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Regulatory and supervisory responses in Europe to the current financial environment

Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, High-level meeting on global and regional supervisory priorities, Basel, 18 October 2017

The public debate about banks is still very much defined by the financial crisis. When you say “banks”, people think “crisis”. And it is indeed true that the many echoes of the crisis can still be heard loud and clear.

Many of the challenges that banks face today can be traced back to the events of 2007 and 2008. For instance, legacy assets, such as non-performing exposures, still weigh on the balance sheets of some banks. Low interest rates weigh on their business models and profits. On top of that, banks have to deal with stronger rules and tougher supervision. And that, too, is a consequence of the crisis.

So yes, almost a decade on, the crisis is still very present in the minds of bankers, supervisors, regulators and the public. But at the same time, life goes on. And this means that there are still new challenges coming up.

Just think of technological change – digitalisation. So many aspects of our lives now fall under the influence of digital technology, and banking is no exception. The banks, therefore, have to think about how to make the most of it. They have to develop new products and new services, and, above all, face up to new competitors. It remains to be seen how this will play out.

And then Brexit suddenly happened. Brexit is a decision taken by the citizens of the United Kingdom that affects the entire European Union – all of us. And it also affects the banks, of course. One of the biggest issues for them is market access. Once the United Kingdom becomes a “third country” for the EU, banks located there will lose access to the European market, and European banks will lose access to the UK market. They will have to act, and there is not much time left to do so.

So while the crisis remains a focal point, other challenges have emerged. But there is still more than that. There are also challenges that stem from pre-crisis times. For many decades, the banking sector in Europe has been growing. And it may well have reached a point where it has grown too large – we could say that Europe is overbanked. So there is another thing that banks need to deal with: consolidation.

I think we can all agree that these are challenging times. So many things are happening that it has become quite hard to keep track of all of them. So let me just focus on one question: what role does regulation and supervision play in all this?

Writing a European rulebook for banks

First of all, regulation too has been shaped by the crisis. It was the crisis that revealed gaps in the rulebook. And it was the crisis that reinforced the need to approach regulation at global level.

The result? A complete overhaul of the rulebook for banks to make future crises less likely. The plan was to make banks more resilient in general and create a global level playing field.

The rules now require banks to hold much more capital of much higher quality. They also require banks to build up liquidity buffers and comply with enhanced reporting and disclosure rules. This puts them on a stronger footing. From whichever direction the storm blows in, they can withstand it.

But we have to make sure that this is the case everywhere. Banking is global in scope and requires global rules. This prevents regulatory arbitrage and ensures that banks worldwide can compete on a level playing field. The ongoing work on Basel III aims to provide exactly that: a harmonised set of global rules.

But the consensus in favour of global rules has been weakening lately. In some countries, national tendencies are gaining the upper hand, and important elements of the rulebook might be postponed or dropped altogether. This is not good, of course. It increases the risk of another crisis – not just in one country but in all countries. That’s why we have to finalise Basel III as quickly as possible.

Agreeing on global rules is an important first step. But equally important is that the rules find their way through national legislatures and become law. The risk is that, during this process, rules become inconsistent between countries.

And to some degree, we can see that in Europe. True, there is a single European rulebook that transposes Basel III into EU law. It aims to level the playing field for banks across Europe. This is all the more important as a single European banking sector would naturally complement the Single Market and the single currency. But the single rulebook has not yet achieved its goal. In regulatory terms, the playing field in Europe remains uneven.

One reason is that parts of the rulebook come in the form of EU Directives. And such Directives are not directly applicable; they first need to be transposed into national law. It’s no surprise that the results differ from country to country. So in my view, legislators should rely more on EU Regulations, which are directly binding on all Member States.

Another reason for the uneven playing field lies in what are known as national options and discretions, or ONDs for short. The single rulebook contains a number of these ONDs, which give governments and supervisors some discretion in applying the rules. And they have used their discretion in various ways.

