Presentation of the ECB Annual Report on supervisory activities 2018 to the European Parliament’s Economic and Monetary Affairs Committee

Introductory statement by Andrea Enria, Chair of the Supervisory Board of the ECB, Brussels, 21 March 2019

I am delighted to address you here today and to present to you the 2018 ECB Annual Report on supervisory activities. Since this is both my first formal appearance at the European Parliament as Chair of the ECB’s Supervisory Board and the last one in this legislative term, I will start my remarks with some personal first impressions in my new role. I will then focus on the lessons we have learned since the banking union was established five years ago. I will discuss two particular areas where we have learned from experience, namely the crisis management framework and the fight against money laundering in the banking union. I will conclude with forward-looking remarks on the supervisory priorities of the Single Supervisory Mechanism (SSM) for 2019 and the ongoing preparations for Brexit.

First weeks at ECB Banking Supervision

Starting my job at the ECB I have been really impressed by the quality and dedication of the staff and by the depth and rigour of our technical analyses. A huge amount of work is smoothly processed according to the tight deadlines defined by a cumbersome decision making process, and notwithstanding the complexity of the legal framework, which in a large number of areas still requires the application of national rules. From the outside this is not easily perceived, even by somebody like me, who was heavily involved in European banking regulation and supervision.

Moving from the start-up phase to a more mature stage will require reflections on the effective interplay between work conducted at the centre and in National Competent Authorities (NCAs), on the further simplification of internal processes and on the transparency and predictability of our actions. But we will be building on a very solid foundation laid down in the past five years.

Lessons learned since the establishment of ECB Banking Supervision

Since ECB Banking Supervision was established in 2014, we have made substantial progress in improving the quality and consistency of banking supervision across the euro area. We have, for example, introduced the harmonised Supervisory Review and Evaluation Process, or SREP, which allows for the consistent assessment of all supervised institutions, and we have harmonised the application of over 130 options and national discretions given to competent authorities.

We also launched our ambitious targeted review of internal models, or TRIM, which aims to ensure that capital requirements based on banks’ internal calculations are both appropriate and consistent across the euro area. TRIM has helped to form a common understanding across the SSM of regulatory requirements related to internal models. Furthermore, it has allowed us to identify the most common shortcomings of internal models used by significant institutions (although our work is still ongoing). Institutions are now asked, via dedicated supervisory decisions, to address the deficiencies detected.

Last but not least, we have developed a comprehensive supervisory framework for non-performing loans (NPLs) consisting of three elements, which either directly address legacy NPLs or aim to prevent the build-up of new NPLs in the future:

  • NPL guidance to banks, outlining qualitative supervisory expectations for managing and reducing NPLs;
  • a framework to address NPL stocks as part of the supervisory dialogue, comprising: (i) an assessment of the banks’ own NPL reduction strategies, and (ii) bank-specific supervisory expectations with a view to ensuring adequate provisioning for legacy NPLs;
  • an addendum to the NPL guidance, outlining quantitative supervisory expectations to foster timely provisioning practices for new NPLs in the future.

And indeed, the volume of NPLs on the balance sheets of banks under our supervision went down from €1 trillion in early 2015 to €628 billion in the third quarter of 2018. Nevertheless, the aggregate level of NPLs in the European banking sector remains high and NPL ratios continue to differ significantly across banks and regions.

Our actions in the first five years of European banking supervision have already contributed to making the banking sector more resilient. Banks’ Common Equity Tier 1 (CET1) ratios rose from 11.3% at the end of 2014 to 14.1% in 2018 due to an increase in CET1 capital and a reduction in risk-weighted assets. Funding and liquidity conditions have also become more stable.

While a lot has been achieved since ECB Banking Supervision was established, we have to acknowledge that we still lack a truly integrated European banking market. There is no alternative but to work continuously towards transforming the banking union into a single integrated area and a genuine domestic market for European banks that is capable of sheltering them from idiosyncratic shocks. This means, most notably, that we need to rely more on regulations than on directives, and to reduce legislative obstacles to cross-border banking wherever possible. And it means that we need to complete the architecture of the banking union with a credible and operational common backstop to the Single Resolution Fund, and with a European deposit insurance scheme.

Enhancing the banking union’s crisis management framework

Setting up a properly functioning banking union means not only reducing the probability of a bank crisis via enhanced supervision, but also increasing the capability to manage bank crises when they occur.

ECB Banking Supervision has therefore established a crisis management framework, the SSM Emergency Action Plan. It enables us to respond in a timely and effective manner when the financial situation of a bank deteriorates. The framework sets out a well-defined escalation process consisting of several stages. At each stage, specific actions are undertaken to ensure an appropriate reaction to the situation. In particular, the liquidity situation of institutions is carefully monitored through the regular assessment of their counterbalancing capacity and liquidity flows.

