Pentti Hakkarainen: Banking Union in the Nordic context
Keynote address by Mr Pentti Hakkarainen, Deputy Governor of the Bank of Finland, at the
Nordic Opportunities/SEB Seminar, London, 3 September 2013.
* * *
Accompanying slides can be found on the Bank of Finland's website: Slides (PDF)
It is an honor and a great pleasure for me to participate in this seminar here in the heart of
the City. It is especially pleasant to do this under the benevolent eye of the present Lord
Mayor. I am proud to say that Roger was actually one of the first investment bankers I got
acquainted with at the beginning of my career in finance when working for a big industrial
company's finance management in the 1980s.
The institution which I represent, the Bank of Finland, has had direct contacts with the City of
London for more than 150 years now. It was year 1861 when the Bank of Finland first
opened correspondent accounts with the London bank, N.M. Rothschild & Sons.
That correspondent relationship was our first outside the Baltic Sea basin and reflected
commercial contacts with Britain as well as the desire of the Finns to take part in the growth
of international finance.
I should also mention that only a couple of years later, we established banking contacts with
a new entrant to the Nordic banking scene, the Stockholms Enskilda Bank, which evolved
into today's SEB. The role of the founder, A.O. Wallenberg, became very significant for
Finland, not least as a trusted advisor in financial policy.
Those were the early years of international banking, and the beginning of the great "first
wave" of financial globalization which continued up till the First World War.
Now, of course, the global integration of finance and banking has reached totally new
dimensions which the recent international crisis has underlined. It is now universally
acknowledged, as a result of the crisis, that regulation and supervision must be brought up to
date with the new realities of the market place.
Nowhere has the crisis been more sobering than in the EU which has been forced to face the
problem of its fragmented structure of supervision and take the bold but long overdue step to
establish what is now called the Banking Union.
The Banking Union is still at an initial phase and much remains to be done before we reach
the goal. Also some changes are still possible.
It is my intention today to describe the most important features of the Banking Union as they
appear from my point of view. I will emphasize the Nordic perspective, but with Finnish twist:
Finland being the only country in the Nordic region which is also a member of the euro area,
and thus by definition a full participant to the Banking Union project.
Why a Banking Union?
[Slide 2]
The crisis since 2008 has made it clear that a highly interconnected and integrated financial
sector requires a stronger institutional framework than what we currently have.
• A problem at one bank can quickly spread to other banks both at home and beyond
national borders with devastating effects on the real economy and taxpayers.
• The crisis led to a sudden stop of capital flows within Europe, as banks withdrew
from foreign operations and financial integration took serious setbacks.
•
In 2010 it became desperately evident that the bank and sovereign risks are tightly
interconnected with two-way causality.
All in all, the mismatch between the scope of bank operations and the institutional
supervisory framework made the situation extremely challenging. As Lord Mervyn King so
tellingly put it, "(global) banks are international in life but national in death".
Credibility of national supervision has suffered because of three reasons.
•
First, national mandates of the supervisors led to inability to handle cross-border
challenges.
•
Second, the so called regulatory capture i.e. close relationships between banks and
the supervisor led to excessive forbearance on the part of supervisors.
•
Third, the large "publicly influenced" financial sector in Europe weakened the
credibility of public authorities.
Regaining of confidence in the banking sector is a necessary condition for reversing the
recent financial fragmentation in the EU, and for restoring a normal interbank market with
capital mobility.
•
Confidence and capital mobility are also important for restoring economic growth in
the area and putting the single market programme back on track.
•
Let me emphasize that public authorities play only a part in this work. Financial
institutions and their stakeholders also have a very important role, in redefining
business strategies, governance and risk management procedures, and
strengthening their capital positions.
Key elements of the Banking Union
[Slide 3]
The first main element of the Banking Union is the Single Rule Book for supervision.
•
This is based on the idea of identical regulatory requirements (such as capital
adequacy rules) for banks. These are achieved through European Regulations or
binding standards issued by the European Banking Authority (EBA), while leaving
leeway for national authorities to impose stricter requirements nationally for
macroprudential reasons - e.g. in order to contain real-estate bubbles.
•
The EBA is charged with the task of harmonizing supervisory practices. It has the
legal competence to develop and monitor the implementation of the Single Rule
Book.