So in the end, the single rulebook does not provide fully harmonised rules. In a worst-case scenario there are 19 different national rules instead of a single European one. The playing field is still a bit uneven.

But we should not forget how far we have come. Despite the elements I just mentioned, we have made a lot of progress since the pre-crisis period. Guided by the lessons from the crisis, we have greatly improved the rulebook for banks.

So, just like for everything else, the crisis has left a distinct mark on the rules. But, as I said before, life goes on. The banking sector is constantly changing: new technologies are developed; new products and services are created; new competitors enter the market and, consequently, new risks may emerge.

Against this backdrop, the question is: how can the rules reflect all this change? Do we constantly need to adapt the rulebook? Well, obviously we can’t do that. It has taken us almost a decade to learn the lessons from the crisis – and we are still not quite done yet. So in a sense, the rulebook is like an oil tanker; it can take quite some time to change course.

But there is a way out. The rules must be designed in a way that allows them to embrace change without needing to be changed themselves. They must be sufficiently broad and principles-based. They should aim to make banks more resilient in general. And they should leave room for supervisory judgement.

However, there is a tendency to make rules as specific as possible, to add more and more details, so that they cover every eventuality. Well, in the first place, that is an unattainable goal. Even attempting to reach it would lead to a very rigid and complex set of rules. And this would impinge on supervisory judgement and open the door to regulatory arbitrage.

Supervisors would be less able to react quickly to newly emerging risks. Given all the change we see in the banking sector, this could turn into a risk itself. Ultimately, we need both solid rules and good supervision. We should not favour one at the other’s expense.

And this brings us to the topic of banking supervision.

Establishing European banking supervision

Banking supervision has also been reshaped by the crisis – or by two crises in the case of Europe. Here, it was the financial crisis and the euro area crisis that made us rethink the way we supervise banks.

It was in 2012, when the turmoil in the euro area was at its peak, that European leaders took a big leap. They decided to create a European banking union. And the first pillar of this banking union was to be a single supervisory mechanism. Banking supervision was to be transferred from national to European level.

And here we are. Since 2014, the ECB has been responsible for supervising banks in the euro area. Our job is to provide tough and fair supervision based on harmonised standards and unbiased by national interests. In doing so, we help to make banks across the euro area safer and sounder.

Looking back, we had a challenging start. Neither the times nor the conditions were easy. In fact, they were extremely difficult. Still, we have come a very long way – much further than I expected at the beginning. So let me highlight a few of our achievements over the past three years.

First of all, European banking supervision is a massive project and we had very little time to set it up. It consists of the ECB and 26 national authorities from 19 countries. At the ECB alone, we recruited around 1,000 people, we created an organisation from scratch, and we specified our supervisory methods. In addition, we carried out a health check on all the banks that we were going to supervise. In my view, that was a great achievement. But frankly it was only possible because we are part of the ECB; we could not have done it on our own.

Second, we had – and still have – to deal with the fragmented rulebook that I already mentioned. We did what was in our power to harmonise it a bit more. We addressed, for instance, the national options and discretions in the rulebook that I already mentioned. Together with the national supervisors, we have agreed to exercise 130 of these ONDs in a harmonised manner. In the first instance, this was relevant for the 120 banks that we directly supervise. We have now extended the harmonised exercise of these ONDs also to the smaller banks that are directly supervised by the national authorities. But more needs to be done. There are still ONDs which lie in the hands of governments. These need to be harmonised, too.

Third, we have harmonised our main tool, the Supervisory Review and Evaluation Process, SREP for short. In the SREP we scrutinise each bank. We assess its business model, its governance structure and its risk management. We also assess risks to its capital and liquidity positions. With reference to the SREP, we make banks face up to their problems and deal with them. Denial is no longer an option.

One of the main advantages of our SREP is that we can compare and benchmark banks across the euro area. This helps us to identify best practices, spot new risks in time and deal with them. Thanks to the SREP, we can treat all banks in the euro area equally and help to make them safer and sounder.

