SPEECH

Preparing for the next decade of European
banking supervision: risk-focused, impactful
and legally sound

Speech by Frank Elderson, Member of the Executive Board of the
ECB and Vice-Chair of the Supervisory Board of the ECB, at the "10
years SSM and beyond" event organised by Allen & Overy

Frankfurt, 27 June 2024

Introduction
Thank you for inviting me to this conference on ten years of European banking supervision.

It is hard to believe that it's only a decade since supervisors from across Europe first came together in
truly European supervisory teams on a Tuesday morning in November 2014.

Just like the first ten years of a child's life, the first decade of European banking supervision has also
been a period of growth and development. During this time, we have matured from a start-up into a
well-established, effective supervisor, building on the best practices of supervisors across Europe. And
this is more relevant than ever given the increasingly complex external risk landscape. Think about
heightening risks from geopolitical shocks, cyber risks and the climate and nature crises.

These evolving risks require supervision to evolve, too. This is why we have embarked on a journey to
make European banking supervision more risk-focused, efficient and effective. For example, we
recently announced change to the Supervisory Review and Evaluation Process (SREP) - our annual

health check of banks - making it more targeted and more risk-focused in a new risk environment.4]
The revised SREP also puts greater emphasis on impact and effectiveness, which is the focus of my
remarks today.

In this context, I am pleased to be speaking to an audience of general counsels from the banks under

our supervision. The way we - ECB Banking Supervision - interact with you - representatives of the
banks we supervise - is of paramount importance for our shared goal of safe and sound banks.

Our supervisory toolkit: broad, effective and going beyond capital

So, what does effective supervision mean in practice?

Our experience of almost ten years of European supervision shows that, in most cases, banks
address the root causes of supervisors' findings and that's the end of the story. If banks remediate

shortcomings in a timely manner based on what we refer to as "supervisory dialogue", we have a very
efficient and effective way of supervising.

But there are also cases where banks fail to address deficiencies in good time. For these cases, the
legislator has given the ECB a very broad supervisory toolbox that we are able and willing to use -
always in a proportionate manner.

Internationally, various reports on the lessons from the banking turmoil in March 2023 all explicitly
recommended that supervisors should make active use of their supervisory tools to compel banks to

take timely and concrete remedial action.! In fact, International Monetary Fund staff concluded in a
paper published in 2010 that a willingness to act is a key ingredient for good supervision.)

Moreover, in 2022 we took the initiative to ask a group of independent experts to review our SREP. In
their report, which was published last year, they also urged the ECB to use the full range of

supervisory tools available./4]

The use of supervisory powers to compel banks to make concrete improvements is therefore not
merely a nice-to-have - it is international best practice to ensure that banks remain safe and sound,
which is the ultimate goal of prudential supervision.

So, when and how do we use these tools?

We act fully in line with the principle of proportionality, using supervisory tools as appropriate, as

necessary and - once the appropriateness and need has been established - decisively. Central to this
approach is an escalation ladder, giving banks the opportunity to address shortcomings and their root
causes within a defined time frame, with interim deadlines if and when appropriate. If using a less
intrusive tool does not lead to the desired outcome being achieved in a timely manner, we will
expeditiously deploy more intrusive tools to compel banks to take the necessary remedial actions in
time.

The escalation process is not, however, automatic and it always depends on the specific
circumstances. This means that some serious issues requiring immediate remediation could lead to
more intrusive supervisory measures being used at an early stage.

The tools available to us range from binding quantitative and qualitative supervisory measures to
sanctions and enforcement measures such as periodic penalty payments. !&]

Let's look at these tools more closely.

Some might think of Pillar 2 capital add-ons", the most common quantitative supervisory measure, as
the sharpest tool that a supervisor has. But while setting bank-specific Pillar 2 capital requirements is
undoubtedly a vital element of our toolbox, it is far from being the only one.

Article 16 of the SSM Regulation gives the ECB the power to impose a wide range of what we call

"qualitative requirements", based on a bank's specific circumstances. These tools are particularly
relevant for addressing the root causes of weaknesses, for instance in internal governance or risk
management. These qualitative areas are very often the source of problems that subsequently
materialise in risks to capital and liquidity. The banking turmoil in March 2023, for instance, was a clear
reminder that shortcomings stemming from weak governance can, if left unaddressed, later resurface
in quantitative areas such as banks liquidity positions. Consider Silicon Valley Bank, which had
significant interest rate risk as a result of holding long-term securities. Despite the bank having

repeatedly breached internal risk limits, its management did not adequately address these issues and
supervisors did not escalate their concerns until it was too late. As interest rates rose, the value of
those securities fell, and SVB incurred substantial losses when it was forced to sell them to cover

withdrawals.!&]
Periodic penalty payments, an example of an enforcement measure, are another vital part of our

toolbox. They are an effective tool that we can use as part of an escalation process to compel
individual banks to comply, by a specific date, with our requirements in respect of any prudential risk
that is not properly covered and managed. While the decision to impose periodic penalty payments is
always specific to an individual bank, if there are breaches of requirements related to risks that affect
several institutions simultaneously, we may need to consider imposing this measure on various banks
at the same time. And this is precisely what we have been doing in the area of climate-related and
environmental (C&E) risks.

