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Progress with European banking supervision
There is no doubt that building European supervision has been a remarkable undertaking. Today we have 900 supervisory staff working at the ECB who, together with 4,700 national supervisors, directly oversee around €22 trillion in assets, representing around 200% of euro area GDP.
But more important than its scale have been the changes the single supervisor has prompted in the conduct of supervision. It has broken with the past in a single, but fundamental way.
That is: it has brought about a more uniform approach in how banks are supervised, leading to a more resilient banking sector overall. The key catalyst for this change – alongside the new EU regulations – has been the harmonisation of the Supervisory Review and Evaluation Process (SREP).
This harmonisation has allowed supervisors to converge towards common benchmarks in how they assess risks; and it has helped them to be consistent in how their risk assessments are then linked to supervisory capital add-ons and other measures.
To illustrate the difference this has made, in 2014 the correlation between SREP scores and Pillar 2 capital requirements was 26% in the euro area. In 2016, it was 76%.
European supervision has therefore resulted in a substantial strengthening of shock-absorbing capacity within the sector. The total capital ratio of banks supervised by the ECB has increased by more than 170 basis points since early 2015. The quality of capital has gone up as well: the high-loss absorbing component – CET1 – now makes up the largest share of total capital of euro area banks.
Specific weaknesses are also now being addressed in their entirety across the euro area. Currently the most important issue here is tackling non-performing loans (NPLs).
We all know the damage that persistently high levels of NPLs can do to banks’ health and credit growth. Internal ECB analysis shows that, over recent years, banks with high stocks of NPLs have consistently lent less than banks with better credit quality, therefore providing less support to firms and households.
And though NPL levels have been coming down for significant institutions – from around 7.5% in early 2015 to 5.5% now – the problem is not yet solved. Many banks still lack the ability to absorb large losses, as their ratio of bad loans to capital and provisions remains high.
We therefore need a joint effort by banks, supervisors, regulators and national authorities to address this issue in an orderly manner, first and foremost by creating an environment where NPLs can be effectively managed and efficiently disposed of.
Importantly, the development of European supervision has not only reduced the risk of individual banks failing. It has also – as we hoped – had some success in reducing the importance of location in perceptions of bank risk, because single, rigorous supervision is an essential precondition for the other pillars of the banking union that more decisively sever the bank-sovereign nexus.
Indeed, looking at the largest banks for which we have data available, the correlation between bank credit default swaps and those of sovereigns is now considerably weaker than at the height of the euro area crisis.
Still, there is no room for complacency, since these improvements are likely to have been driven, in part, by the improved economic situation. It is therefore crucial that further reforms to de-link banks from sovereigns do not lose steam, notably completing the other pillars of banking union.