The establishment of the Single Supervisory Mechanism (SSM) is the second main element
of the Banking Union.
•
Contrary to the Single Rule Book the institutional framework in the Banking Union
will only cover a subset of EU member states - the euro area countries and the
countries opting in.
•
As the name implies, the SSM will be a unitary supervisory system, composed of
national competent authorities and the ECB - and close cooperation between them
- and with the possibility of non-euro area Member States to participate.
• The ECB will assume direct supervisory responsibility and major decision making
powers for significant banks meeting certain criteria. We expect the number of
banks falling under direct ECB supervision to reach some 130-140.
•
I will return to the subject of the SSM in a moment.
The third element of the Banking Union is the Single Resolution Mechanism (SRM).
•
The single resolution mechanism is needed to coordinate and direct the resolution
policies of the member states, in particular of institutions whose failure would have
cross-border implications.
• An important precondition for the SRM is a swift adoption of the Bank Recovery and
Resolution Directive (BRR), as it lays out a harmonised toolbox enabling the orderly
resolution of even a systemically important institution.
The Single Supervisory Mechanism
The SSM will operate as a system, gathering all of the expertise of national supervisors and
at the same time possessing a strong decision-making centre.
•
Appropriate decentralisation procedures are being planned, while preserving the
unity of the supervisory system and avoiding duplication.
•
The justification for the two-tier system is that the local supervisors will have an
information advantage with respect to local banks. The centralized decision making
is required to address cross-border issues and to minimize the risk of excessive
forbearance on the part of local supervisors.
• The shared competence is important also because credit cycles differ nationally and
the associated potential problems need to be mitigated through nationally
differentiated ways.
The SSM, with the ECB at its centre, is entrusted with an extensive set of micro- and
macroprudential powers, covering all key tasks relating to the prudential supervision of credit
institutions.
The SSM will possess early intervention powers according to the draft Bank Recovery and
Resolution Directive. The early intervention powers are significant and make it possible to
take action with respect to institutions which are approaching the point of non-viability.
To ensure a strong centre, the ECB's overall responsibility for supervision is matched by
controlling powers over the system as a whole.
•
First, all the components of the system will have to act in accordance with a system
of guidelines, ECB-specific regulations and manuals of supervisory practices.
• Second, the ECB supervisory function will have the power to overtake direct
supervision of any bank or group of banks, if this is deemed necessary in order to
preserve financial stability and confidence in the institutional framework.
•
Third, the centre monitors that adequate supervisory quality prevails in national
competent authorities.
•
Fourth, the ECB supervisory function, at the centre, will receive all supervisory data
regarding all the banks. This will make the power to overtake the supervision of any
bank effective, and will also make it possible to ensure overall supervisory quality.
The supervision will, in practice, be based on a risk-based approach.
• A common SSM Risk Assessment System is being developed, relying on an
integrated and harmonized information base.
• The System will be used for assessing the capital and liquidity needs of banks and
also to direct supervisory resources (e.g. inspections planning) on the basis of the
risk- and impact assessment.
•
Common methods and processes will be developed for assessing the adequacy of
banks' capital and liquidity levels. This establishment of common supervisory
practices within the SSM will go considerably deeper than the work of the EBA in
developing the Single Rule book and harmonizing supervisory practices at the
EU-level as a whole.
The governance structure of the SSM has been designed so as to separate the ECB's
monetary policy and supervisory roles, and to make the position of different participating
countries as fair as possible.
•
A new body, the Supervisory Board, will be responsible for the supervisory functions
of the SSM. While the decisions are formally and finally adopted by the Governing
Council of the ECB, the Supervisory Board will be, de facto, the main
decisionmaking body in supervisory matters.
-
The Governing Council cannot alter the decisions of the Supervisory Board,
but only prevent their entry into force.
-
Such a veto power could be exercised when the decision is seen to be in
conflict with monetary policy.
-
This principle was accepted at the level of the European Council by all
governments, which seems to indicate that in the future we see an extension
of the SSM further beyond the euro area.
The special status of the non-Euro Area countries is taken into account in the
decisionmaking mechanism.
•
Non-euro area member states can participate through establishing a close
cooperation agreement with the ECB.
