Presentation of the ECB Annual Report on supervisory activities 2017 to the European Parliament’s Economic and Monetary Affairs Committee

Introductory statement by Danièle Nouy, Chair of the Supervisory Board of the ECB, Brussels, 26 March 2018

Mr Chair,

Honourable Members of Parliament,

It’s a pleasure to address you here today and to present to you the 2017 ECB Annual Report on supervisory activities. As in previous years, I will give you an overview of our key activities in 2017. I will, in particular, elaborate on our work on non-performing loans, NPLs for short, the targeted review of internal models, TRIM for short, Brexit, thematic reviews and less significant institutions. I will then conclude with some remarks on where I believe we need to take further steps to strengthen the banking union. Let me start, however, with an overview of developments in the banking sector.

General developments in the banking sector

Throughout 2017, euro area banks – supported by the improving economic environment – further strengthened their capital positions and improved their balance sheets. Their average CET1 ratio increased from 13.7% in the third quarter of 2016 to 14.3% one year later. Continued efforts to tackle NPLs resulted in an overall decrease of the NPL ratio for banks under ECB supervision from 6.5% to 5.2% over the same period.

Banks’ profitability also improved in 2017. The first nine months of 2017 saw a recovery in pre-impairment operating profits[1]. Coupled with a strong decline in impairments[2] and a stable net interest margin, this led to a relative improvement in the annualised return on equity for significant institutions, which averaged 7.0% compared with 5.4% in 2016[3].This brings them closer into line with their US peers[4]. However, the overall improvement masks considerable differences across banks.

Also in 2017, for the first time since it was established, ECB Banking Supervision had to declare three of the banks it directly supervises “failing or likely to fail”. Overall, close cooperation and information-sharing between the ECB and the Single Resolution Board significantly contributed to an efficient crisis management process.

Work on NPLs

Let me now turn to our work on NPLs. As you know, tackling NPLs is a priority for us. Our approach comprises three elements.

The first one is our qualitative Guidance to banks on non-performing loans, which we published in March 2017. The Guidance requires banks to implement ambitious, yet credible, NPL strategies. It is used by banks to define their own plans to reduce NPLs.

The second element is the supervisory dialogue, where our Joint Supervisory Teams closely follow and challenge the banks’ NPL strategies and the way they are implemented.

Our supervisory initiatives have started to bear fruit. Over the last two years we have observed the considerable efforts made by significant institutions, which have led to a decrease in NPL stocks of around €200 billion. Nevertheless, NPL ratios remain far too high in a number of Member States, a situation which inhibits new lending and prevents them from benefiting equally from the economic expansion in the euro area.

The third element is an Addendum to our guidance, which we published on 15 March 2018 following a public consultation which ran from 4 October to 8 December. The Addendum specifies, in the interests of transparency, our supervisory expectations for the prudential provisioning of new NPLs, and serves as a starting point for our supervisory dialogue with individual banks. We carefully reviewed the Addendum in the light of the comments received during the public consultation. Among other things, we have taken into account the legal concerns you raised at my last hearing in November, and we have shifted the cut-off date for new NPLs to April 2018.

Finally, in this context, we welcome the Commission’s legislative proposal on the introduction of statutory prudential backstops to tackle potential under-provisioning for new loans that turn non-performing. The ECB and the Commission have closely collaborated on the legislative proposal and the Addendum, which are complementary initiatives and will together support the needed efforts to tackle NPLs in the future.

The Targeted Review of Internal Models – TRIM-project

The Targeted Review of Internal Models (TRIM) project, which is being conducted in close cooperation with the national competent authorities (NCAs) until 2019, is progressing according to plan. About 90 TRIM on-site investigations were launched in 2017. Meanwhile, the first results of the project have become available: cases of non-compliance with the regulatory framework in respect of issues such as model governance and model validation have already been addressed through supervisory decisions.

Work on Brexit

Regarding the preparations for Brexit, the ECB is closely monitoring the relocation plans of banks. We see an increase in the number of banks taking decisions on their Brexit plans and starting to relocate to the euro area. We are also continuing to work on policy stances to ensure that banks are adequately prepared for Brexit and have suitable governance structures, are well managed and have a sustainable business model for their entities located in the banking union. We have communicated the time needed for supervisors to process applications. For those banks wishing to relocate to (or expand activities in) the euro area and needing an authorisation for their (expanded) activity post-Brexit, the ECB and national supervisors expect to receive authorisation applications as soon as possible but at the very latest by Q2 2018, if not already submitted.

