Sabine Lautenschläger: From supervision to resolution - a German
perspective
Speech by Ms Sabine Lautenschläger Deputy President of the Deutsche Bundesbank, at the
Institute of International and European Affairs, Dublin, 25 June 2013.
* * *
1. Introduction
Dear Mr Halligan,
ladies and gentlemen
I would like to thank you very much for your invitation. It has been my pleasure to come to
Dublin to discuss with you those new developments relating to the banking union which are
of such great importance to Europe. The title of my remarks refers to the "German
perspective". I would like to talk with you about my vision, and that of the Deutsche
Bundesbank. And - I will make no secret of it - I have a case to put before you today.
One of James Joyce's most famous literary characters, Stephen Dedalus, once observed
that errors were the portal of discovery. Having failed to prevent the crisis in the first place,
policy makers and supervisors alike are at least rightly being called on to learn the right
lessons. One of these lessons is the banking union, which was launched in June 2012. The
eurozone summit resolved, amongst other things, to transfer banking supervision to the ECB.
Further elements were added in December 2012. These include the Single Supervisory
Mechanism (SSM) and the Single Resolution Mechanism (SRM) here in the euro area. A
single European deposit insurance scheme is also being discussed.
Adding a single resolution mechanism to a single supervisory mechanism is, in my opinion,
not just a good idea, but one whose time has come. Control and liability should go hand in
hand. But a European resolution mechanism likewise needs harmonised standards and
instruments, which are currently being developed with the EU's Bank Recovery and
Resolution Directive (BRRD). If I may say so here: the Irish Presidency has distinguished
itself admirably during these difficult negotiations.
The third pillar of a banking union - a European deposit insurance scheme - is currently not
regarded as a priority task. I concur with this view. After all, a deposit insurance scheme is a
promise by a government to its depositors to indemnify them to a certain degree in the event
of a crisis. A joint deposit insurance scheme would thus necessarily mean joint liability of the
member states' taxpayers. However, joint liability in this area requires joint European control
in economic and fiscal policy. And we are nowhere near that stage yet.
However, there are more conditions to be met for an effective and efficient banking union,
which concern material supervisory legislation: a centralised European supervisory regime
requires common supervisory rules. The adoption of the Capital Requirements Regulation
and Capital Requirements Directive, and their probable entry into force on 1 January 2014,
have brought us a major step closer to a "single rulebook" for banks and supervisors alike. I
would also like to give my warmest thanks and congratulations to the Irish Presidency here,
too, for their negotiating and organisational skills in this thorny matter, one on which no fewer
than four presidencies had to work very hard at that. Well done!
2. Single supervisory mechanism
Where do things now stand with regard to the Single Supervisory Mechanism, the SSM?
Where do I stand? A fundamental political consensus has been achieved. A formal resolution
in Germany is still pending, however, as this significant transfer of powers requires a
two-thirds majority in each of Germany's two houses of parliament. The required majority
was reached in the Bundestag, or lower house, on 14 June 2013; the Bundesrat, or upper
house, will vote on 5 July 2013. I trust that everything will go smoothly, and that the Single
Supervisory Mechanism Regulation will enter into force in the late summer so that, in the
second half of 2014, the European Central Bank (ECB) can start supervising banks in
cooperation with national supervisors.
I expect major benefits from the forthcoming European cross-border supervision of banks.
The last five years, in particular, have brutally shown us that crises do not stop at national
borders, especially in a monetary union. An advantage of the SSM is that it will draw on a
broader and better basis of information across the eurozone, thereby making it possible to
reveal undesirable developments more quickly. If designed correctly, with a strong arm in
benchmarking and peer review, we can uncover trends in individual business lines and risk
management much sooner in future. I also expect this to be a major step towards the
consistent application of the supervisory rules, as a second pillar of the single rulebook, so to
speak. I am hoping that European supervision, in teams of supervisors from various nations,
will provide a new approach which incorporates the best elements of each nation's approach
to supervision. This new approach will leave no room for a "home biased" supervisory
regime.
