Cyril Roux: Working with the Single Supervisory Mechanism regime
Address by Mr Cyril Roux, Deputy Governor (Financial Regulation) of the Central Bank of
Ireland, at the Banking and Payments Federation Ireland (BPFI Banking) Conference, Dublin,
27 November 2015.
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Introduction
Ladies and gentlemen
It is my pleasure to take part in today's BPFI conference on the Banking Union and speak after
Ignazio Angeloni, my fellow member at the ECB Supervisory Board, and before Elke König,
the Chair of the Single Resolution Board.
I would like to offer a second insight into the workings of the Single Supervisory Mechanism
(SSM) from the perspective of the national head of financial regulation in one of the Eurozone
countries.
The SSM is an unprecedented experiment. For the first time, prudential banking supervision is
conducted at supra-national level. The financial crisis has been a catalyst for the decision to
do so, but it is no surprise that the European Union Treaty had already provided for the
possibility to conduct banking supervision at the same level as the conduct of monetary policy,
well before the financial crisis of the past decade.
Indeed, I would agree that banking supervision is best conducted by the institution which is the
lender of last resort. The provision of emergency liquidity assistance, which is sometimes
necessary, is dependent upon the medium term prospect of solvency. A conversation between
separate arms of a central bank on these issues, adjudicated by a single body, appears to me
a happy medium between necessary separation of duties and useful proximity of knowledge
and effective decision making.
That being said, only time will test the governance and effectiveness of the SSM. Monetary
economists would be familiar with the debate around optimal currency areas, and the history
of international currency unions. The large and diverse Eurozone is the first real-life case study
of an international banking supervisory area. In the course of this speech I will underline some
of the strengths and challenges of supra-national supervision, based on the first year of
operation of the SSM.
The SSM in operation
As you know, the SSM is both a legal framework and a supervisory approach embedded in an
operational architecture.
The legal framework is made of the SSM Regulation and the SSM Framework regulation.
These regulations designate the ECB as the competent authority for supervising Eurozone
banks against their prudential requirements. The largest banking groups of the Eurozone, and
the top three in any country, the so called Significant Institutions - or SIs-, are supervised
directly by the ECB; all the other ones, named Less Significant Institutions - or LSIs - are
supervised by the national competent authority - in Ireland, this is the Central Bank .
For the LSIs, the decision-making authority, except for acquiring transactions, and all
supervisory staff have stayed within the Central Bank, so the changes may not be manifest,
although the ECB mandates the approach and methodology for supervision and exercises
oversight.
For every significant institution, on the other hand, decision-making has shifted to Frankfurt
and the daily supervision has been attributed to an international team headed in Frankfurt but
mostly made of local supervisors - this team is what we call in our lingo the joint supervisory
team or JST. The functioning of the SSM is thus based on the co-operation between the 19
national competent authorities, including the Central Bank of Ireland, and the ECB. In practical
terms, the establishment of these Joint Supervisory Teams means that SIs will now have
worked for a year with their Frankfurt-based JST Coordinators, along with some Frankfurt
based supervisors.
Notwithstanding this, the vast majority of JST members continue to be those based in Dublin,
who have likely been in your supervisory team before the SSM, and who you continue to
interact with throughout the year. In addition, a number of Central Bank Inspection and Analysis
staff support the JSTs through dedicated on-site activity, cross-sectoral and specialised
expertise. All in all, the vast majority of the supervisory work is and will continue be conducted
in Dublin for the Irish SIs.
Banking supervision can thus benefit from the varied perspectives and judgment brought by
an international team of supervisors, and the strength brought by the critical mass of
knowledge of combined national competent authorities and the ECB. On the other hand, the
functioning of the JSTs faces the combined management challenges of international public
institutions, matrix structures, and the tensions brought by the transfer of powers and
responsibilities. Familiar in other contexts, these management challenges are specific to the
conduct of supervision at a new supra-national level. Delivering consistent, timely and effective
supervision, including the issuance and follow-up of remediation programs, is proving
challenging for issues that go beyond capital requirements. So too is keeping staff motivated
throughout this complex network of national authorities and the ECB. It is a credit to the SSM
that it acknowledges these teething problems and is determined to address them.
Notwithstanding these hurdles, there have been numerous speeches to mark the first
anniversary of the SSM which have recognized its many achievements. These successes have
been well documented and Ignazio Angeloni has reminded us of them. Let me add to this
chorus that one of the critical success factors of the SSM has been the ECB's success in
attracting high quality staff. Many of them are experienced banking supervisors coming straight
from the national banking authorities, including the Central Bank of Ireland. They have been
attracted by the exciting challenge of working abroad, in helping establish the SSM, and the
much better financial terms and employment conditions offered to them. A second wave of
supervisors is expected to leave the Central Bank and other national competent authorities
next year, as the ECB will be increasing its SSM headcount by 25%. Combined with the familiar
constraint of FEMPI, this will bring further stresses to the bench strength of banking supervision
in the Central Bank, and to the challenge of replenishing once more our ranks.
