Pentti Hakkarainen: Banking union - implications for Nordics?
Speech by Mr Pentti Hakkarainen, Deputy Governor of the Bank of Finland, at the Sveriges
Riksbank, Stockholm, 5 May 2014.
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Accompanying slides can be found on the Bank of Finland's website.
In Nordic countries we have a long tradition and experience on highly interconnected and
integrated financial market. If we look at the banking sector, same names are represented in
all countries. We had our own severe crises in early 1990s, but this time our financial sector
has survived pretty well, keeping itself in a rather good shape.
Since 2008, we have experienced a series of different types of crises. Each of them has had
devastating effects on the real economy.
In 2010 it became desperately evident that the bank and sovereign risks are tightly
interconnected and with a two-way causality, the so called bank-sovereign loop, weak banks
weakened sovereign and vice versa. A problem in one bank can quickly spread not only to
other banks but also to sovereigns beyond national borders with damaging effects on the real
economy and taxpayers both at home and in other countries.
The crises have made it very clear at least that international, highly interconnected financial
markets require a stronger institutional framework than what we have had in recent years.
The authorities need proper tools to deal with ailing banks operating in integrated
crossborder markets. The creation of these tools has taken major steps forward since, but there is
still a lot of work ahead.
The key lesson we have learnt is that economic dislocations without proper arrangements to
tackle troubled banks have devastating effects on the real economy, taxpayers and the
whole society. And coming back to "normal" proves to be painfully slow and long-lasting.
Financial market flaws
All in all, the mismatch between the scope of international bank operations and the national
supervisory framework made the situation extremely challenging.
What to do? In principle, we can envisage three solutions. First of all, we could re-nationalize
the financial markets. In such a solution, the single market would be lost. We would turn the
clock back, lose benefits of integrated markets. Second, we could just accept the risk of
financial instability and periodically pay the price. Or, finally, we could work to create a
banking union, with better suited institutions and systems for single supervision and
resolution.
Only the last one of these is acceptable. Institutional arrangements for supervision and
resolution need to match the integrated structures of banking business in the real world.
Before I continue to the Banking Union, I would like to recall ideas that Stefan Ingves raised
in 2006
"I propose the establishment of a new pan-European body, a European
Organization for Financial Supervision (EOFS). The idea is to create a separate
agency to follow the major cross-border banking groups in Europe".
"The EOFS should only focus on the presently about 40 truly cross-border
banking groups and not deal with the about eight thousand European banks with
a predominately national character."
"The EOFS should have three tasks: It should gather information about the
banking groups and their activities in different countries. Importantly, it should
also create unified risk-assessments of each cross-border banking group. Finally,
it should also oversee the activities and risks of these banking groups."
"To achieve these tasks, there is a need for a separate agency, staffed with a
sufficient number of competent employees. Initially, these employees could of
course be recruited from the existing national supervisors. Also the staff of the
EOFS would have to cooperate with the national supervisors."
At the moment, after eight years and severe crises, we are taking steps pretty much towards
the direction proposed by Stefan. However, he also mentioned that the authority should be
independent and not the ECB or the European Commission, but as we know according to the
current EU-treaties this was not a feasible option..
The European Union is now taking a significant step forward by establishing the Single
Supervisory Mechanism for the euro area and the non-euro area member states have a
possibility to join in the form of "close co-operation". Therefore, it may be fair to ask whether
we someday see Sweden to join the Single Supervisory Mechanism.
Banking Union
As part of the economic and monetary union and as a remedy for the crisis, the EU leaders
agreed in June 2012 on creating a true Banking Union.
The Single Rulebook provides a foundation for the Banking Union. It is based on the idea of
identical regulatory requirements, such as capital adequacy rules for banks. These are
achieved through European legislation and lower-level technical standards.
One of the main pillars of the Banking Union is the Single Supervisory Mechanism. I will
come back to the recent developments in its construction later on.
Another important pillar is the Single Resolution Mechanism. As you know, intensive talks in
the form of EU trilogue ended in March and European Parliament approved the SRM
regulation in April. In addition, deposit insurance schemes will be strengthened and
harmonised as part of the banking union in the long run.
The Banking Union may also be complemented by structural reforms. The European
Commission has made a legislative proposal based on the Liikanen report and it will be
finalised under the term of the next European Parliament.
In the future, the Banking Union, when properly implemented, will help us resolve banking
problems while avoiding to use taxpayers' money for bail-outs. This in turn means also better
incentives in banking and hence a more stable financial system.
Preparations for Single Supervisory Mechanism
Let me now share with you some recent developments in the Single Supervisory Mechanism
(SSM). The EU Regulation assigning supervisory tasks to the ECB became effective in early
November 2013. Already well ahead of this time in late summer 2012, the ECB and national
supervisors established the High-Level Group which steered practical preparations to ensure
timely adoption of supervisory responsibilities by the SSM. Thus we have got a "flying start"
for the whole project.
