12 February 2013

ECB/Constâncio: Towards the Banking Union

My intervention today is divided into two parts. In the first part, I will touch upon the different elements of the Banking Union and reflect upon the underlying rationale for its establishment. In the second part of my speech, I will focus on the SSM by reviewing its main features as well as the immediate challenges for the ECB to prepare itself to assume its supervisory task.

The key building blocks of a Banking Union

The Banking Union aims at building an integrated financial framework to safeguard financial stability and minimise the cost of bank failures. As we all know, it consists of five complementary building blocks, of which the SSM forms an integral part.

The first block is the establishment of a single rulebook, which in a substantial way exists already. The European Banking Authority (EBA) has the legal competence to monitor its implementation. The addition of the CRD IV, the Resolution and Deposit Guarantee harmonisation Directives will lead to the creation of a single rulebook that will significantly contribute towards creating a level playing field. Likewise, the SSM will also contribute to reinforce the single rulebook, as a European dimension will be provided to the way supervision is conducted.

The establishment of a EU framework for single supervision forms the second element of the Banking Union and will be at the centre of my talk today. The SSM will be a mechanism, composed of national competent authorities and the ECB, with the possibility of non-euro area Member States to participate. The process to establish the SSM is underway, with the Council proposal forming the basis for the current discussion at the European Parliament. We at the ECB are quite pleased with the Council’s proposal which is being assessed by the European Parliament. In all my comments I will refer it as it corresponds to the current basis for the future SSM.

A third element of the Banking Union is the establishment of a Single Resolution Mechanism. An important pre-condition is a swift adoption of the Bank Recovery and Resolution Directive, as it lays out a harmonised toolbox of resolution powers. The Single Resolution Mechanism would build on the measures and tools laid down in the Directive, particularly by providing a robust framework that allows for prompt and coordinated resolution action, specifically where cross-border banks are concerned. As we all know, the swift and orderly resolution of cross-border banks is the Achilles' heel that needs to be addressed.

The existence of this financial backstop can be considered as the fourth element of a complete banking union, especially because, as announced by the European Summit, there will be the possibility of direct capitalisation of banks by European funds. This element, whatever its terms, will be of great important for the achievement of one goal of the banking union project, namely to mitigate the negative feedback loop between banks and sovereigns.

Finally, the fifth element of the Banking Union will be the establishment of a common system of deposit protection. A first step in this direction will be the adoption of the legislative proposal on deposit guarantee schemes, providing a harmonised framework. This framework should ensure depositor confidence and enable the national deposit guarantee schemes, built on common EU standards, to interact with the SRM. A European deposit guarantee scheme is therefore not essential in the short term. Nevertheless, a common system, built on common EU standards, will be important in the future to ensure enhanced depositor confidence in the robustness of all European banks. This element would also contribute to reduce the risks of financial fragmentation that results from contagion fears and is detrimental to the smoothing functioning of the single monetary policy.

Rationale for a Banking Union

First, a single supervisory mechanism is necessary because of the increasing interconnectedness between financial institutions and markets across the euro area over the past decade, be it through internationally active banking groups, bilateral trading exposures, or presence in the same market segments. The recent financial crisis demonstrated how quickly and powerfully problems in the financial sector of one country can spread to another. This is especially the case in a monetary union. As a result, problems in the banking sector might originate at the national level, but are more and more likely to affect other countries of the euro area as well, and may quickly threaten the stability of the entire euro area banking system.

A second reason that justifies the banking union project regards the requirements for a smooth functioning of the single monetary policy. Its transmission mechanism across all member countries of the euro area requires an appropriate level of financial integration that ensures well performing cross border money markets. After a spectacular integration of money and financial in the first 10 years of monetary union we have observed increasing fragmentation that only recently, after the creation of our OMT programme, started to abate. This fragmentation has impaired the transmission mechanism of monetary policy.

The third reason that justifies the banking union project has to do with the development of large financial imbalances within the euro area in both public and private sectors. In particular, the development of macro and external imbalances was significantly driven by private sector indebtness, proving that the fiscal brake was not enough to guarantee macro stability and excessive heterogeneity among Member States. This provided the rationale for the recent creation of a formal Macroeconomic Imbalances Procedure to monitor and promote timely policy measures to avoid the building up of macroeconomic instability in Member States.

