02 June 2023

SSM's Enria: Well-run banks don’t fail – why governance is an enduring theme in banking crises

The lessons we have learnt from the recent turmoil are much more relevant for supervisors than for regulators, says Supervisory Board Chair Andrea Enria. The common root causes of recent bank failures were weak governance and poorly managed risks.

Today I will speak about the lessons we in ECB Banking Supervision are drawing from the recent turmoil in the US and Swiss banking sectors. The recent events were, in my view, the first real test of the regulatory reforms put in place after the global financial crisis. Of course, they came after two major shocks – the COVID-19 pandemic and the Russian war in Ukraine – which also tested the banking sector’s resilience. But whereas those shocks originated outside of the banking system and did not lead to widespread questions about banks’ risk management or internal governance, the events in March this year had echoes of 2008. Seemingly unnoticed, significant vulnerabilities had built up in parts of the banking system. When the interest rate environment started changing, those vulnerabilities resulted in a widespread loss of confidence, with rapid deposit outflows leading to some banks failing in the United States, Swiss authorities having to orchestrate the acquisition of Credit Suisse by another Swiss institution, and everyone asking which bank would be next.

But whereas the 2008 crisis ultimately resulted in hundreds of bank failures worldwide, the global banking system has so far weathered the recent storm relatively well.

In my remarks today, I will argue that the resilience we’ve seen in the euro area is evidence that the banking sector is now in the final stage of the difficult and lengthy transition that started in the aftermath of the global financial crisis. European banks today are strong in terms of capital, liquidity and asset quality, and they tend to have well-diversified funding sources and customer bases. Most significantly, the chronic problems of low profitability and weak business models that held the sector back for so long are now finally starting to abate.

The banking union has played an important role here – the change in the institutional regime, with the ECB being assigned supervisory responsibilities, provided an opportunity to shift to strong and intrusive supervision, with unified practices built on the best approaches developed by national authorities in the euro area and at international level. The Single Resolution Framework has also helped strengthen the banking sector, in particular by asking a large set of banks to build up significant loss-absorbing capacity, which makes their liability structure less vulnerable to panic runs.

In my opinion, the lessons we have learnt from the recent turmoil are much more relevant for supervisors than for regulators. Looking at the candid assessment of the US authorities, I strongly share the view that the key takeaways for public authorities relate to the ability of supervisors to escalate issues and ensure prompt remediation by banks. And for these supervisory actions to be targeted, they should be grounded in a strong risk prioritisation framework.

We should abandon the ambition of designing ever-more precise regulations that accurately measure all risks under any circumstances, covering even the most extreme business models and risk configurations. That approach only results in excessive complexity, with burdensome procedures for supervisors and excessive rewards for the few institutions that have the wherewithal to game the system. Instead, we should focus our efforts on empowering supervisory teams, within a strong accountability framework.

And if the recent turmoil teaches us one supervisory lesson above all, it is the importance of ensuring banks have sound internal governance and risk management. Failures in this area are the common theme underpinning recent events in the United States and Switzerland, and they have also been the core theme of many past crises. In my view, this is the one priority area that both banks and supervisors should be focusing on.

The renewed solidity of the euro area banking sector

European banks emerged from the global financial crisis in pretty bad shape. They took longer than their peers in other regions to build up a stronger capital position, deal with their stock of legacy assets and restore their profitability to levels that would attract international investors. While I don’t want to tempt fate, it was comforting to see that, as the recent turbulence spilled over to European markets, European banks managed to withstand the impact. Let me set out what has changed in the euro area banking sector that underpins this new-found resilience....

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