As a concrete step, the ECB Governing Council nominated Ms Danièle Nouy for Chair of the
Supervisory Board of the new Single Supervisory Mechanism. The Heads of Directorates,
four Director Generals have been appointed and most of the mid-level managers have been
nominated as well. A broader recruitment process of supervisors and analyst is under way
and they will join the ECB in waves by the end of the year.
The Supervisory Board had its historical first meeting in January and now on it meets twice a
month. At the beginning many of the issues have related to accepting, confirming and further
developing the issues prepared by the High-Level Group.
Now there is an on-going transition period, during which a comprehensive assessment of
significant banks is carried out. During the same period other preparations for the SSM are to
be completed.
Comprehensive Assessment
The Comprehensive Assessment of European banks is an essential element of the
preparations for the SSM. It should be noted that the SSM Regulation also enables the ECB
not only to obtain all the relevant information from the national authorities necessary for
making the assessment but also to take over direct supervision of any credit institution it
deems necessary. This is important to guarantee consistent application of high supervisory
standards.
The Comprehensive Assessment has three main goals. First of all, the assessment aims at
transparency through enhancing the quality of information available on the condition of
banks. Its second goal is to repair banks' condition by identifying and having the necessary
corrective actions implemented where necessary. Finally, the Comprehensive assessment
builds confidence by assuring all relevant stakeholders that banks are fundamentally sound
and trustworthy.
The ECB will conduct the Comprehensive Assessment in close cooperation with national
authorities, and also with ESRB and EBA. The ECB will detail the design and strategy of the
assessment exercise, monitor its execution, perform quality assurance as well as collect and
consolidate the results and finalise and disclose the overall assessment. National
supervisors execute the exercise at the national level, benefitting from local knowledge, but
following common data requirements and methodology. As an example of the extensive
methodology, the Asset Quality Review Phase 2 Manual was published in March. The
manual provides specific guidelines for all involved parties on the conduct of relevant steps
of the exercise.
The Comprehensive Assessment is indeed comprehensive. First we do a Risk Assessment
addressing key risks in the banks' balance sheets, including liquidity, leverage and funding.
After that an Asset Quality Review is carried out examining banks' balance sheets based on
information at the end of 2013. And finally, a Stress Test, done in collaboration with the EBA,
complements the asset quality review by providing a forward-looking view of banks'
riskabsorption capacity under stress.
The Asset Quality Review has progressed and some details of its coverage have been
released. Approximately 135 000 loan books will be examined by the authorities. The loan
file review covers both corporate and retail portfolios. It covers total banking book
riskweighted assets (RWA) of approximately € 3.7 trillion, representing 58 % of total credit
riskweighted assets across the banks subject to the assessment. In addition, 29 banks with
material trading book exposures are subject to a specifically tailored AQR of the trading
book.
The structure of the Comprehensive Assessment also clarifies the frequently asked question,
how this assessment differs from previously conducted EU level stress tests? The key
differences to my mind are as follows:
• Banks' risks and asset quality are assessed in a comprehensive manner at the
Banking Union level. Assessments are made applying common definitions,
abolishing - or at least showing explicitly - any diverging national interpretations.
• Sufficient corrective measures can be guaranteed as the ECB in its supervisory role
will have all the necessary supervisory powers.
• Quality of assessments is ensured not only by the ECB's strict procedure for
ongoing quality assurance, but also by the involvement of third party evaluators.
The results of the assessment will be published in a single disclosure, including all three
parts of the exercise.
The results of the Comprehensive Assessment will be followed by corrective measures
where necessary. The ECB published last week more details on how banks' should cover
possible capital shortfalls. Capital shortfalls will be expected to be covered within six months
for those identified in the AQR or the baseline stress test scenario, and within nine months
for those identified in the adverse stress test scenario. Recapitalisation measures to cover
any shortfalls detected should rely on capital instruments of the highest quality, unless the
shortfalls are reduced through other means. Such other measures could include, for
instance, retained earnings, and reduced bonus payments, new issuances of common
equity, suitable strong contingent capital and sales of selected assets at market prices.
Other preparatory work for SSM
Alongside the Comprehensive Assessment, a lot of other preparatory work is going on.
The SSM Supervisory Model is constructed so that the decision-making on supervisory
matters and other related procedures are kept separate from the monetary policy. As regards
supervisory matters, the new Supervisory Board will have a predominant role; in most of the
cases, it will be the final decision maker. In addition to internal rules and restrictions on
exchange of information, a concrete example of this separation is that supervisory function
and monetary policy are located in separate buildings and from 2015 even in separate areas
in Frankfurt.
At the practical level in the supervisory model, the joint supervisory teams are key actors.
Such teams are created for each significant bank or banking group that will be directly
supervised by the ECB. Joint supervisory teams are responsible for day-to-day supervision
of significant banks. Each team will be composed of staff from both the ECB and national
supervisors.
