff cross-fertilisation throughout the SSM (for example, as regards participation in on-site inspections); we are currently exploring ways to achieve this. Moreover, while great strides have been made on certain fronts, like raising solvency ratios and reducing non-performing loans, certain other areas of supervision remain comparatively less explored, for example our criteria and methods for benchmarking alternative business models, or to measure operational risks. Our methodology to assess bank risks and to set prudential requirements, which is called Supervisory Review and Evaluation Process, or SREP, is already at the frontier of the supervisory profession but requires continuous refinement and adaptation.
The euro area banking sector is stronger and more resilient today than it was years ago, owing also to the new supervision. But more needs to be done to reduce bank risks further and to enhance transparency and even-handedness of supervision across the banking sector. Even more importantly, we are still far from achieving one of the key goals set at the beginning of the SSM, namely to neutralise the transmission of risks between banks and public sector finances at the national level.
European supervision is still young and its journey has just started. There are plenty of items in our “to do list” for the years ahead.
Thank you for your attention.
- I am grateful to Francisco Ramon-Ballester for preparing a first draft of this speech, and to Giuseppe Siani and Paolo Corradino for helpful suggestions. I am solely responsible for the views expressed here.
- See “Council 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”, available under http://eur-lex.europa.eu/.
- Draft decisions prepared by the Supervisory Board are then completed by the Governing Council through a short non-objection procedure. This step is needed since, by its statute, the Governing Council is the only decision-maker of the ECB.
- I am referring specifically to banking law. I am abstracting from other parts of the legislative that may have important effects on the performance of banks, such as those regarding company insolvency or the appropriation of collateral.
- The ECB will be releasing soon a formal legal opinion on the legislative review.
- Regarding non-performing loans, it is worth mentioning that in July this year the European Council approved a detailed action plan to deal with this problem, consistent with and complementary to the ECB policy in this domain. See “Council conclusions on Action plan to tackle non-performing loans in Europe”, available at www.consilium.europa.eu, and for the ECB policy, “Guidance to banks on non-performing loans”, available at www.bankingsupervision.europa.eu. The Council plan mentions also the harmonisation of national insolvency laws.
- The Annual Report of the ECB banking supervision, available in the ECB’s supervision website, publishes every year specific supervisory priorities for the year ahead.