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The EU regulatory environment – room for improvement

Remarks by Pentti Hakkarainen, Member of the Supervisory Board of the ECB, on the panel “Risk and Profitability in European Banking – The Search for Strategies against Margin Erosion” at the Governance, Risk Management and Compliance conference

Frankfurt am Main, 19 November 2019

In my remarks today, I will focus on the regulatory framework for the European banking sector.

We are currently seeing a spirited debate on the merits of recent banking reforms, and on the best way forward from here.

Such debates have been commonplace over the past decade, but now, at a time when profitability is being squeezed, some industry voices are calling for elements of the post-crisis banking reforms to be rolled back. Their main criticism is that bank capital charges are now too high, and that this is generating excessive costs for the economy.

I will emphasise today that the ECB remains of the view that capital reforms have not gone too far, and that what is needed is a full and faithful implementation of the final elements of Basel III. Such robust capital requirements are fundamental to ensure that the banking sector operates in a sustainable manner and is able to withstand difficult economic circumstances in the future.

I will also touch on the future of the banking union – including the topic of European deposit insurance. Creating a European deposit insurance scheme remains a vital component of the banking union and would help to further level the playing field for banks across Europe.

Finally, I will mention the issue of supervisory reporting requirements. This is an area where supervisors and banks in fact have a common interest and can work together to streamline processes. Investment in technological solutions to help automate data submissions will be one important element of this shared work.

Basel III – an agreement worth implementing

In the wake of the financial crisis, concerted efforts were made at the global level to reform the regulatory framework for banks. At the end of 2017, agreement was reached on the final elements of the global regulatory measures, known as the “Basel III” reforms.

Before considering the merits of these reforms, it is worth recalling the situation in which the banking sector found itself in the immediate aftermath of the crisis. In many countries, weak balance sheets meant that the banking system was unable to absorb the shocks created by collapsing sub-prime and housing markets.

This resulted in huge collateral damage far beyond the banking industry. A recent IMF Working Paper measures the global fiscal resources spent on bank recapitalisation during the crisis at $1.6 trillion.[1] Beyond this, the wider impacts on economic activity were even greater, as credit became scarce, and investment fell away.[2] Cross-border financial flows virtually stopped, and trade volumes plummeted.

Given the extent of the damage, a global consensus formed in favour of a strong regulatory response. It is also worth remembering at this point that many people still question whether the response in fact went far enough.

The first round of Basel III reforms has already been implemented in domestic legislation, resulting in a significant strengthening of banks’ capital and liquidity standards. This has enhanced the shock–absorbing capacity of the banking system and will enable banks to support economically productive lending in future downturns.

Although the work of implementing the remaining Basel III reforms is unfinished, there are some in the industry and in European politics who argue that balance sheet strengthening has already gone far enough. They raise concerns about the short-term costs of transitioning to a more stable long-term steady state. Profits may come under pressure and lending capacity may be restricted.

While I sympathise with those who are weary of the long process of reform, I am not convinced by the arguments for stopping short of full Basel III implementation.

Banks that have strong balance sheets are generally those that are capable of supporting their customers through the cycle. If they want to return to satisfactory profits, banks need to look at things other than lowering capital requirements: how to refocus their business models faster, control costs better and invest in new technologies.

Besides, the Basel III reforms have been agreed, and so its signatories cannot simply now opt out of the arrangements. If we do not implement the agreement faithfully, then we undermine our own banking industry’s position by encouraging others to deviate from the commonly agreed approach too. That is not in our interests, as without global standards, the banking industry would revert to fragmentation and fragility.

The European Banking Authority advised the European Commission earlier this year that an additional €91 billion of Common Equity Tier 1 capital would be needed across the European banking sector.[3]

For the vast majority of banks, the new requirements will be manageable – and could be met to a large degree through the retention of earnings. In a few cases, more substantial adjustment efforts may be needed. In that context, it should be recalled that addressing those outliers is precisely what policy-makers had in mind when the Basel reforms were designed and agreed. And in any case, the long transition period until 2027 gives plenty of time to make needed adjustments.

Overall, we remain of the view that finalising the implementation of Basel III will be beneficial for the euro area economy. It will have a positive effect on GDP, as the benefits of reducing the likelihood of a crisis are likely to outweigh any costs arising from higher loan spreads.

We should thus not waste any time in completing the Basel III reforms.

Further scope for improvement

In addition, we would welcome further harmonisation of EU rules across countries.

The capital markets union project includes a number of promising proposals. Great benefits would arise from greater convergence in capital markets, for example in the area of insolvency frameworks – for financial as well as non-financial companies.

Discrepancies across insolvency regimes are a significant source of financial fragmentation. This is relevant both for the broad financial sector as well as for the banking sector.

A common framework should be offered to companies and investors that would provide ex-ante clarity on insolvency proceedings. Specifically, I see merit in developing a “28th insolvency regime” linked to the Statute for a European Company. I also believe that a single supervisor would be a further useful step towards truly integrated European capital markets. This would help to ensure a genuine level playing field and limit room for supervisory arbitrage.