For the legal dimension of the SSM, preparations included the development of the SSM
Framework Regulation on covering cooperation within the SSM, among other things. In this
respect, after the public consultation, it was published on 25th of April.
From accountability point of view, the SSM has started to publish periodically a report called
the SSM Quarterly Report to the European Parliament, the EU Council and the European
Commission. The next report will be published in these days and it covers progress achieved
since the publication of the first report in the beginning of February.
Banking supervision requires a smooth flow of information between banks and their
supervisors. To this end, a high-standard data reporting framework and the associated
infrastructures for the SSM are being developed.
SSM vs national interests
Banking, and financial services more generally, is a high value added industry and there are
national interests at play. One can even say that national banking supervisors have
traditionally had a dual role to play: first, to carry out effective supervision and thus promote
financial stability but, second, to also promote the interests and competitiveness of the
national financial industry. In today's economies and also for banks themselves it may be
better to create level playing field internationally and enhance competition than look after
interests of domestic banks only. Over time, the banking union is envisaged to lessen the
role that national interest play but, in the short term, the banking union may exacerbate the
conflict between the two roles.
The ECB, as an established and strong European institution, is well placed to tackle the
emergence of national interests in supervision. It is therefore imperative that the powers are
concentrated at the ECB. The structures and the processes of the SSM must support
European perspective and interests. So far, all the developments seem to point to this
direction. The fact that the ECB can, if deemed necessary, take over the direct supervision of
any bank operating in the Banking union area underlines that the ECB is fully in charge of the
SSM.
Banks' perspective on SSM
Are there any benefits for banks? From the banks' perspective, the introduction of the SSM
means numerous changes. I will mention here only a few of them.
For a cross-border bank, operating in multiple countries within the Banking Union, the single
supervision effectively simplifies its contacts with the authorities. It will need to work with a
single supervisor and operate following a single rulebook. This implies lower costs for the
bank in complying with the regulatory requirements.
Common rules and methods of supervision also have a broader impact on competition
among banks, not only for international but also domestically oriented banks. The banks are
treated equally in supervision and regulatory capture can be fully avoided, thereby ensuring a
level playing field.
In general, I believe that the SSM will become one of the leading banking supervisors in the
world, applying the best possible tools for supervision - and developing such tools also for
the benefit of other supervisors.
Bank resolution
The second pillar of the Banking Union is the Single Resolution Mechanism (SRM), which is
the necessary complement to the Single Supervisory Mechanism. The SRM creates a single
authority, which is responsible for swift and orderly resolution of cross-border banks in the
euro area and participating member states. The SRM is complemented by the Single
Resolution Fund which will be financed via levies on the banking sector itself. The Fund will
start from national compartments but it will gradually, in eight years, mutualise to become a
truly single European Fund.
Underlying the new regime is the Bank Recovery and Resolution Directive (BRRD) which
dramatically changes the culture. It ends the era of the bail-out and moves us to the culture
of the bail-in. Bail-in will be the rule, bail-out a rare exception. As from the beginning of 2016,
or in some countries even earlier, the BRRD requires bail-in of shareholders and creditors
equal to at least 8% of the total liabilities of a bank. In most cases this should be enough.
Only after the threshold of 8% bail-in can money from the resolution fund be used and only at
the very end of the process can public money be used. It is notable that public money can, in
exceptional cases, be used to fund resolution functions, not to bail-out nonviable banks.
Macroprudential policy
Finally, I would like to make a couple of short remarks on macroprudential policy that is
becoming effective in the EU alongside the changes in microprudential supervision due to
the establishment of the SSM
In Finland, a government bill was submitted to Parliament in April, including provisions
establishing macroprudential policy tools and the Board of the Finnish FSA as
macroprudential policy authority. The law is expected to become effective in June 2014.
Following the adoption of this law, the macroprudential policy frameworks in Sweden and
Finland are likely to resemble each other in several respects. While the supervisory authority
would be the actual macroprudential decision-making body in both countries, other relevant
authorities, including central banks, have a role in analysing the systemic risks and needs for
macroprudential action.
However, there is one notable difference between the macroprudential frameworks in our
countries if Sweden remains outside the banking union. Within the banking union, while
macroprudential policy responsibilities lie in the first place with the national authorities, the
SSM Regulation assigns some macroprudential tasks also to the ECB. In particular, the ECB
may decide on stricter measures than national authorities, using the counter-cyclical buffer or
other macro-prudential tools provided for by the EU legislation. The role of the ECB in
making macroprudential decisions within the banking union can be seen as a useful
complement to our framework so as to avoid the so called inaction bias in macroprudential
policy.
As a conclusion and positive end of my presentation, let me recognise the very good
cooperation we have had not only between authorities from Banking Union countries but also
with authorities outside the Banking Union. Indeed a lot of progress has been made to
correct basic flaws we have had in our internationally integrated financial markets. And in
doing that, national interests, and I argue that banks' interests as well, are taken care of
when matching regulatory and supervisory institutions with the reality of banking business.