Single rule book, EBA and SSM – implications for supervisory convergence

Director General Ulrik NødgaardFebruary 27 2014

Financial integration after the crisis

The regulations on the European Financial Supervisory System (setting up the ESAs and the ESRB).

The 2nd, 3rd and 4th capital requirements directive and a regulation.

Bank Recovery and Resolution Directive (BRRD)

2. Convergence in 4 different areas

4 core areas where sustantial convergence is to be expected:

• Solvency and own funds: Treatment of risk weights Quality of capital Asset quality reporting

• Liquidity

• Recovery and resolution

• Supervisory Colleges

Solvency: Risk weights (I)

Before the financial crisis:

• More risk-sensitive risk weights introduced with the CRD. Banks’ internal estimates, subject to supervisory approval.

• Potential for very considerable differences across banks. Different data history, modelling approaches, treatment of

uncertainty. In some cases also differences in supervisory practices and range

of options in the CRD.

Solvency: Risk weights (II)

After CRR/CRD IV:• Increased importance of benchmarking (CRD 78).

At least annually. Identify outliers and reasons for deviation. Corrective action in case of underestimated capital requirement. Important role for the EBA in ensuring convergence via guidelines

• Increased supervisory convergence via numerous technical standards and guidelines produced by the EBA, for example: Material changes and extensions (CRR 143). Methodology for assessing compliance with minimum requirements (CRR

144). Permanent partial use and roll-out plan (CRR 148 and 150). LGD floor (CRR 164). Waivers to use shorter data histories (CRR 180, 181, and 182). Downturn conditions for LGD estimation (CRR 181).

Solvency: Quality of capital (I)

Before the financial crisis:

• Multiple national discretions in the CRD including for important deductions and prudential filters.

• Lack of regulation of standards for innovative hybrid AT1-capital instruments led to a proliferation of hybrid issuances which were not loss absorbent in a crisis.

• Lack of harmonisation of T2-instruments

Solvency: Quality of capital (II)

After CRR/CRD IV:

• Implementation of the 14 Basel-criteria for Common Equity Tier 1 (CET1) making it very difficult to financial engineer new instruments that are not loss-absorbing.

• Enhancements and harmonisation of the definition of hybrid capital and T2-capital.

• Harmonised prudential adjustments to all classes of own funds and more deductions taking in CET1.

• EBA shall monitor the CET1-issuances ex post and report to the Commission.

Solvency: Asset quality reporting

Before the financial crisis:

• Very diverging supervisory standards and practices regarding supervisory reporting on asset quality

After CRR/CRD IV:

• Common European definitions of reporting of forbearance and non-performing loans.

• More uniform reporting

• Enhanced transparency at the EU-level in relation to stress-test

Liquidity

Before the financial crisis:

• 28 different liquidity regulations set by national authorities where quantitative regulation was non-existing in some Member States.

• No alignment of liquidity-buffer requirements as to for example volume and composition of assets.

• Very few Member States had requirements regarding stable funding.

Liquidity

After CRR/CRD IV:

• Alignment of liquidity regulation based on the Basel-standards taking into account European specificities on a harmonised basis.

• Liquidity Coverage Requirement (LCR): Promote the short-term resilience of the liquidity risk profile of institutions. Hard limit requirement for LCR from 2015 with a phasing in until 2019. Harmonised standard which can be compared across European banks.

• Stable Funding Requirement: Institutions shall ensure that long term obligations are adequately met with a

diversity of stable funding instruments from 2016. Possible introduction of a stable funding metric (NSFR) and hard limit requirement

later EU-Commission to present legislation by end 2016 at the latest.

• Additional liquidity monitoring metrics (for example concentration of funding, maturity mismatch etc.)

Recovery and resolution

Before the financial crisis:

• No harmonisation of recovery and resolution tools and insufficient national legal frameworks relying on regular insolvency procedures for companies.

• No bail-in mechanism to ensure alignment of incentives and that also junior and senior debt holders have proper ”skin in the game” thereby securing better pricing and rationing of credit in the system.

• No cooperation between authorities in different Member States in place to handle complex large banks operating in many countries.