Work on thematic reviews

Let me turn to our thematic reviews. They represent an important supervisory tool; they enhance our understanding of risks and facilitate a common supervisory response. Given the importance of the new accounting standard, IFRS 9, the ECB made it again one of its supervisory priorities in 2017, assessing, among other things, the degree of preparedness of institutions for the implementation of IFRS 9. This exercise improved the quality of the implementation and allowed advanced data collection of the quantitative impact on the prudential figures.

Given the differences in banks’ profitability, ECB Banking Supervision continued to closely analyse banks’ business models and profitability drivers. Within this priority area, we carried out a dedicated thematic review looking into business models and profitability drivers in 2017. The results of the review will feed into the supervisory evaluation of the banks and the Joint Supervisory Teams will conduct bank-specific follow-up actions.

Furthermore, the ECB performed an in-depth assessment of the overarching governance of credit institutions and of data aggregation capabilities and reporting practices for a sample of banks. The results were communicated to the banks in question via supervisory dialogues and requests for remedial actions were included in the final follow-up letters.

Overview of the ECB’s work on less significant institutions in 2017

Regarding the less significant institutions, the ECB works closely with NCAs to monitor developments in this sector, particularly in cases of institutions facing financial deterioration. Our joint aim is to enhance their supervision in a manner that is consistent with that of significant institutions, while ensuring proportionality.

Joint supervisory standards developed in the past have been implemented and new ones, for example on the licensing of less significant institutions with fintech business models, have been developed. A common SREP methodology for LSIs was adopted, and we harmonised the way in which NCAs exercise options and national discretions for less significant institutions.

SSM supervisory priorities for 2018

For 2018 we have defined four supervisory priorities. Three of them have been carried over from 2017. First, the business models and profitability drivers of banks will remain a focus of supervision; second, credit risk will continue to be a priority, with the emphasis still being on NPLs as well as on scrutinising exposure concentrations, in particular in real estate; third, in the priority area of risk management, the review of internal models (TRIM) will go on and, likewise, ECB Banking Supervision will continue to push for the improvement of banks’ internal processes for capital and liquidity adequacy, the so-called ICAAP and ILAAP tools. A newly added fourth priority area covers supervisory activities along multiple risk dimensions, such as this year’s supervisory stress tests and the ongoing preparations for Brexit.

Making progress with the banking union and conclusion

Let me conclude. A genuine banking union not only needs the three pillars, but it also has to be a real union, without regulatory fragmentation and ring-fencing of national markets.

Currently, liquidity and capital do not flow freely in our banking union. This is due to regulatory impediments in the form of unwarranted national options and discretions, such as diverging large exposure rules. Also, in order to foster European regulatory harmonisation, more banking legislation should be adopted in the form of regulations rather than directives. The rules for fit and proper assessments are a case in point, as the ECB currently needs to apply 19 pretty different sets of national rules. Furthermore, a full, timely and consistent implementation of all elements of the finalised Basel III package, including the new prudential framework for market risk, will be important. In this regard, possible updates of some technical aspects of this framework by the Basel Committee should not be used as an argument to delay its implementation. Trading activities are a major source of risk for banks and adequate prudential safeguards need to be in place as soon as possible.

Regulatory harmonisation has to be accompanied by the completion of the institutional architecture, with a credible common backstop to the Single Resolution Fund (SRF), which should cover both solvency and liquidity support, and a fully mutualised European deposit insurance scheme (EDIS).

In October 2017, the Commission announced proposals to align the regulation and supervision of large and complex investment firms with the corresponding arrangements for banks, with the ECB taking responsibility for supervision. This possibility was highlighted in the context of Brexit preparations, as large investment firms with substantial cross-border links can pose risks that need to be addressed at European level. The ECB supports these proposals, that will ensure that prudential rules are applied consistently across Member States and that both large and complex bank-like investment firms and credit institutions will be subject to the same high standards of supervision.

Let me finally mention one other area where I personally think we need a more European approach: combatting money laundering. The legislation should be harmonised, possibly with a European institution, which cannot be the SSM, in charge of ensuring consistent and thorough application across Member States. I am now looking forward to answering your questions.

[1] +2% year-on-year.

[2] -14.9% compared with 2016.

[4] They recorded a return on equity of 8.4% in 2017.

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