30 October 2023

Andrea Enria (Chair SSM) at LSE's FMG: Exogenous shocks and endogenous challenges: five years of European banking supervision (and beyond)

The events that shaped the SSM’s trajectory include the exogenous shocks of the past five years – a pandemic, a war at the borders of the European Union, and an unexpected flare in inflation with a fast exit from a low interest rate environment.

Thank you for inviting me to speak today at the LSE’s Financial Markets Group. I will look back on and assess my five years at the helm of European banking supervision now that my mandate is about to come to an end.

We would all probably agree that the past five years have not been easy. But they have not been boring either. Indeed, if you allow me to invoke the ironic expression “may you live in interesting times” retroactively, we have been through an extremely interesting period, full of unexpected events that we could well have done without.

I will start by explaining how we brought the Single Supervisory Mechanism (SSM) to the next stage of its development after a successful start-up phase.

The events that shaped the SSM’s trajectory include the exogenous shocks of the past five years – a pandemic, a war at the borders of the European Union, and an unexpected flare in inflation with a fast exit from a low interest rate environment.

But I will also touch upon the endogenous challenges we still face: making our supervision more effective in repairing banks’ governance, business models and internal controls, while respecting the private nature of the banking business; and supervising a banking sector segmented along national lines, while the banking union remains incomplete, with the political discussions on its institutional framework hampered by a lack of urgency and red lines set by individual Member States.

Moving out of the SSM’s start-up phase

European banking supervision celebrates its tenth anniversary next year. But the political decision leading to the centralisation of prudential supervision at the ECB dates back to 2012, during the sovereign debt crisis in the euro area.^[1]

In the early summer of that year, we were undergoing an existential crisis for the euro area and the European banking sector.

The close interconnection between the banking sector and its sovereign, the infamous doom loop, was threatening the fiscal viability of some Member States and the stability of their banking sectors. The damage to banks’ lending activities was having a serious adverse impact on the euro area’s recovery following the great financial crisis, leading to a painful double-dip recession.

To deepen our understanding of the root causes of these developments and the rationale for establishing a banking union, I would like to recall a seminal lecture by Tommaso Padoa-Schioppa given here at the Financial Markets Group almost 25 years ago.^[2]

The main thrust of Padoa-Schioppa’s analysis was that, before the creation of the single European currency, the jurisdiction of monetary policy and that of banking supervision had never been separated.

But he argued that this unprecedented institutional set-up could still work, and also effectively manage financial crises, provided that “…cooperation among banking supervisors, which is largely voluntary but which finds no obstacles in existing Directives or in the Treaty, will allow a sort of euro area collective supervisor to emerge that can act as effectively as if there were a single supervisor”.

Alas, far from taking this area-wide perspective, when the Lehman crisis affected the European markets, national authorities took a “chacun pour soi” attitude, as aptly characterised by Jacques de Larosière in his report on the financial crisis^[3]: ring-fencing behaviour at the national level deepened the impact of the crisis; well-integrated pan-European banking groups had to be split along national lines, with massive destruction of value, to enable local crisis management tools and backstop measures to be activated; and national budgets were burdened with very expensive bailout packages to prevent the meltdown of the domestic banking sectors.

Those difficult times, and the political debates that culminated in centralising supervision at the European level, influenced the SSM’s agenda during its start-up phase and the five years of my mandate.

In fact, while the decision to set up a single European supervisor at the ECB was broadly shared as a response to the failure of the previous institutional set-up to deal with the twin crises – the great financial crisis and the sovereign debt crisis –, establishing the other components of the European safety net has proven far more controversial politically.

Setting up guarantees to finance resolution processes, especially the provision of central bank liquidity after resolution, and establishing a European deposit insurance scheme are still proving elusive because some finance ministers are reluctant to provide fiscal facilities that could be used to backstop banks in other Member States.

But from day one it was crystal clear that a key condition for moving towards completion of the banking union was to successfully repair banks’ balance sheets, bringing all European banks to a comparable level in terms of capital adequacy and, especially, asset quality.

Responsibility for cleaning up banks’ balance sheets from the heavy legacy of non-performing loans (NPLs) inherited from the crisis lay squarely with the SSM. This essential first step for a successful banking union was a key focus during its start-up phase and was still a priority when I became Chair of the ECB’s Supervisory Board in 2019.^[4]

Looking at the euro area banking sector today, we may argue that the mission of repairing banks’ balance sheets has been fundamentally accomplished. At the start of banking union, NPLs in the euro area banking sector amounted to more than €1 trillion, for a total share of NPLs on banks’ balance sheets of 8%, compared with less than €340 billion and 1.8% respectively for the second quarter of 2023...

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