08 July 2021

ECON Brief: What are the main differences between the practice of supervising large banks in the UK and in the euro area, and what are the

The ECB is likely to take a more stringent stance in prudential supervision than UK authorities. The setting of risk weights and the design of macroprudential stress test scenarios d o cu ment this hypothesis.

The withdrawal of the United Kingdom (UK) from the European Union (EU) has implications for the supervision of large banks. The newly-gained regulatory a n d s u p er v iso ry a u t on om y allows UK r eg u la-tors and supervisors to retreat from previously adopted common European standards. An incremental divergence in regulatory and supervisory standards can lead to regulatory competition if E U a n d UK banks can enter the other economy’s market for financial services under a regime of mutual recognitionof prudential standards.

Leaving the level playing field increases the dependency of banks’ host econ-omies on the institutions h o me regulation with regard to financial stability. Although we do not e xpect a race to the bottom, we currently identify important differences in supervisory practices, partly rooted in fundamentally diverging institutional set-ups. Diverging institutional architectures: While supervision of large banks in the euro area is partly su-pranationalised within the Single Supervisory Mechanism (SSM) and involves a multitude of European and national authorities, oversight over UK banks is o r g an is ed in a single, national agency, the Pr u d en-tial Regulation Authority (PRA) as a part of the Bank of England (BoE).

These differences translate into a more complex governance structure at the European Central Bank (ECB), the lead supervisor in the SSM, as well as a multilayered o r g an is at io n of Joint Supervisory Teams (JSTs) in the SSM. A lt h o u gh the UK architecture may make the PRA a more effective decision-maker in times of crisis, the euro area complexity is – at least in part – the price for establishing powerful and credible safety nets in the bank-ing union that may help solve future banking crises more efficiently than the UK.

Diverging calibration of capital requirements:

Prior research identified that the ECB, in the direct supervision of large banks, takes a tougher stance than National Competent Authorities (NCAs) when it comes to setting risk weights for banks’ loan exposures to corporate clients and that banks respond to this approach by seeking to avoid ECB supervision and shifting riskier lending relationships to smaller, nationally supervised institutions. We believe that these insights carry over to the ECB/SSM – PRA/BoE relationship, because UK supervisors as national prudential authorities can be expected to behave like euro area NCAs.

We corroborate this hypothesis by partly replicating the empirical analyses conducted in prior research contributions and observe declining risk-weights a large UK ba n k s and unchanged risk-weighs at German and French large banks after the introduction of the SSM.

Diverging stress test assumptions: Macroeconomic stress test scenarios provide further evidence of differences in supervisory approaches between EU and UK authorities. In the 2021 stress test scenarios, projections of real GDP and unemployment rate develop m en t s in the EU, the UK and the US differ sub-stantially, depending on the conducting authority. Overall, the BoE takes a significantly less-restrictive stance than EU authorities, but is more or less aligned with predictions in the scenario that underpins 2021 stress testing in the United States (US)....

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