Such movement towards capital markets union would be a major help to underpin integration in the European banking sector. And to make further progress in this regard, it must also be mentioned that work remains outstanding to complete the banking union.

Creating a fully-fledged European deposit insurance scheme (EDIS) should be the main priority here. A fully mutualised European deposit insurance fund would have benefits for all parties.

First, it would act as a confidence mechanism that would reduce the likelihood of bank runs. It can thus be seen as a risk-reduction, as well as a risk-sharing, mechanism.

Second, by ensuring a uniform level of depositor protection independent of bank location, it would act as an integration mechanism, paving the way for truly pan-European banks.

Finally, by pooling resources at the European level, EDIS would make national deposit insurance schemes less vulnerable to local and systemic shocks, thus reducing the bank-sovereign nexus that was so damaging during the financial crisis.

Now, it has been argued that such a fully-fledged EDIS would result in some countries subsidising the banking systems of others. However, ECB analysis simulating a severe banking crisis demonstrates that, with proper bank risk-based contributions, an almost negligible level of cross-border subsidisation occurs.[4]

Even on the assumption of an extremely severe crisis and conservative bail-in provisions[5], evidence of cross-subsidisation only materialises when losses reach 20% of banks’ total assets. This would only be the case in a crisis that was considerably more harmful than the one we experienced between 2007 and 2009.[6]

The contributions to EDIS should thus be risk-adjusted on the basis of bank-specific strengths and weaknesses, which would be benchmarked at the banking union level.

I welcome the opening provided recently by German Minister of Finance Olaf Scholz and the work that is being done by the High-Level Working Group on EDIS. I hope that this will allow tangible progress to be made towards establishing EDIS and, more broadly, towards completing the banking union, thereby facilitating further cross-border integration of the banking sector.

Reducing reporting burdens

Looking beyond the regulatory framework, let me also briefly touch on the importance of efficient supervisory reporting processes.

To perform our daily tasks as supervisors, we need to have constant access to accurate and up-to-date data on banks. This inevitably places something of a burden on the industry, as banks must ensure that they can provide us with the information we ask for promptly, accurately and in the right format.

Over the first five years of European banking supervision, much work has been done to establish the Single Supervisory Mechanism (SSM) as an effective modern supervisor. We continue to take steps to ensure that reporting requirements are organised intelligently and efficiently.

We are developing a database to provide an inventory of all the reporting requests that the SSM imposes on banks each year, from both the ECB and the national competent authorities. This will help us to govern the flow of future reporting requirements and ensure that our requests do not result in an excessive burden. The database will also help us to streamline reporting requirements by exploiting potential synergies and avoiding duplication.

In the longer term, I envisage that technology will allow increasing amounts of supervisory reporting to be done automatically. I am supportive of investment in suptech and regtech as a means both to reduce the administrative burden for banks and to enhance the accuracy and versatility of the data supervisors receive.


I would like to finish by briefly reiterating the main points I have made here today.

The long-term sustainability of the European banking sector relies on the existence of a sound underlying regulatory framework that is compliant with global standards. It is therefore in all our interests to implement Basel III faithfully and fully in Europe.

It is crucial to complete the banking union by creating a European deposit insurance scheme. This would help to develop a truly cross-border European banking market, and would weaken the nexus between banks and sovereigns.

Finally, European banking supervision will continue to work on making reporting requirements as efficient and streamlined as possible.

If we make progress on each of these steps, our banking system will be in a much better position to achieve profitability while delivering good outcomes for the people of Europe.

  1. The Long Shadow of the Global Financial Crisis, IMF Working Paper, by Deniz Igan, Hala Moussawi, Alexander F. Tieman, Aleksandra Zdzienicka, Giovanni Dell’Ariccia, and Paolo Mauro.
  2. The IMF has shown that output losses after the crisis appear to be persistent. Sluggish investment was a key channel through which these losses registered, accompanied by long lasting capital and total factor productivity shortfalls relative to pre-crisis trends. See: International Monetary Fund (2018): “The Global Recovery 10 Years after the 2008 Financial Meltdown”, World Economic Outlook, Chapter 2, October, pp 71–100.
  4. “Completing the Banking Union with a European Deposit Insurance Scheme: Who is Afraid of Cross-subsidisation?”, J. Carmassi, S. Dobkowitz, J. Evrard, L. Parisi, A.F. Silva, M. Wedow, Economic Policy, forthcoming.
  5. 10% riskiest banks assumed to simultaneously fail at the euro area level, and only regulatory capital, subordinated debt and senior unsecured bonds with a remaining maturity of at least 12 months assumed to be loss-absorbing.
  6. These results proved to be robust to several tests, including country-specific shocks, shocks affecting the largest banks in the system or when explicitly accounting for moral hazard (the possibility that banks would be incentivised to take higher risks when moving from national deposit insurance schemes to EDIS).

European Central Bank

Directorate General Communications

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