•
By giving non-euro area Member States full membership and voting rights in the
Supervisory Board they are placed on an equal footing with the euro-area members.
•
If the Governing Council prevents the entry into force of a decision, which results in
a modification of the decision, a non-euro area country may announce
nonsatisfaction with such a decision.
•
If the Governing Council decision prevails, the non-euro area country can choose
not to adopt the decision. For its part, the ECB could then consider breaking up the
agreement of close cooperation.
Joint Supervisory Teams will be established. They will integrate the ECB and national
competent authority staff into single supervisory units responsible for the conduct of the
on-going supervisory activities, planning of on-site inspections and other supervisory work
and for preparing supervisory decisions.
•
The Teams will be established and led by the ECB.
•
There will be one Team for each significant banking group, tailored to the needs of
each banking group (proportionality).
•
The Joint Supervisory Teams will provide a single interface for the supervised banks
and a single entry point for applications e.g. concerning internal models to be
approved by the supervisor.
The crisis has shown that micro-prudential supervision at individual bank level is not
sufficient, and that macro and micro risks can actually be mutually reinforcing. This calls for
very close cooperation between the macro- and micro-prudential functions. The SSM has
powers also in the macro-prudential area, which is a shared competence with national
macro-prudential authorities.
•
The ECB will comment on national measures and has the possibility to tighten the
national measures if they are deemed inadequate.
•
Macro-prudential instruments could also be applied to the euro-area financial
system as a whole.
•
The role of the EU macro-prudential supervisor, the European Systemic Risk Board
(ESRB), is broader both geographically and functionally than the SSM. The ESRB
covers all EU member states and the whole financial system rather than only the
banking sector.
The practical preparation of the SSM has been well underway since autumn 2012.
•
The main elements of the supervisory model and the Supervisory Manual are in the
process of being developed.
•
The ECB is preparing a Framework Regulation, setting out the main responsibilities
of the ECB and national authorities and the main requirements set for banks in the
SSM.
•
The main features of the SSM Risk Assessment System should be available and the
list of significant banks entering into SSM direct supervision should be completed in
the next few months.
•
Provided that the SSM regulation is accepted and promulgated in time, the
Supervisory Board of the SSM will be established in October 2013.
•
During late 2013 and the spring of 2014 the newly established SSM Supervisory
Board carries out the needed consultations and then adopts all the basic documents
setting out the operations of the SSM.
•
The ECB supervisory functions will be staffed during the remainder of 2013 and the
beginning of 2014 in order to have the SSM fully operational as of October 2014.
Of particular relevance for the start of the SSM and a key element in confidence rebuilding
will be the Balance Sheet Assessment of banks to be conducted before the SSM is up and
running.
•
The Balance Sheet Assessment is intended to make sure that legacy asset
problems will be detected and sufficiently addressed before the operational start of
the SSM.
•
The plan is to have the BSA finalised in the spring 2014, after which pan-European
stress tests will be conducted in close cooperation between the European Banking
Authority and the SSM.
The Single Resolution Mechanism
The need for swift and orderly resolution of failing cross-border banks is the Achilles heel that
needs to be addressed. Europe needs to move from national to supranational resolution
arrangements for significant banks.
Enhanced resolution policies complement and would be supported by the structural
regulations proposed by the Vickers commission in the UK and the Liikanen report on the EU
level.
The Single Resolution Mechanism will be based on the Bank Recovery and Resolution
Directive. This will create an institutional framework with enhanced powers to restructure and
wind down failing banks.
•
The new powers to bail-in bank debt holders are a crucial, element of the future
resolution mechanism, which should limit the use of bail-outs significantly. The
intention is that in the new regime, bail-in will be the rule, bail-out a rare exception.
•
The draft BRR Directive requires that national resolution authorities cooperate with
each other and that resolution colleges are established from all the resolution
authorities of the countries where the bank has business operations. This takes us
some way in facilitating orderly resolution of cross-border banks. There are some
weaknesses that remain:
-
The draft BRR Directive or any other existing arrangement do not contain
compulsory coordination of resolution measures before they are taken by
home and host authorities. Hence, there is no explicit and binding resolution
mechanism for cross-border banks.
-
Conflicts of interest and incentives for ring-fencing that have plagued
crossborder crisis management will still be inherent to the framework. Both home
and host authorities could exercise ring-fencing at their own discretion.