Main features of the SSM Regulation

The SSM will operate as a system, catering for all expertise of national supervisors and at the same time possessing a strong decision-making centre. As I mentioned before, this is an important feature necessary for the effectiveness of the new entity. Appropriate decentralisation procedures will need to be defined while preserving the unity of the supervisory system and avoiding duplication.

To ensure a strong centre, the ECB’s final responsibility for supervision within the SSM is matched by control powers over the system as a whole, as well as by very close cooperation arrangements with national authorities.

A second important feature of the SSM regards its extensive powers in the conduct of its supervisory function. The SSM, with the ECB at its centre, is entrusted with an extensive set of micro- and macro- prudential powers, covering all key tasks relating to the prudential supervision of credit institutions. This broad array of tasks and powers is crucial, as it is the foundation for the SSM to effectively supervise banks.

In concrete, the micro-prudential tasks range from the authorisation of credit institutions to having the power to carry out early intervention when a bank is in financial distress. These tasks are matched with a broad set of powers to carry them out. In this context, the ECB may conduct all necessary investigations and on-site inspections and obtain all necessary information to carry out its task effectively. In addition, in order to enforce its decisions and rules, the ECB also avails of sanctioning powers.

A third important feature of the SSM relates to the preservation and deepening of the Single Market, particularly the fact that national competent authorities of non-euro area Member States have an option to participate in the SSM. They can participate through establishing a close cooperation with the ECB. By giving non-euro area Member States full membership and voting rights in the Supervisory Body, the body responsible for the preparation of decisions on supervisory matters, they are placed on an equal footing with euro-area Member States. However, as the ECB Governing Council is the ultimate the decision-making body of the ECB, its role in the SSM is reduced to the possibility of accepting of accepting or rejecting the decisions of the Supervisory Board. At the same time, a system integrating a mediation panel is foreseen in the Regulation in case of divergences that may involve a non-euro area Member State. All these mechanisms were accepted at the level of the Council by all governments which seems to indicate that we might see an extension of the SSM well beyond the euro area.

A final feature of the SSM Regulation I would like to highlight relates to the principle of separation of the monetary and supervisory function. The important role given to the Supervisory Board vis-à-vis the Governing Council, already referred to, is one of the various safeguards ensuring a clear separation between the monetary and supervisory function of the ECB. Additionally, deliberations of the Governing Council on supervisory matters will be strictly separated, including separated agendas and meetings.

Main immediate tasks of the SSM

One of the main priorities for the ECB during 2013 is ensuring the operationalisation of the SSM, so that it can assume its responsibilities effectively and efficiently.

Building a strong centre

Creating a strong centre in a decentralised system such as the SSM, will be crucial to ensure the ECB’s reputation is safeguarded. The monetary policy function of the central bank requires that it maintains a high level of credibility. This is essential to keep anchored inflation expectations. When the central bank is responsible for both price stability and banking supervision, weaknesses in supervision could damage the reputation of the central bank as a competent monetary authority. Furthermore, it could be argued that the central bank faces higher reputational risks in conducting its supervisory function than its monetary policy function. This is simply due to the very different nature of the tasks. News about a failing bank can be automatically wrongly perceived as a result of deficient supervision cancelling out reputation built over a stream of years with no news about problem banks.

Review of banks’ balance-sheets

An immediate task of the SSM will be a comprehensive review of the banks brought under its responsibility, namely the banks that will come under the direct supervision of the ECB. This is requested in the Council Regulation in view of possible legacy issues, which could put the SSM reputation at stake further down the road. Ahead of assuming the responsibility for the supervision of banks, the ECB in cooperation with national supervisory authorities will need to carry out a comprehensive assessment of their balance-sheets.

Harmonising supervisory procedures and risk assessments

At a larger scale, the ECB needs to conduct fundamental work – in cooperation with the EBA – to develop a manual of supervisory practices, defining processes and procedures for conducting supervision in the EU. This should ensure a harmonised approach to the way supervision is conducted and increase comparability across supervisory assessments – e.g. regarding provisioning and risk mitigation policies - under the new EU supervisory framework.

Related work that is underway and coordinated by the EBA, notably on forbearance risk and impaired asset classification will represent in this connection valuable contributions to the convergence of procedures to best practices. Provisioning and loss mitigation policies may differ quite substantially across countries at present. The need for harmonisation is apparent as these represent key elements affecting assessments of banks’ capacity to withstand credit losses. Furthermore, work done within EBA on risk assessment inputs to the supervisory review process – a topic that I will return to in a second – also represent important steps in this harmonisation process.

Full speech

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