Let me focus on this example. Considering the clear requirements set out in the Capital Requirements
Directive and the need for banks to implement a regular process for identifying all material risks, we
have been clear that all banks under our supervision must ensure that their practices are fully aligned
with the sound management of C&E risks. Building on what banks themselves considered reasonable,
we have set a series of (interim) deadlines by which banks have to reach certain milestones.

As a first step, we asked all banks to ensure that they had sound and comprehensive materiality
assessments in place, which is the basis for managing any kind of risk. We were clear that we
expected all banks to meet this deadline by March 2023 and that, if necessary, we would use all the
tools at our disposal to enforce it, as well as any subsequent deadlines.

Most, but not all, of the banks under our supervision made significant strides in advancing their
materiality assessments by the March 2023 deadline. So, it should be no surprise that we took action
on this: we moved further up the supervisory escalation ladder and issued binding supervisory
decisions for 23 banks, which included the potential imposition of periodic penalty payments for 18
banks if they failed to comply with the requirements by the deadlines set out in these decisions.

Encouragingly, most banks have now submitted a meaningful materiality assessment. This shows that
our supervisory pressure has been effective and has led to the desired outcome for the majority of
banks.

In parallel to our actions in relation to the first interim deadline, we are currently concluding our
assessment of banks' progress in meeting the second interim deadline. For this second deadline, we
asked banks to clearly include C&E risks in their governance, strategy and risk management by
December 2023. As with the first interim deadline, if we see that banks have not satisfactorily
delivered, we will consider adopting supervisory measures that already contain an enforcement
measure. In other words, we may tell those banks to remedy the shortcoming by a certain date and, if
they don't comply, they will have to pay a penalty for every day the shortcoming remains unresolved.

The last tool that I would like to mention is sanctions, which are intended to punish banks for

misconduct and to deter future infringements." For instance, we have imposed penalties on banks

that failed to comply with the requirements set out in binding ECB decisions" or with EU prudential
requirements.

Legal considerations for effective supervision

Let me now turn to the legal considerations that constitute our guiding principles for exercising our
supervisory powers.

When we - European banking supervisors - are using our rich supervisory toolkit and exercising our
margin of discretion in imposing supervisory and enforcement measures, as well as sanctions, we take
great care to remain within our mandate, to act in accordance with the relevant EU law and to act
proportionally.

We make sure that both our findings and the requirements we impose in our supervisory decisions fall
squarely within the prudential tasks conferred on us under Article 4 of the SSM Regulation. We use all
powers available to us to ensure that banks manage and cover their risks properly and that they

comply with the applicable prudential legislation.

Our underlying objective is to ensure the safety and soundness of credit institutions and the stability of
the financial system.

When deploying our supervisory toolkit in the exercise of our mandate, we apply the relevant Union
law. We carefully analyse EU and national legislative texts, when applicable, taking into account the

wording, context and objectives of the legislative provisions.
We consider relevant case-law and general principles of law.

We state the reasons on which our decisions are based with the aim that banks understand what we
perceive their shortcomings to be and what we expect from them.

When we issue sanctions or impose periodic penalty payments, we use a coherent methodology.

We always make sure that we use our tools in line with the principle of proportionality. In other words,
we consider whether the powers we use at any given time are appropriate for attaining our prudential
objectives. We ascertain that we are not going beyond what is necessary and that the effects of our
measures are not disproportionate to the prudential objective we are pursuing. Accordingly, one of the
objectives when escalating supervisory action is to enable us to act swiftly and proportionally.

In doing all this, we also ensure that our decisions are based only on facts and findings on which the
banks have been able to comment.121

The right to be heard is a key procedural safeguard. We take it seriously and are committed to
listening to banks' arguments and comments. In a number of cases we have changed supervisory
decisions based on the comments made during the right to be heard process. For example, there have
been cases where we have changed requirements into recommendations or prolonged the deadlines
for compliance with our requirements, reflecting our willingness to consider the specific circumstances
and arguments of individual banks.

We - as European banking supervisors - believe that both the supervisory dialogue and banks'

comments during the drafting phase of the decision can lead to increased mutual understanding and
better decisions with better calibrated measures.

Finally, if after those exchanges you - the supervised banks - still doubt the substantive and
procedural conformity of the ECB's decision with the SSM Regulation, you may request an internal

administrative review at the Administrative Board of Review,."3]

While we do everything we can to ensure that we act within our mandate, correctly apply the relevant
Union law, act proportionally and listen to your arguments, we note that banks are fully within their
rights to ask EU courts to review our decisions. Litigation is, ina sense, a natural aspects of
supervision, with supervisors actually using the tools they have been granted by the legislator to
ensure compliance and timely remediation. Indeed, in the past ten years the ECB has been involved in
98 cases involving 102 actions requesting either annulment or damages, or alleging that the ECB was
failing to act.

So far, in most cases the courts have upheld our decisions in which we exercised our supervisory
powers. And whenever one of our decisions has been annulled, we have drawn lessons from that

experience to further improve the way we work.