•
It is thus doubtful that a resolution college could effectively coordinate in time the
necessary decisions involved in the resolution of a cross-border banking group and
resolve the conflicts of interest.
-
We need a supranational decision making body with resolution powers and
good decision making procedures, and the same institutional and
geographical scope as the SSM.
-
Ideally there should be a Single Resolution Authority, which would govern the
resolution of banks and coordinate the application of resolution tools. It should
have:
o a clear and relatively narrow mandate to protect it from political pressure
and to achieve credibility.
o a comprehensive set of enforceable tools, powers and authority to
resolve all banks under the SSM.
o a task to ensure that failing banks are resolved swiftly, through impartial
decision-making focused on the European dimension.
Agreeing on the mandate and powers for the EU-level resolution authority will be easier if
unfounded national interests are not allowed to play a role, and if it is clear that the following
two principles are respected in reorganizations:
•
Minimizing taxpayers' liability (with regard to the governments)
• Striving for the least cost solution (with regard to the financial sector).
Even though these principles are the main thrust of the commission proposal, a clear
statement on the principles is warranted. I believe that kind of explicit statement would
facilitate discussions on who is deciding and about what.
Orderly and efficient resolution is not only a problem for the so-called peripheral countries
which have made the headlines recently.
•
The UK has had its share of these cases, as you know.
• In the Nordic region there was earlier experience from the banking crisis of the early
1990's.
• The dramatic crisis in Iceland had some repercussions in the other Nordic countries,
and in the UK and the Netherlands as well, when local host country authorities had
to intervene in order to control the situation, with more or less satisfactory outcomes.
•
There have been also other cases of authorities' intervention in the Nordic region,
mostly in Denmark, where the local property financing market threw a number of
banks into trouble. In Sweden and Finland there have been cases of small
"boutique" type banks which have been closed.
Deposit guarantee schemes
A Pan-European Deposit Guarantee Scheme has also been proposed as an element of the
banking union. The planning of such a scheme is still in a very early phase. It is clearly more
difficult to establish than the SSM or the SRM. One reason is that the existing national
systems are very heterogeneous.
•
A politically sensitive issue is the possibility of mutualisation of risks, or national
funds in a situation in which significant funds have already been gathered in some
countries while at the same time none, or very little, have been gathered in other
countries.
•
Nevertheless, as long as deposit guarantee systems are predominantly national, a
strong channel of potential contagion remains between banking sectors and the
states.
It may be that once the SSM and the SRM have established an effective control of the
European banking sector, and the legacy issues from the previous crisis have been solved,
the discussion about a common deposit guarantee scheme will move forward.
•
As a first and important step, further harmonization of national schemes along the
lines suggested by the Commission in the draft Directive is called for.
The Nordic dimension
[Slide 4]
The cross-border character of the Nordic banking sector has a long tradition and has become
more and more pronounced. It calls for a corresponding structure for its supervisory
framework.
•
The Nordic banking sector is dominated by a small number of international banks,
which are large relative to their home-country GDP. The assets of the six largest
banking groups (Nordea, Swedbank, SEB, Handelsbanken, Danske Bank and DnB)
comprise roughly 94 percent of the total assets of all 53 publicly-listed Nordic banks
and equal over 180 percent of the combined Nordic GDP. Four of these have their
parent banks in Sweden, one in Denmark and one in Norway.
•
Each of the large banking groups is nationally very significant. However, their
operations, credit exposures and depositor base are typically regional. About
85 percent of the largest six banks' exposures and deposits are located in the four
Nordic countries and roughly 3⁄4 of their full-time employees are based in the region.
Local banking groups add to the heterogeneity of the Nordic banking sector.
•
Of the six large banking groups, only the DNB limits almost all of its operations to its
home country (Norway).
•
OP-Pohjola Group, with cooperative roots, focuses its operations on the domestic
market and is one of the two largest banks in Finland.
•
The national networks of savings banks have a strong footing in many Nordic
countries.
The establishment of the SSM is very interesting from the perspective of the Nordic banking
sector.
•
As a euro area country, Finland will automatically participate in the Banking Union.
