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Everything is connected - the international dimension of banking regulation and supervision

Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, King's College, London, 23 October 2017

South of Chicago, you find two cities: Calumet City and Hammond. While Calumet City is in the state of Illinois, Hammond is in Indiana. Spatially, however, these two cities are one entity. They are merely divided by a road –the State Line Road. On one side of the road, you are in Calumet City, Illinois, on the other side you are in Hammond, Indiana.

Now, I am not here to talk about the administrative peculiarities of cities in the United States. But we can draw a parallel between these two cities and a globalised banking sector. What challenges does it pose for regulators and supervisors? And how can they deal with them? Let us take a closer look.

Everything is connected – challenges for regulators and supervisors

Banking is well and truly a global business. National borders have become rather like the State Line Road and banks can easily move from one side to the other. To borrow the words of a Calumet City official: the banking sector is really a neighbourhood that just happens to be crossed by national borders.

And the issues that arise are rather like those faced by Calumet City and Hammond. Let’s say you own a small business on the Illinois side of the state line. The sales tax on that side of the road is 8.64%. If you feel that’s too high, you just move your shop across the street, serve exactly the same customers as before and reduce your tax burden to 7%.

That is the economic side of it. But there is also crime. The State Line Road was a favourite spot for drug dealers. Whenever the police showed up, they just moved to the other side of the street and were safe. The police from Illinois are not authorised to pursue suspects in Indiana and vice versa. But on whichever side of the road shady crimes are committed, the problems they cause are felt on the other side as well.

Now, banking isn’t a small business and of course it isn’t criminal. But the basic issues are the same. Let me highlight three of them.

First, banks too can just move across national borders and set up shop elsewhere. They can do so to evade high taxes. But they can also do so to evade strict rules or intrusive supervisors. This is known as supervisory and regulatory arbitrage.

Second, there is the question of responsibilities. Who, for instance, should supervise the activities of a British bank which operates in the United States? Who should supervise its activities in other countries?

That is a relevant question also in respect of the third issue, namely that any problems which arise will not stay on one side of the border. If a large bank, a systemic bank gets into trouble, the fallout will be felt everywhere. The banking sector is so closely interconnected that the failure of a single bank can cause a global crisis. What happened in 2008 after the failure of Lehman Brothers is a case in point.

So the worst thing that can happen is this. Countries try to attract banks for business reasons. And they do so by softening the rules and supervision – they compete in being lenient. A race to the bottom ensues and prompts other countries to lower their standards as well. This enables banks to pile up risks, and it raises the threat of a crisis. And then, when the crisis finally happens, it spreads all around the globe. Banks are inclined to take on more risk – and in doing so they make a crisis more likely.

But don’t misunderstand me. That was just the worst-case scenario. A globalised banking sector is not a bad thing per se. And it is not just about banks moving across borders to evade taxes, rules and supervisors. It is also about banks setting up subsidiaries in other countries to expand the market they serve and reap the profits.

A global banking sector of this kind is a good thing. It facilitates global trade and investment. It unlocks new and diversified sources of funding for the economy. And it improves the way capital is allocated across countries.

But still, a global banking sector poses global risks; that has become clear. And that in turn raises questions about the scope of regulation and supervision. Is it still appropriate to have rules on one side of the road that differ from those on the other side? Or do we need the same rules everywhere? Is it still appropriate for supervisors to just look at what is happening on their side of the road? Or should they work closer together with the supervisors on the other side?

For me, the answer is obvious: a banking sector that is global in scope needs a global set of rules. Likewise, it needs some degree of supervisory cooperation. And, in fact, we have been going in that direction for quite some time now. Still, we are not where we should be, and there is a risk that we might go into reverse.

Let us start by taking a look at Europe, which has grown closer together in terms of regulation and supervision. Then we can move on to the global level and see what has been done there, and what still needs to be done.

The European level – more harmonisation needed

Since the Treaty of Rome was concluded in 1957, Europe has moved closer and closer towards a single market. And that includes banking, of course. Over the past decades, many steps have been taken to form a single European banking market.