Avery recent example I can mention is the ECB decisions requiring part of the prefunding given to the
national deposit guarantee schemes and the Single Resolution Fund to be deducted from banks'
capital in cases when the banks did not reflect the loss of economic resources from this funding in
their capital. These decisions revolved around the technicalities of the so-called irrevocable payment
commitments, how these commitments are secured by collateral and how banks reflect the loss of
economic resources in their capital, liquidity and internal arrangements. Our first set of decisions was

annulled in 2020 by the General Court!4], which considered that our reasoning for imposing these
measures lacked an individual assessment of how the risk we identified was managed and covered by
the arrangements implemented by the banks and the capital and liquidity held by them. Following
these judgments of the General Court, the ECB improved its methodology to better cater for this
individual assessment and took new decisions in relation to the irrevocable payment commitments
with an improved motivation. These new decisions were again challenged by some banks, but this

time the General Court upheld the new decisions with our improved methodology.) This learning
process is part of us striving to be an effective supervisor that, while always acting legally and
proportionally, never rests until material prudential risks are covered and managed, necessary
compliance has been achieved and remediation has been ensured. In this sense, we will not stop
using our toolbox for fear of litigation, as we firmly believe that we can also learn when subject to

judicial scrutiny.

Conclusion
Let me conclude.

As we approach the next decade of European banking supervision, the fundamental objective of
supervision - ensuring safe and sound banks - will not change. To achieve this objective, we are
putting greater emphasis on impact and effectiveness. We need to have a razor-sharp analytical focus
on risks, and we need to insist that the weaknesses we identify are remedied in good time. Ensuring
timely remediation is more relevant than ever considering the fast-evolving environment that we live in.

And crucially, we have an extensive toolkit at our disposal that we are willing to use to meet that
objective.

In our supervisory process, we listen to you - representatives of the banks we supervise - because,
ultimately, both supervisors and banks have a common objective: ensuring that the banks remain safe
and sound.

So let us make good use of every aspect of our supervisory dialogue, including the right to be heard,
so you - the banks we supervise - can better understand our prudential concerns and we - European
banking supervisors - can better understand the implementation challenges you may face.

Together, we can navigate the challenges of this new risk environment.
Together, we can make sure that European banks are also able to weather these storms.
Together, we can ensure that banks remain safe and sound in the decades to come.

Thank you for your attention.

1.
Buch, C. (2024), "Reforming the SREP: an important milestone towards more efficient and effective

supervision in a new risk environment", The Supervision Blog, 28 May.

2.

Board of Governors of the Federal Reserve System (2023), Review of the Federal Reserve's

Supervision and Regulation of Silicon Valley Bank, April, p. 8; Basel Committee on Banking

Supervision (2023), Report on the 2023 banking turmoil, October, p. 26; International Monetary Fund

(2023), Good Supervision: Lessons from the Field, September, pp. 4 et seq.

3.

Vifials, J. et al. (2010), "The Making of Good Supervision: Learning to Say "No", IMF Staff Position
Note, International Monetary Fund, 18 May.

4.

ECB (2023), "ECB welcomes expert group recommendations on European banking supervision',
press release, 17 April.

5.

Elderson, F. (2024), "You have to know your risks to manage them - banks' materiality assessments

as a crucial precondition for managing climate and environmental risks", The Supervision Blog, 8 May.

6.
Article 16(2)(a) of the SSM Regulation (Council Regulation (EU) No 1024/2013 of 15 October 2013

conferring specific tasks on the European Central Bank concerning policies relating to the prudential

supervision of credit institutions (OJ L 287, 29.10.2013, p. 63).

7.

Elderson, F. (2023), "Powers, ability and willingness to act - the mainstay of effective banking

supervision", speech at the House of the Euro, 7 December.
8.
Board of Governors of the Federal Reserve System (2023), Review of the Federal Reserve's

Supervision and Regulation of Silicon Valley Bank, April.

9.
Periodic penalty payments require the bank concerned to pay a daily amount - up to 5% of its average

daily turnover - for every day the infringement continues during a maximum period of six months.

10.

Sanctioning proceedings can be initiated both in the case of ongoing breaches and after the breach
has ceased. The ECB can impose pecuniary penalties on banks for failing to comply with EU
prudential requirements. The ECB may impose penalties of up to 10% of a bank's total annual
turnover in the preceding business year, or twice the amount of profits gained or losses avoided as a
result of the breach, where those can be determined.

11.

See the ECB's banking supervision website for an overview of sanctions imposed by the ECB and the
national competent authorities in proceedings opened at the ECB's request, as well as statistics on
sanctioning activities in the context of European banking supervision.

12.

Article 22(1) of the SSM Regulation.

13.

To date the Administrative Board of Review has delivered 36 opinions.

14.

See the judgments of the General Court in cases T-143/18, T-144/18, T-145/18, T-146/18, T-149/18
and T-150/18.

15.

See the judgments of the General Court in cases T-182/22, T-186/22, T-187/22, T-188/22, T-189/22, T-
190/22 and T-191/22.

CONTACT
European Central Bank