•
If the national competent authorities of non-euro area Member States, Denmark and
Sweden, opted to participate in the SSM the supervision of the significant banks in
these countries would be the direct responsibility of the ECB.
•
Should the home-country authorities of the large banking groups headquartered
outside the euro area remain outside of the SSM, the ECB would assume the
responsibility of a host supervisor of the major subsidiaries in the euro area.
-
Nordea and Danske Bank have significant subsidiaries in Finland, which
would bring them under direct supervision of the ECB.
-
Also some other banks from the outside potentially fall under SSM
supervision. The Swedish SEB, for instance, has a subsidiary in Germany.
-
Other large subsidiaries of non-euro area banks in the euro area include Bank
of America (Ireland), HSBC (France and Malta), RBS (Netherlands), Bank
New York Mellon (Belgium), Barclays (Spain), GE Capital (France), State
Street (Luxembourg) and Cerberus (Austria).
A strong Nordic dimension in the Banking Union would be a positive development, not only
for the Nordics themselves, but it would also help in building highly competent regulatory
bodies.
•
It would simplify the supervisory structure if all Nordic authorities would operate
under the SSM roof.
•
I believe that the Banking Union would benefit from the tradition of integrity and
transparency which are at the core of supervision practices in the Nordic countries.
•
Good supervisory practice in the region is built on the experience from the banking
crisis that struck the Nordic countries in the early 1990s. I believe that the whole
Banking Union could benefit from this experience.
There is a long and evolving tradition of cooperation between Nordic supervisors.
Participation in the SSM would strengthen the governance of this cooperation and make it
better aligned with the structure of the major banks in the region.
Implications for banks
[Slide 5]
The changing structure of supervision will probably have some interesting implications for
competition in banking and the operating conditions of the banking sector.
Banks will find that the SSM brings benefits in the form of reduced administrative costs and
increased certainty and commonality in supervisory practices.
•
Even within such a closely integrated region as the Nordic, there are still differences
in the supervisory practices. Without the SSM, this generates uncertainty and
additional administrative costs.
Banks in the SSM can benefit from uniform supervisory practices and the single entry point
to authorities, which should reduce the supervisory burden on cross-border banking groups,
including reporting costs. It will also provide additional assurance of a level playing field
across the banking market.
• Participating in the SSM may also mean easier conduct of cross-border mergers
and acquisitions as supervisory decisions and approvals on such transactions are
centralised at the ECB.
•
With the creation of a banking union, it might also be that the idea of the European
corporation, which was discussed some 5 to 10 years ago, and some Nordic banks
were contemplating, will revive. This would have implications in particular for the
operational efficiency of cross-border banks.
The unified supervision and the resolution tools of the SRM in particular may have some
impact on funding costs.
•
While the net impact of the Banking Union on the banks' funding costs is less
straight-forward to assess, the benefits of better credibility of supervision and
eventually also of a larger pool of resources for crisis resolution would be positive for
banks. Cutting the bank-sovereign linkage of creditworthiness, which is the aim of
the Banking Union, would be important for banks based in countries where
government finances are weak.
•
However, the net impact on the funding costs of banks will depend on how much of
the implicit government guarantee remains. Within the banking union, large
crossborder banks are likely not able to continue to enjoy their too-big-to-fail status. This
will correct the artificially low funding costs that these banks enjoy. In countries
outside the banking union, where there will be no pooling of resources to alleviate
the too-big-to-fail problem, systemically important banks will likely continue to have
lower funding costs than less significant banks.
There are reasons why the Banking Union may have an impact on the market value of
banks.
•
The increased confidence in banks based in countries participating in the banking
union may increase investors' interest in them, thus facilitating their funding.
•
The core factor is a credible assessment of bank balance sheets.
-
There is an "uncertainty discount" attached to (almost) all banks due to opacity
of bank's balance sheets creating some uncertainty as to the quality of the
assets. The market (currently) assesses assets with some caution and is
hence undervaluing many, if not most, banks to be on the safe side.
-
The Banking Union and in particular its Balance Sheet Assessment, provided
that it is seen as credible, will increase transparency and thus reduce the
uncertainty attached to the market value of banks.
-
Pricing will more correctly reflect the true value of the banks. The discount
unfairly attached to good banks will be reduced, or even eliminated. The weak
banks will, however, most probably see their share price drop even further.
