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Banking union: prospects for integration and further consolidation

Speech by Pentti Hakkarainen, Member of the Supervisory Board of the ECB, SAFE Policy Center Lecture at Goethe University Frankfurt am Main, 19 June 2018

Slides of the presentation

“The best way to predict the future is to create it.” Credited to Abraham Lincoln, these words reflect very well the attitude that, in my view, Europe should take towards the integration of its financial markets.

In my speech today, I would like to talk about what has already been done to push ahead with financial integration, the current state of affairs and what we still need to achieve.

The introduction of the euro on 1 January 1999 was a milestone in the history of European financial integration. Financial integration in the euro area took a leap: national borders became less important and confidence in cross-border activities grew in almost all segments of financial services.

It was already well known at that time[1] that we needed a robust prudential environment and a level playing field to make financial integration sustainable. We had to ensure that any bank is able to operate in any euro area country exactly as it operates in its domestic market. In turn, this meant we were called upon to put in place a single harmonised supervisory approach for all euro area banks.

It took more than a decade and a severe financial crisis to get these necessary elements in place. We now benefit from the banking union, consisting of the Single Supervisory Mechanism that became operational on 1 November 2014 and the Single Resolution Mechanism that assumed full responsibilities in 2016. This architecture is already a great step towards financial integration

To build on these achievements, the banking union now needs to be completed with the third pillar, the European Deposit Insurance Scheme. Its introduction may not fundamentally change the existing depositor confidence that is already supported under national systems. European deposit insurance scheme would, however, eliminate potential impediments to financial integration – and could thereby help underpin a truly integrated banking system in the euro area.

Achievements of European banking supervision to date

Let us first focus on the Single Supervisory Mechanism, which is perhaps the most important pillar for banks in the euro area as it ensures they operate under equal conditions no matter where they are located.

We need to remember that, for all the things I am about to mention, this was the first time they had been done at the European level, and they were done by a newly created team of supervisors. In a very literal way we were pioneers in everything that we were doing. It helped us that the SSM was established within the ECB, as this made it easy to gain input from experienced ECB staff on organisational issues. We also benefitted from the supervisory experiences of 26 national authorities.

As a starting point, in 2014, we conducted a comprehensive assessment of the 130 largest banks in the euro area.[2] This “health check” was an important step in the process of developing common methodologies.

Another important step towards equal supervisory treatment for banks was developing a harmonised supervisory review and evaluation process (SREP), which is now being conducted annually for each and every bank.[3]

One more thing I would like to mention is the harmonisation of on-site supervision. This topic is especially close to my heart because I chair the High Level Group on Cross-border On-site Missions. The aim of this work is to foster a more consistent, euro area wide approach to on-site missions by increasing the number of cross-border missions.[4] These efforts are extremely important to develop and nurture a single European supervisory culture – as they spread a shared understanding of our single approach to on-site work.

So far, we have conducted only modest numbers of cross-border missions. In 2017, of the 150 total missions only 10% were cross-border. The High-Level Group proposed a number of measures related to resource allocation and trainings which enabled us to double our target for cross-border missions in 2018. Indeed, the early indications from activity to date this year show that we are on track to meet this ambitious new target.

Supervising smaller banks is also a part of our mandate, even though their day-to-day supervision is carried out by the national authorities. This is an effective and useful division of labour for the enforcement of our rules at each level of the banking industry. We have developed joint supervisory standards, common procedures and methodologies for supervising these smaller banks, otherwise known as less-significant institutions, or LSIs. We are currently working on a SREP for LSIs that will enable convergence and a level playing field when assessing both larger and smaller banks, while respecting the issues of proportionality and flexibility.

State of progress – a stronger euro area banking system

Let us now look at developments in the banking industry, which in recent years have resulted in a general strengthening of balance sheets.

A range of factors have played a role in this strengthening, and the hard work of ECB banking supervisors should be listed as one of those factors.

Since the inception of European banking supervision – supported by the improving economic environment – euro area banks have further strengthened their capital positions and improved their balance sheets. Their average CET1 ratio increased from 11.3% at the end of 2014 to 14.6% at the end of 2017. Continued efforts to tackle NPLs resulted in a decrease in the overall NPL ratio from 7.6% to 4.9% over the same period. Tackling these high levels of NPLs remains one of our supervisory priorities in 2018.[5]

Banks’ profitability in 2017 has also improved compared to 2014. However, let’s not get carried away with these average numbers; we still have some concerns.

For example, banks perform quite differently both across and within euro area national markets. Furthermore, European banks are not faring as well as their US peers.

The euro area banking system continues to struggle with low profitability and, for many banks, their return on equity is still below the cost of their equity.[6]

Banks must find ways to become more profitable without taking on excessive risks. They need to develop appropriate strategies, reconsider their business models, increase revenues where possible, and cut costs where necessary.

At the same time, cost-cutting should not come at the expense of prudent management. For example, banks must not allow any complacency in their risk management.