The SREP is a great tool, but we need to refine it, of course. For instance, we have specified what we expect from banks with regard to the processes they use to assess and maintain adequate capital and liquidity buffers – the ICAAP and the ILAAP.

Moreover, in addition to the SREP, there are many other tools that supervisors can use. But some have not yet found their way into the toolbox of European banking supervision. Among these tools are the moratorium powers, when declaring banks failing or likely to fail. That is something we still need to work on.

Our fourth achievement relates to the legacy assets of banks, as I already mentioned: non-performing exposures, NPEs for short. In parts of Europe, banks still carry high volumes of NPEs on their balance sheets. And that is a problem. It weighs on the profits of these banks, which is unfortunate at a time of already weak profitability. And more than that, NPEs keep banks from providing loans to the economy, which is unfortunate at a time when the economy needs to recover.

So we had to deal with this issue. That’s why we set up a high-level working group in 2015. Our first step was to publish qualitative guidance to banks on non-performing loans. The second step was to define what we expect from banks in quantitative terms for the steady state – particularly concerning the prudential provisions that they should set aside. This guidance was published for consultation at the beginning of this month.

Regarding the current stock, the legacy assets, we have asked the banks to come up with plans on how to reduce these exposures. Our supervisory teams have engaged with banks carrying too high levels of NPE to review and challenge the banks own plans and ensure that they address the issue in a both ambitious and realistic fashion. For those banks that are lagging behind, we intend to come up with additional quantitative guidance.

And that brings me to another issue. As European supervisors we help to make banks safer and sounder. But we need to be clear about one thing: it is not our job to prevent each and every bank from failing. Failure is part of a well-functioning market economy.

That’s why the banking union does not rest on European banking supervision alone. There is a second pillar: the Single Resolution Mechanism, SRM for short. The SRM allows us to resolve failing banks in an orderly manner. This helps to strengthen market discipline and makes the banking sector more stable.

The good news is that the SRM and the Bank Recovery and Resolution Directive (BRRD) have now passed their first test. This year, three euro area bank failures were addressed effectively, efficiently and without disrupting the financial system. This success is also due to the fact that all the institutions involved cooperated very well: the European Commission, the Single Resolution Board, the national authorities and the ECB.

But this experience also revealed that we all need to be prepared to handle the failure of a bank. And this includes the banks themselves, of course. They too need to prepare for potential failure. This is also an area where we constantly and closely work together with the Single Resolution Board.

What is missing?

Ladies and gentlemen, I have now talked about the tools and the methods that we European banking supervisors use, and the challenges we face. But we need to look further. European banking supervision is more than that.

Through our work, we contribute to a level playing field for banks across the euro area. This in turn provides the foundation for a truly European banking sector. This is our objective.

Looking to the future, we want to see banks that offer their services throughout the euro area and reap the benefits of a larger market; savers that can choose from a wide range of options when investing their money, and corporations that can tap sources of funding across the euro area.

For that, we need more than a single rulebook and European banking supervision. We need a fully-fledged banking union – a banking union that rests on three pillars. And so far, only two of these pillars are in place; the third one – a single European deposit insurance scheme – is still missing.

So banks are supervised and resolved at the European level. But the negative consequences, if they fail, are felt mainly at the national level. There is a mismatch between European supervision and national liability. This mismatch needs to be resolved. It is time to build the third pillar of the banking union; it is time to set up a European deposit insurance scheme. This would further level the playing field and take us closer to a truly European banking sector.


Ladies and gentlemen,

The banking sector is constantly changing. In recent years, most of these developments have been driven by the financial crisis. Now, they are driven by other elements, such as the digitalisation.

With that in mind, regulators have rewritten the rules since the crisis, and supervisors have rethought their approach to supervising banks – in Europe even more so than in other parts of the world. There are still things that need to be improved – no doubt about that. But all in all, we have come a long way in better ensuring that the banking sector is stable and serves the economy reliably.

Thank you for your attention.


European Central Bank

Directorate General Communications

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