However, the SSM also has some major weaknesses, and I would like to single one out for
particular emphasis. It has to do with the fact that the final say on central decisions taken by
the ECB - and thus also in the SSM - rests with the Governing Council of the ECB. It is true
that these decisions will be prepared in a Supervisory Board, composed of representatives of
all eurozone national supervisory authorities and central banks, and that the Governing
Council of the ECB can only accept or reject the proposals. A mediation panel would resolve
disagreements. However, the Governing Council would have ultimate responsibility no matter
what. I have misgivings about this setup, for two reasons. First: this governance structure is
quite complex, and its functional viability still needs to be demonstrated. I admit that I side
with the sceptics here. Second: it will not be possible here to draw a clear dividing line
between monetary policy and supervision: the Single Supervisory Mechanism Regulation
only goes as far as EU primary law allows.
I therefore see the ECB facing conflicting aims: price stability and a stable banking system.
This conflict of aims can threaten the ECB's "internal independence". Over the medium to
long term, I believe it is necessary to put the SSM on a sound legal footing; there is no
getting around changes to primary law to improve the governance structure and to draw a
clear line between the monetary and supervisory functions. I am convinced that we need to
tackle the issue of these changes.
3. Single resolution mechanism
Let me now turn to my second main topic for today: the Single Resolution Mechanism
(SRM). The financial market crisis has shown us the magnitude of the hazards and costs
associated with buzzwords such as "too big" or "too complex to fail". The G20 governments
have therefore committed to take measures to prevent taxpayers from having to bail out
distressed banks. The onus is now on policymakers and supervisors to develop a bank
resolution and restructuring process.
This issue takes on a new dimension in the context of joint supervision. After all, within a
cross-border supervisory structure, there also has to be a common restructuring and
resolution regime in order to achieve a balance between liability and control.
To that end, we have to establish a central European resolution agency and a joint European
resolution fund.
In order to make such a single European restructuring and resolution regime lawsuit-proof, a
change to primary law is required here, too. In my view, the current legal framework for the
establishment of a special resolution authority for the euro area, with extensive powers of
intervention, is insufficient. As a European resolution authority will have extensive powers to
intervene, its legal basis must be absolutely watertight. Resolution will invariably be followed
by lawsuits - that much is certain.
What shape should such a resolution authority take in practice? Transferring the relevant
tasks to the EU Commission, limited to only a subset of member states, and even if just for a
transitional period, is not a really good idea. It harbours legal pitfalls: restricting the
authority's powers to the euro area is hardly covered by Article 114 of the Treaty on the
Functioning of the European Union (TFEU) and also poses the threat of conflicts of interest.
Resolution and state aid would be merged into one single authority.
As in the context of the SSM, in this area, too, policy makers are called upon to tackle with
determination the task of laying the groundwork under EU primary legislation for an
independent resolution authority.
4. Hierarchy of liability
What other unfinished business is there? Well, there is, above all, the issue of the
instruments and procedures to be applied when a bank is to be resolved or restructured.
At all events, the resolution and restructuring of a bank supervised directly by the ECB
requires common instruments and procedures, which will also benefit EU countries which
join the SSM. I therefore welcome the Irish Presidency's efforts to push ahead with the highly
complex and controversial BRRD dossier.
The crucial precondition to finalising this dossier is agreeing on who will ultimately foot the
bill. To this end, we need to define the hierarchy of liability clearly and ex ante:
Shareholders should be the first to bear losses; if that does not suffice we must not hesitate
to bail in junior and senior debt holders as well - at least most of the time. The big issue is
currently whether or not deposits should be put in a class of their own in the hierarchy of
liability - in other words, should there be a "depositor preference". Some member states also
want all deposits, or at least those insured up to €100,000, to be exempted from a bail-in.
A privately financed resolution fund is a further line of defence. All banks supervised directly
by the ECB would have to contribute to this joint European resolution fund, which would
supersede national regimes in the medium term. This fund should also be able to require
additional payments from member banks.