Rather, they must put in place efficient risk appetite frameworks or RAFs.[7] The policies, processes, controls, systems and procedures set out in the RAFs must be fully integrated into their decision-making processes and risk management. At the same time, the RAFs must be aligned with the banks’ business plans, strategies, capital planning and remuneration schemes. Banks must also continue to strengthen their governance. This requires them – to improve the collective knowledge of their board members; to improve data quality and the capacity to assess data within reports provided to the management boards; and to increase oversight of senior management, among other things.

Last but not least banks must clean up their balance sheets. At over €720 billion[8], NPLs still pose a problem not only for banks’ profitability and stability, but also for the economy as a whole. NPLs make it harder for banks to provide new loans to the economy, which keeps the economy from growing.

Conditions for stimulating financial integration

Let me now turn to the factors that can stimulate more and deeper financial integration in Europe. Today, conditions for financial integration are better than ever.

First, as I already mentioned, we have a robust prudential environment and a level playing field.

Second, banks have strengthened their balance sheets by increasing their equity. To improve their return on equity, they need to generate more profits, which will only be possible if they offer attractive financial products and services. So, they need to cater to customers’ needs.

Third, the digitalisation of banking makes it easier for banks to enter the market in other jurisdictions, which – in principle – means they can provide cross-border services – thereby increasing customers’ choices.

And fourth, the development of fintech is giving rise to a range of new business models and products that can be offered cost-effectively across borders.

Introducing a European system for deposit insurance will further help in cultivating the financial conditions we need. With this in place, the euro area would become a single jurisdiction for banks, which would further support the development of a financially integrated market. It looks possible that we can soon see progress on this crucial dossier.[9]

Consolidation approaching

Several countries in Europe are currently over-banked, and so we are entering a period where consolidation is required[10]. This over-banking is a clear signal that further consolidation is needed.

Cross-border mergers and acquisitions could make a valuable contribution to the efficiency and resilience of banks, profiting from diversification benefits as well as scale. They could also contribute to the resolution of various financial stability issues, such as NPLs.


To conclude I would like to look to the future.

Financial integration has taken its time, but the moment for its acceleration has come. And I am sure it will be beneficial for the whole of Europe.

An integrated financial market would allow for the smooth and balanced transmission of monetary policy throughout the euro area. It would also increase financial stability as it improves risk-sharing and promotes well-functioning payment systems. Further, it would lead to more economic growth in Europe as companies and individuals would have better financing options.

Financial integration would benefit Europe’s economy and its people. Companies and entrepreneurs across the euro area would have a level playing field for financing their businesses. This is not currently the case; for example, loan pricing differs from country to country, and borrowers are not offered the same terms and conditions in their credit as peers in similar projects with the same credit quality in other countries.

Furthermore, financial integration will intensify competition, resulting in savers and borrowers gaining access to a better quality of service and to cheaper prices. Overall, I believe that in a prudentially sound environment – with good regulation and strong supervision – competition is an unambiguously positive thing.[11]

Ladies and gentlemen,

We are on the road to more and more integrated financial markets. The banking industry – as any other businesses in private sector – is dynamic, is persistently changing and looking for ways for increased profits.

This dynamism and the resultant changes will keep us supervisors busy for the years ahead.

However, there is only one way to reap the benefits: on the road we have selected, we must keep going ahead.

Thank you for your attention.

  1. For example, see – “EMU and banking supervision”, Lecture by Tommaso Padoa-Schioppa Member of the Executive Board of the European Central Bank at the London School of Economics, Financial Markets Group on 24 February 1999
  2. For detail, see – “Aggregate report on the Comprehensive Assessment”, ECB, October 2014.
  3. For detail, see – “SSM SREP methodology booklet” ECB, 2017.
  4. Cross-border and NCA-led missions both follow the same on-site inspections and internal model investigations methodologies. Cross-border missions facilitate the learning of that single methodology, and help to build a single culture across ECB banking supervision. See – “Guide to on-site inspections and internal model investigations”, ECB, July 2017.
  5. For detail on supervisory priorities, see – “Supervisory Priorities 2018”, ECB.
  6. For a detailed analysis on euro area bank profitability – see “Financial Stability Review”, ECB, May 2018, section 3.
  7. For detail on ECB banking supervision approach to governance – see, “SSM supervisory statement on governance and risk appetite”, June 2016.
  8. Supervisory Banking Statistics, fourth quarter of 2017
  9. Based on recent studies, the concerns that European deposit insurance could create unfair risks and transfers of costs across countries are not founded. See – ”Completing the Banking Union with a European Deposit Insurance Scheme: who is afraid of cross-subsidisation”, April 2018, ECB Occasional Paper Series, J. Carmassi, S Dobkowitz, J Evrard, L Parisi, A Silva, M Wedow.
  10. Financial Integration in Europe, 2017
  11. Some theories suggest that there can be a tension between intense competition and financial stability. The “charter value hypothesis” is particularly relevant in this regard, see –“Scale and scope economies in the multi-product banking firm”, Gilligan, Smirlock and Marshall, Journal of Monetary Economics, 1984, vol. 13, issue 3, 393-405.

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