Let me highlight just one of these steps. It was an important step, and it was a step that has now become very relevant for banks here in the United Kingdom. In 1989, the Second Banking Directive was adopted. It entered into force in 1993 and, among other things, it established the idea of an EU passport for banks.

What does that mean? Well, it means that a bank that has a licence in one Member State of the EU can do business in all the other EU countries. No additional licences are needed. That was a major step towards a European banking sector.

And now it has become a major problem for banks that access the European market via the United Kingdom. In the wake of Brexit, banks located here in the United Kingdom will likely lose their EU passport. And that means they will probably lose access to the European market. So what they will need to do, obviously, is to apply for a licence in another EU country. That takes time, and time is short. So all the banks that are affected by this cannot wait until the end of the negotiations; they should act now.

But let us go back to banking regulation and supervision. While the European banking sector has grown together, the rules have also been harmonised. This too has been done in a series of steps. And the most recent one was triggered by the financial crisis.

In 2008, in Europe, a high-level group of experts was set up to advise on the future of financial regulation and supervision in Europe. One year later, the group published a report that became known as the “de Larosière Report”. Among other things, it stated that Europe suffered from “the lack of a consistent set of rules”.[1]

This gave the impetus to devise a single European rulebook for banks. Writing that rulebook was a big step. However, it did not take us all the way. The single rulebook is not as single as it should be. The rules remain fragmented. There are three main reasons for that.

The first reason is that three quarters of the single rulebook come in the form of EU Directives. There is the Capital Requirements Directive, the Bank Resolution and Recovery Directive and the Deposit Guarantee Schemes Directive. The fourth quarter of the single rulebook is an EU Regulation: the Capital Requirements Regulation.

That is important because only EU Regulations constitute directly applicable law in all Member States. EU Directives, on the other hand, still need to be transposed into national law. And the result in Spain, for instance, can be very different from the result in France. That’s one reason why the rulebook for banks is still fragmented.

A second reason lies in what are known as national options and discretions, ONDs for short. Both the Capital Requirements Regulation and the Capital Requirements Directive contain such ONDs. They give governments and supervisors leeway to apply the rules in different ways. And that’s what they did.

This only changed when European banking supervision entered the scene. Together with the national supervisors, we have agreed to exercise a lot of the ONDs in a harmonised manner across the euro area. But some ONDs are not in our hands; they are in the hands of governments. These ONDs need to be harmonised, too.

And then there is a third reason for the fragmented rulebook. Some governments continue to adopt national laws that affect the banking sector. Given that we are striving for a single rulebook and have started to build a banking union, this seems to be a bit out of order. In any case, it leads to an even more fragmented rulebook for banks.

So what we need are more EU Regulations and fewer EU Directives. We need to harmonise the remaining ONDs, and we need to stop passing national laws for the banking sector. If we are serious about a banking union, that’s what we need to do.

But it’s not just about a single rulebook. Rules are just one thing. The other thing is supervision. And here, we have done a lot in terms of cooperation and harmonisation.

It was at the height of the crisis in the euro area that European leaders took a far-reaching decision. They agreed to build a European banking union. And as a first step they put an end to national banking supervision; it was to be taken to the European level. Just two years later, in 2014, the ECB became responsible for supervising banks in the euro area. The first pillar of the banking union had been built.

So in 2014, banking supervision in the euro area became a joint task. The ECB takes the lead, but the national authorities still play an important role. The ECB directly supervises the 120 largest banks, while the national authorities take care of the around 3,200 smaller banks. But the national authorities are involved when it comes to decision-making – also with regard to the large banks.

This joint European approach brings many benefits. Most importantly, it allows us to take a broad view. We can see across national borders, and we can compare banks from all over the euro area. This allows us to spot common problems and address them in time. And we can treat all banks equally, according to the same high standards and unbiased by national interests. This helps to make banks safer and sounder; it helps to level the playing field; and it helps to bring about a truly European banking sector.

But the banking union rests on more than just one pillar. The second pillar is a European resolution mechanism for banks. It allows us to resolve failing banks without disrupting the financial system. Earlier this year, the mechanism passed its first test, when altogether three banks failed. So, there is no longer a need for governments to support weak banks in order to prevent a systemic crisis. This helps to strengthen market discipline and correct incentives. The prospect of failure has become very real for banks, and that should help keep them from taking on too much risk.