In this context, I would also like to mention that ECB Banking Supervision and the Single Resolution Board (SRB) cooperate closely on a day-to-day basis. The review of the ECB-SRB Memorandum of Understanding was finalised in mid-2018 and published on the websites of both institutions to ensure transparency towards both the industry and the wider public.

I would also like to mention that the crisis management framework is not yet complete. From a regulatory perspective, improvements to the early intervention framework are needed to enable the supervisor to apply these measures properly. The overlap between supervisory and early intervention measures should be removed, and the ECB’s early intervention powers should be given a legal basis in the form of a regulation, with a view to limiting the legal uncertainty linked to different national implementation laws.

Fighting money laundering in the banking union

If there was one key lesson in the area of financial supervision in 2018, it was that the EU framework for fighting money laundering and terrorist financing requires further improvement. While the ECB is not an anti-money laundering (AML) authority, we are drawing lessons from the recent scandals involving European banks and strengthening our supervisory capabilities on issues linked to AML, such as fit and proper assessments, governance and internal controls. We recently concluded an agreement with national supervisors in the European Economic Area which are responsible for ensuring compliance with obligations on AML and countering the financing of terrorism, with a view to facilitating and enhancing the exchange of information. In addition, as my predecessor announced last year, we are creating an AML coordination function. This coordination function will facilitate regular exchanges of information between the ECB and the national authorities responsible for AML supervision, as well as coordinate the work of Joint Supervisory Teams with regard to supervisory AML-related matters.

However, the ECB has limited scope to address the issue of AML, and I therefore very much support the Parliament’s moves to strengthen the European AML framework.

SSM supervisory priorities for 2019

Let me now update you on our supervisory priorities for 2019.

First, in the area of credit risk, ECB Banking Supervision will continue to promote the reduction of the stock of NPLs. Furthermore, as part of a new initiative, we will assess banks’ credit underwriting criteria with a view to avoiding excessive risk-taking by banks. The quality of specific asset class exposures, such as commercial real estate, residential real estate and leveraged finance, will be closely examined.

Second, with regard to risk management, the TRIM review I mentioned earlier will continue. ECB Banking Supervision will also continue to push for improvements to banks’ internal processes for capital and liquidity adequacy, the so-called ICAAP and ILAAP processes. This year’s supervisory stress test will also assess banks’ resilience to liquidity shocks, while new measures will be taken to examine IT and cyber risks.

Finally, supervisory activities planned for 2019 include work relating to trading risk and asset valuations as well as ongoing preparations for Brexit, which I will now discuss.

Brexit preparedness – update from a supervisory perspective

Brexit has been a supervisory priority for us over the past two years.

There is considerable uncertainty on the next steps in the negotiation process. At the current juncture, it appears that a hard Brexit is still not off the table.

From a supervisory perspective we have worked very hard to prepare ourselves, and to push the banks to prepare as much as possible for all possible contingencies. We have assessed multiple licence applications from banks relocating to the euro area and provided rigorous feedback to bring their applications in line with our supervisory expectations. We have granted authorisations to all banks which applied on time and submitted proposals that met our requirements. We also worked closely with the few late applicants to ensure that they have contingency measures in place. Furthermore, we examined the Brexit contingency plans of banks headquartered within the euro area. Depending on the degree to which banks rely on their UK branches, the transition to the post-Brexit environment may entail a number of organisational challenges. Overall we are finding that banks, both those relocating to the euro area and those based here with operations in the United Kingdom, have prepared reasonably well.

As part of our supervisory strategy, we are also closely working with the UK authorities to agree on a solid post-Brexit cooperation framework. The EBA has successfully coordinated the preparation of a template supervisory cooperation MoU for all EU authorities to be used bilaterally with the UK authorities. In addition to this MoU that covers aspects, such as information exchange and the reciprocal treatment of cross-border banking groups, ECB Banking Supervision and the PRA have also agreed on a split of supervisory responsibilities in relation to branches’ supervision.

We have also made internal preparations at the ECB. We have started the process of taking over the direct supervision of institutions that have become significant as a result of Brexit and have recruited skilled staff to supervise them. Of course, we are also closely monitoring banks’ implementation of their contingency plans so that we can intervene if delays occur.

Conclusion

Let me now conclude. The first five years of European banking supervision have levelled the playing field for banks in the euro area and strengthened the sector’s resilience. However, more still needs to be done. In particular, we should not forget the lessons learned from the crisis and succumb to the temptation to relax the rules as soon as the situation gets better. I thank you very much for being a competent, critical and helpful counterpart to ECB Banking Supervision during this legislative term and for pushing the banking union project forward in the interest of European citizens. I very much look forward to continuing to foster the strong relationship between ECB Banking Supervision and the Parliament after the European elections. I am now happy to address your questions and comments.

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