Every now and then, I hear the notion that the Eurosystem could also make a contribution,
for instance, by providing bridge loans. I don't think that's a good idea. True, a central bank
can provide emergency liquidity - but only if a bank is suffering from temporary liquidity
shortages. However, it may not, and should not, contribute aid towards resolution or
restructuring, as this can easily cross the line into fiscal policy.
As a last resort, however, the fund could request public financial assistance for example,
from the ESM, as there could be threats which, in extraordinary cases, could require
recourse to public funding.
5. Direct recapitalisation through the ESM
Public funds is a buzzword and a hot-button issue, one that is inseparably linked to the
question: who is the public that is supposed to be doing the funding? Should nation-states be
called to pay up whenever a crisis occurs, or should there be a joint European fund? I see no
compelling reasons why the costs of bank restructuring should be shifted entirely to the
European level. You see: the weal and woe of a bank depends not only on the competence
of its management but also on external factors: the quality of supervision; the financial and
economic strength of its borrowers, which in turn hinges on a nation's economic policy; and
also the fiscal policy of the country where a bank is based. Ample proof of this assertion is
provided by the fact that a bank's funding costs are dependent on the sovereign credit rating
of its home country. Although we will be centralising supervision in Europe next year, other
factors such as economic and fiscal policy will remain largely the responsibility of individual
nations. And, as long as that is the case, the arguments for shifting losses completely to the
European level do not appear to be compelling.
The Balance Sheet Assessment provided for by Article 27 of the SSM Regulation also
acquires major significance in this context: this article requires the ECB to assess the
portfolio quality of the banks it will be supervising in future. What the regulation does not say,
however, is what happens if hidden losses are disclosed. I have two things to say about this.
I consider the Balance Sheet Assessment to be very important. For it to be successful, we
should base our assessments of banks' balance sheets not only on supervisors' judgements.
We should also enlist outside specialists - external auditors - for a quantitative assessment.
Not only in order to restore market participants' confidence in the European banking industry,
but also to minimise reputational risk for the ECB. All supervisors in Europe are familiar with
ad hoc examinations. These are precisely the instruments we should be using here. This is
the only way we can avert the suspicion of national supervisors taking too much account of
national special circumstances.
My other remark follows on directly: it concerns the legacy risks of banks supervised under
the SSM. As these risks were created in the past, under the responsibility of individual
member states, they should be borne in a national context, too.
6. Changes to primary law
I have twice mentioned changes to primary law in the context of the banking union: once
referring to the SSM and again with regard to the SRM.
I am indeed aware that many are recoiling at the thought of changing primary law, as it is a
long and winding road. Ultimately, however, the project of creating a banking union is similar
to the creation of the single monetary policy. And, we did things properly then and started by
establishing a sound legal foundation. If it was good enough for establishing a monetary
union, it will be good enough for a banking union.
That notwithstanding, I think the SSM and a restructuring and resolution mechanism should
be launched prior to changing EU primary law. However, we should start working on
amendments to primary law right away, given the foreseeable difficulties and the amount of
time this endeavour will probably take.
7. Significance of the single supervisory mechanism to the Bundesbank
While I am here with you today, the ECB is visiting my colleagues at the Bundesbank to put
on a "road show" extolling its virtues as an employer. As Goethe's Faust put it: "Two souls,
alas! are dwelling in my breast" - as much as I look forward to a single supervisory
mechanism, to the success of which many of my fellow Bundesbankers will be instrumental, I
will be very, very sorry to have to do without them at the Bundesbank. The SSM, after all, is
designed in such a manner that the quality and expertise of national supervisors will continue
to be the decisive factor.
This constituent of the EU - the principle of subsidiarity - will have a place in the banking
union, too. Nonetheless, themes relating to banks and their supervision and resolution will
acquire a new European dimension. And, as long as it is done well, this is as it should be.