National Competent Authority
From an National Authority perspective, the establishment of the SSM for banking supervision
has led to a thorough change in how supervisors within the Central Bank work. There is the
complex multi-location JST relationship to manage with an even greater emphasis on analysis,
"constrained judgment", quantitative assessments (including of risk and control frameworks)
and, a particularly large change for the Central Bank, a move to formalised end-to-end on-site
inspections.
The approach to supervision developed by the ECB, with our input and influence, gives the
Central Bank, and banking supervision, the opportunity to build on the significant
developments and achievements that have already taken place in the post-crisis and
Programme years. These include the roll-out of risk-based supervision, the development of
leading stress testing approaches and data analytics. This has been combined with instilling
an assertive culture amongst our supervisors, as well as using our powers under a credible
threat of enforcement. These hard-earned achievements contributed to the delivery of large
tracts of the financial sector reform programme but also mean that Irish banking supervision
staff are well-placed to demonstrate tier-one supervisory capabilities and to operate with
excellence in the SSM.
With this in mind, Banking Supervision in the Central Bank has been restructured last year with
three Divisions: namely: Supervision, Analysis and Inspections in order to:
1. Create a very clear distinction between off-site supervision, on-site inspections, and
specialist expertise;
2. Establish strong relationships, organisational workflows and seniority of engagement
between the Central Bank and the ECB.
In working within the SSM, the Central Bank has sought to impact and influence the nature,
approach and outcome of supervision to ensure that we have safe banks and increased
financial stability at home and abroad. We have done this by helping extensively in the
formative stages of the SSM; guiding the development of the Comprehensive Assessment
methodology; facilitating the development of the SSM's supervisory IT system though the
provision of PRISM to the ECB; supporting significant numbers of secondees to the ECB ; and
providing leadership on those areas where we have well-founded expertise. An example of
this is Sharon Donnery's - the Central Bank's Director of Credit Institutions Supervision -
appointment as chair of the SSM High Level Group on Non-Performing Loans. Ireland has
learned the hard way to deal with the problem of NPLs and we can offer our insights in leading
this work, and in our membership of numerous other working groups.
The Supervisory Board
The governance of the SSM rests on its Governing Council and its Supervisory Board. Both
are comprised of six ECB members and 19 national members. For the Supervisory Board, the
national member is the deputy governor in charge of banking supervision or his equivalent in
each of the 19 Eurozone countries.
The Supervisory Board is the highest body of the ECB where, in practice, substantial debates
take place on supervisory decisions. Proposals are brought to the Board by the JSTs and
debated with a view to issue draft decisions. The Governing Council, as a rule, adopts these
decisions, although it can object to any; this exceptional circumstance would then trigger the
convening of a Mediation panel. This has not happened so far.
The composition of the Supervisory Board brings unique strengths and challenges to its task.
All its members are senior and experienced supervisors or central bankers or both. The
aggregate wealth of knowledge and experience of the Board is formidable, and further
supported by the staff of the ECB and the national competent authorities. I can say, as Ireland's
member of the Supervisory Board, that all decisions are approached with rigour and integrity
and that the Board brings thorough challenge to supervisory proposals tabled to its meeting.
However, it is fair to say that the Central Bank would not accept from a regulated entity to have
such a numerous Board, and it proves indeed unwieldy at times. Furthermore, the best national
supervisory boards have a mix of supervisors, magistrates and members with a long banking
industry experience. Although the members of the Supervisory Board of the ECB have a variety
of skills, including in business management, law, accounting and risk, and although the six
members chosen by the ECB have been carefully chosen to bring as much diversity as
possible, the institutional set-up leaves the Supervisory Board with less first-hand banking
experience than perhaps desirable.
The Supervisory Board plays an extraordinary central role in the SSM because all supervisory
decisions requiring approval under the prudential legislation for all significant institutions must
be approved by it and subsequently by the Governing Council. The SSM is hampered by the
EU Treaty which limits decision making authority at the ECB to the Governing Council and the
Executive Board. Ireland has learned from the previous modus operandi of its Financial
Regulator the pitfalls of overly centralised decision-making and of a two tier decision making
body. As a result, supervision in the Central Bank has been highly devolved since the
beginning of the decade, and very few decisions are deemed so important that they need to
be taken by a Director or the Deputy Governor. In a stark contrast, the SSM has operated since
day one at the extreme end of centralisation. Not a single decision, even the most routine and
least consequential one, has been delegated. Electronic mailboxes of Supervisory Board
members and Governors are clogged with a daily shower of insignificant written procedures,
and unproblematic fitness and probity applications can take months to be processed. Legal
impediments need to be lifted to make delegation possible and bureaucracy reduced. The
governance and decision making structure are yet to be truly tested as admittedly the SSM
has yet to face its first open crisis.