Banks that are no longer deemed viable need to be restructured or wound
down through orderly resolution processes.
-
An unanswered question still is the potential impact on the required return on
equity. While some studies suggest that owners could accept lower returns
due to a safer and more stable business environment, there is no really clear
evidence on that yet.
•
The Banking Union will moreover reduce the impact of the financial position of the
country in which the bank is headquartered on the market value of the bank.
-
The size and significance of the cross-border banks will no longer be related
to the size and fiscal strength of a single country but rather to a region that
reflects its operations in a more appropriate way.
In thinking about the effects of the Banking Union on individual countries and banks we
should bear in mind that the Banking Union is built for the long term.
•
The current positions of strength or weakness of various countries and banks will
not be permanent: "The last will be first and the first will be last". We should
therefore evaluate the Banking Union from a general, not particular or transitory
perspective.
• Finally, the increased confidence in banks that fall under the SSM supervisory
umbrella may open up wider cross-border business opportunities for banks and
reignite the integration process of the European banking sector.
Customer perspective
The SSM will also impact bank customers.
• For retail customers and depositors especially, there can be some enhanced
comfort through perceived high-quality supervision that can come to some benefit
for SSM banks as e.g. attracting new customers is facilitated. This is particularly true
for foreign subsidiaries, which may be perceived as less reliable than the well
established banks.
•
Again such matters can become particularly significant if the financial standing of the
national safety nets is put in doubt.
• Despite the strong financial position of the Nordic countries and the high integrity of
Nordic supervisors, there, may still be a positive impact on the customer perception.
One could also expect that improved prudential supervisory procedures could have positive
spill-over effects on the market-conduct supervision and even consumer protection which will
remain national responsibilities within the SSM.
Conclusions
[Slide 6]
The disparity between international banking and national supervision and resolution powers
have been the Achilles heel of the European banking market, a problem that is now finally
being addressed. It is regretful that we had to wait until the recent crisis before progress
started on this front.
•
This is particularly important for the Nordic banking market, which is exceptionally
integrated and interconnected, while the countries' starting positions are so
divergent, not all being members of the euro area. I hope that the different currency
arrangements in the region will not prevent progress in supervision.
An important impulse for the establishment of the Banking Union came from the desire to
protect taxpayers and reduce their liability in the banking system. However, in my view, the
SSM should also offer significant benefits to the supervised banks: supervisory requirements
will be harmonised across borders and there will be one entry point into supervision.
Grouplevel supervision will be emphasised rather than the supervision of subsidiaries.
•
This should be quite beneficial especially for those banks which have large
crossborder activities. Big Nordic banks are prime examples of such banks. Clearly, the
SSM will ease banks' international operations and help ensure a level-playing-field
for banks.
To the above we can add the benefits of stronger investor confidence which should result
from the strong, objective and high-quality supervisory work.
Finally, the billion dollar question: would the recent financial crisis have been avoided in
Europe if the EU had established the banking union before the problems surfaced?
I think probably not completely, since the reasons for the crisis were to a large extent global
in nature. But the crisis would likely have been milder and less damaging. The European
market would have been less fragile and the authorities could have been able to act more
quickly and more decisively. Both supervision and resolution would have contributed to that.
On the supervision side, better, more credible and internationally uniform supervision would
have reduced uncertainty among investors and politicians about the condition of the banking
systems of the highly indebted countries. That would have made markets more resilient and
avoided some of the costs of the drying-up of the interbank market, which hurt even the
fundamentally healthy banks.
On the resolution side, if clear ex ante rules for dealing with problem banks had been in
place when the crisis hit, the resolution of unviable banks could have been enforced more
quickly and more efficiently.
The bail-in tool would have been available to reduce the cost of the crisis to taxpayers. Also,
favouring of "national champions" would have been avoided, so recovery and resolution
policies would have been more consistent and effective. Healthy competition in the banking
sector could have been restored sooner without compromising the stability of the system.
To conclude: Bygones are bygones, but by learning from the past we can prevent or at
least mitigate many risks and problems in the European banking sector in the future.
This requires unifying our regulatory structures to match the European financial
market. We should avoid the use of taxpayers' money and leave unfounded national
interests aside. The Nordic region should certainly be no exception.