And this brings us to the third pillar of the banking union: a European deposit insurance scheme, or EDIS as we call it. That pillar is still missing, though. And in my view, it is time to set it up. Banks are supervised and resolved at European level. But the consequences, if they fail, still have to be borne at national level. National deposit insurance schemes still have to step in when a bank fails. And they have to do so even in cases where the national level was not involved either in supervising the bank or in resolving it. Liability and control are clearly disconnected.

Let me give you an example. If the Spanish bank Banco Popular Español had failed, instead of being bought in the resolution procedure by Banco Santander, the Portuguese deposit insurance scheme would have had to refund depositors in the Portuguese subsidiary, although the latter was supervised and resolved not by the Portuguese authorities, but at European level.

To reconnect liability and control, we need EDIS; we need a European deposit insurance scheme.

To sum up, Europe has grown closer together when it comes to regulating and supervising banks. There is still more to be done, of course, but we can be proud of what has been achieved so far.

The global level – finalise Basel III

However, the banking sector reaches beyond the borders of Europe. So let’s move on to the global level. How far have we got there in terms of harmonising and coordinating the ways in which we regulate and supervise banks?

In my view, we have come quite far. More than 40 years ago, in 1974, the Basel Committee on Banking Supervision was set up. It brings together 28 countries to foster a global approach to regulating and supervising banks. In 1988, it released a first set of global standards, known as Basel I. A revised set was released in 2004, Basel II.

And then came the global financial crisis. It revealed gaps in the regulatory framework that needed to be filled in order to prevent future crises. The result is a new set of standards, known as Basel III. It has been in the making for almost a decade now; parts of it have already been released, and it is almost done. But the key word is “almost”, as there are still some open issues that need to be finalised.

And that is a problem. Because it seems that not everyone still believes in the idea of a global approach. It seems that in some countries, national priorities have gained the upper hand. But as I said before, a global banking sector requires global rules. It is a serious mistake to believe that national rules will be enough. That’s why it’s in the interest of all countries to follow through with Basel III and finalise it as quickly as possible. I am confident that this can be done.

But devising a set of global standards is just the first step. These standards still need to be transposed into law. And this has to be done in a consistent manner around the world. I already discussed how difficult it is to draft consistent rules in Europe. Doing that worldwide is even more of a challenge.

But there’s more. For almost a decade, the Basel Committee has worked on revamping the global set of standards, on devising Basel III. Once that is done, the focus should shift. It should shift to the question not only of how lawmakers implement the standards, but also of how supervisors apply them, as the rules need to be applied in a consistent manner.

And here, we all could benefit from more cooperation. Supervisors need to work together, particularly in relation to multinational banks. They need to share information, agree on risk assessments and prepare for potential crises. And they need to learn from each other. Supervisors can improve their tools and techniques by identifying best practices from around the world. Against that backdrop, I welcome the fact that the Basel Committee has shifted its focus and made stronger supervision part of its work plan for 2017 and 2018.


Ladies and gentlemen, let us return to Calumet City and Hammond. It wasn’t until the year 2000 that the police departments in both towns realised something very important – that the towns had grown too close together for them not to cooperate. So they decided to work together in the fight against crime.

And the same is true for banking. We need to work together to rein in the risks from a banking sector that has a global reach.

In Europe, we have come a long way in that regard. We have a single rulebook; we have European banking supervision; and we have a European resolution mechanism. Are we there yet? Well, not quite. We still need to further harmonise the rulebook, and we need to establish a European deposit insurance scheme.

At global level, we have come a long way, too – particularly with regard to regulation. And that’s good because a global banking sector requires global rules. So, we need to finalise Basel III; and we need to do it quickly.

We need to act together. That’s the only way to deal with a globalised banking sector – and with a globalised world in general. A country which stands alone can easily lose its way. Countries which act together, on the other hand, have more opportunities and fewer risks.

Thank you for your attention.

  1. Report of the high-level group on financial supervision, chaired by Jacques de Larosière (2009), p. 27.

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