Issues of substance
Let me move now to some issues of substance. It remains the case that many banking systems
in the Eurozone, including Ireland's, are largely nationally focused. Allied to this are the deeply
different business models, legal environment, ways of banking, and economic outlooks and as
a result the SSM has to strike a balance between consistency and taking due account of
national realities.
As Ignazio Angeloni has reminded us, the ECB has launched a consultation on the 'Options &
National Discretions' in an attempt to facilitate the application of the Capital Requirement
Directive and Regulation across the Eurozone. This is an important initiative consistent with
the SSM mandate, but it is clear that certain national discrepancies will continue to apply, if
only because they are beyond the reach of this consultation. For instance, the European text
recognises as CET1 instruments deferred tax credits and in some instances the shares of
cooperatives banks held by their clients, notwithstanding the fact that these shares are
repayable when the clients terminate their banking arrangements. Competitive differences will
thus continue to apply within the Eurozone, and even more within the EU. That is, however,
primarily an issue for co-legislators, and competitions authorities, rather than the mandate of
the prudential supervisor.
Ignazio Angeloni has also delineated how the SSM has been conducting the first round of the
common Supervisory Review and Evaluation Process (SREP) in 2015, with a view to
determine the so-called pillar 2 capital requirements. The SREP decisions will be finalised in
the coming weeks but it has already been publicly said that the Pillar2 capital requirements
envisaged for the SSM significant institutions in 2016 are slightly higher than in 2015. Pillar 2
capital is held to account for those risks not fully captured in the standard Pillar 1 requirement,
such as concentrations of exposures, and must be held at all times, just like pillar 1. So I will
add my voice to Ignazio Angeloni's and acknowledge that the amount of both pillar one and
pillar two capital requirements are material for investors in securities issued by credit
institutions. The prudential supervisor is right in willing to preserve a space for a private
dialogue and engagement with the banks on the way it assesses them, and the detailed
appraisal of their risk profiles need not be disclosed. But the sum of all capital requirements of
a bank, including macroprudential buffers, can hardly be held secret to those who own it or to
those who are asked to provide it credit.
A final issue of substance that I wish to address is that of enforcement. It is the Central Bank's
strongly held view that enforcement is critical to supervision, including to prudential
supervision. Here also, the unfortunate experience of the Irish Financial Regulator of the
previous decade has convinced us that the credible use of enforcement must be deployed to
be an effective supervisor. The SSM so far has not yet concluded nor managed to significantly
progress enforcement cases and in some cases found legal difficulties in national competent
authorities bringing to a close their own cases. Even though the SSM supervisory powers only
extend to taking sanctions against banks, whereas local supervisors can take actions against
individuals, breaches of the prudential regulation must be enforceable in practice and the SSM
has to find its feet as an enforcer as it enters its second year of operation.
Beyond the SSM
The SSM has very broad remit but not an exclusive one. The Central Bank's position as the
national macro-prudential authority, national resolution authority, institution in charge of
antimoney laundering in the financial sector and the national consumer protection authority for
financial institutions places us at the centre of many regulations that apply to banks prudentially
regulated by the SSM. In all these guises, the Central Bank's role remains to safeguard stability
and protect consumers. We bring all these perspectives when debating prudential decisions
within the SSM.
Furthermore, the creation and imminent commencement of the Single Resolution Board (SRB)
and the second pillar of Banking Union will add a new dimension to the supervision of banks.
As Resolution authorities will go to the banks and draw up their resolution plans, they will need
to undertake both desk-based and on-site work similar to that of the SSM. The European
legislators have chosen to give to Resolution authorities, as well as the supervisory authorities,
the ability to determine that banks are failing or likely to fail. This overlap of responsibility will
also mean that Resolution authorities will need to be able to know banks well enough to make
that determination, through work of their own and sharing of information with supervisory
authorities, including the SSM. I trust Elke König, Chair of the SRB, will in a moment delineate
how she sees this operating in practice.
Conclusion
I will conclude by looking to the future and the challenges ahead. We recognise that banks
face continued headwind on profitability, the on-going drag of non-performing loans, new and
emerging risks such as cyber threats and the implementation and full application of regulatory
reform from Basel III and the second pillar of Banking Union, the Single Resolution Mechanism.
The cumulative impact on banks' balance sheets of the Minimum Required Eligible Liabilities
allied to the increased capital and liquidity requirements arising from the Capital Requirements
Directive is yet to be felt. Business model viability and sustainable profitability assessments
will drive much of the supervisory engagement in the coming period as well as the operational
risk issues such as IT and cyber risk. The SSM is also conscious of the potential impact of
International Financial Reporting Standard (IFRS) 9 and will seek to engage with the banks on
these issues in 2016.
Working well within the Single Supervisory Mechanism and the Single Resolution Mechanism
is critical to conducting efficiently this programme of work. I hope I have given some insight
into this new regime, some of the successes and some of the issues that will need to be
resolved in the coming years in the pursuit of harmonised supervision reflective of national
circumstances.