29 January 2013

ECB/Constâncio: Establishing the Single Supervisory Mechanism

There are two main objectives in establishing the SSM. First, it aims at addressing the so-called “financial trilemma”, which can be defined as the impossibility of achieving at the same time, financial stability, financial integration and maintaining national financial policies in an integrated financial market. This is especially the case in a monetary union with a high degree of interconnectedness between financial institutions and markets. The current financial crisis showed how rapidly and forcefully problems in one country’s financial system can spread to another and even threaten the stability of the entire euro area banking system. Such developments can best be assessed and addressed by a central supervisory authority with a bird’s eye view of the entire euro area banking sector rather than through cooperation between national ones.

The second objective of the SSM is to help breaking the negative feedback loops between sovereigns and banks, which were key features during the present crisis. This manifested itself in increasing debt levels of sovereigns that had to provide financial support to struggling banks as well as losses for banks from exposures to sovereigns under stress. We also saw increases in the correlation between the cost of funding of euro area banks and that of their respective sovereigns, particularly in some countries under stress.

The SSM and macro-prudential supervision

From a policy perspective, the new focus has led to an increased interest in the macro-prudential approach to bank regulation and supervision, following ideas developed originally by the Bank for International Settlements. As a result, the international debate has shifted focus on how to detect and prevent systemic risks. In Europe the new regulatory and supervisory infrastructure currently emerging should provide supervisors with enough tools also on the macro prudential supervisory side which should support them to curb these risks specifically and to reduce the pro-cyclicality of the financial sector.

Regarding macro-prudential instruments, the initiative can be taken by national authorities but at the same time the ECB will also be empowered to apply higher requirements for capital buffers and other prudential measures specifically set out in relevant Union law, if deemed necessary to address systemic or macro-prudential risks. The application of these measures will, however, be subject to the procedures set out in the Capital Requirements Directive (CRD IV).

As you may be aware, the CRD IV will consist of a Directive and a Regulation. The legislative package is currently being finalised under the trilogue process and political agreement is expected to be reached soon. The Directive includes instruments such as the counter-cyclical capital buffer, the systemic risk buffer and possibly also the capital surcharge for Systemically Important Financial Institutions as well as Pillar II measures. On the other hand, the macro-prudential toolkit defined in the Regulation will probably contain large exposure limits, public disclosure requirements, liquidity requirements, risk weights for mortgage exposures, and intra financial sector exposures. The technical details of the implementation and the coordination mechanism among national authorities, the SSM and other EU bodies are still subject to discussions.

The establishment of a single supervisory mechanism is part of a wider project aimed at completing the Economic and Monetary Union. On the basis of the Van Rompuy Report, prepared in close collaboration with the President of the institutions of the Union (including the ECB), the European Council adopted on 14 December 2012 a roadmap with a number of policy actions. In particular, the ECB supports the Commission’s announcement to present a legislative proposal for a single resolution mechanism, having at the centre a resolution authority. Such arrangements are an important complement of the SSM and should be in place when the SSM would be fully operational.

The prospect of the creation of Banking Supervision at the European level, complemented by future European banking resolution, is the more far reaching change introduced since the inception of the euro. It reveals the willingness of Member States to continue to deepen European integration and create at the same time a better framework for the effective functioning of the euro area. Beyond that, the fact that the draft Regulation opens the SSM, in fair and equal terms, to countries outside the euro area creates a positive dynamics to the single market completion and to the future of European integration. The scope and repercussions of what has been now initiated cannot be fully anticipated.

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