• Part of the explanation why a very large number of banks in Europe of banks were bailed out in Europe using tax payers money (state aid approved of around 40 per cent of GDP for Europe from 2008-2011).

Resolution: Bank Recovery and Resolution Directive (BRRD)After CRR/CRD IV and BRRD:

• The BRRD contains a number of standards for supervisory early intervention actions and recovery plans.

• EBA will play a substantial role here also through binding technical standards and guidelines.

• Harmonised resolution tool-box with bail-in as an important tool with clear water-fall of burden sharing.

• Standards for minimum eligible liabilities will contribute to gone concern loss absorbency in crisis situations.

• Harmonised level of resolution funds set in legislation.

• Trigger for when resolution funds can be drawn upon set at 8 per cent bail-in/write down of liabilities.

Supervisory Colleges Before the financial crisis:

• Colleges of supervisors established via memorandum of understandings (MoU), i.e. bilateral/multilateral agreements and initiatives.

After CRR/CRD IV:• Colleges of supervisors – driver for supervisory culture:

• Formalized cooperation regarding cross-border banking groups

• Joint risk assessments and decisions (capital and liquidity)

• Common view on essential supervisory measures

• RTS and ITS from EBA: RTS and ITS on the functioning of Supervisory Colleges (CRD 51 and

116) ITS on joint decisions on institution-specific prudential requirements

(CRD 114)

3. The effect of the EBA on the convergence in EU28

• It follows from the revised EBA-regulation that EBA - also after setting up the SSM - shall continue to enhance convergence of supervisory practices across the Union as a whole.

• Supervisory convergence in the future will occur partly through the the numerous binding technical standards written into the CRD/CRR and the BRRD and the guidelines which EBA is preparing.

• However EBA is also mandated through the revised EBA-regulation to develop a Supervisory Handbook which should identify best practices across the Union as regards supervisory methodologies and processes.

Further effects of the EBA on convergence in the EU28

• Work is in the pipeline on a number of ”chapters” in this Supervisory Handbook for example: Business model analysis Common scoring methodology for the Supervisory Review and

Evaluation Proces Supervisory review of institutions stress-testing Methodology and process for the assessment of recovery plans

• The Supervisory Handbook will not be legally binding and will give sufficient room for supervisory judgement.

• Nonetheless the work being done will to a large degree probably contribute to ensure further harmonisation of supervisory practises across EU28 at a high supervisory level.

4. Limits to convergence : Macroprudential concerns

• Adressing macro-prudential concerns calls for flexibility

• CRR/CRDIV tries to strike a balance between single rule book and flexibility

• Several macro-prudential tools in the CRD/CRR including temporary stricter measures in art. 458 on: Own funds Large exposures Liquidity requirements Risk weights in the residential and commercial property sector Intra financial sector exposures

• Constrained discretion: complex coordination proces in place involving Commission, Council, Parliament, the ESRB and EBA.

Limits to convergence: National Specificities

The ”Supervisory Diamond”:• Specific supervisory tool called the ”Supervisory Diamond” has been

introduced for banks setting limits to counteract excessive risk-taking, but at the same time enable banks to offer credit.

• Calibration specifically based on specific risks seen for Danish banks.

Increased transparency on pillar 2-add on and inspections reports:• Publication of internal capital assessments since the annual reports

2009. If the Danish FSA has stipulated an additional pillar 2 capital requirement, this also has to be stated.

• Publication of inspection reports (on-site and off-site).

Specialised mortgage banks

5. The effect of the SSM on convergence in EU28 (I)

Single rule book(CRD/CRR/BRRD)

Single Supervisory Mechanism (SSM)

Single Resolution Mechanism (SRM)

Single deposit guarantee (delayed)

The effects of the SSM on convergence in the EU28 (II)

• Starting point: High degree of convergence

• The ECB through the SSM will assume responsibility for supervision in the SSM on 4 November 2014 in the 18 euro Member States: for initially 128 significant institutions and for several 1000’s lesser significant institutions

• Two channels of interactions: The work of colleges Negotiating BTS, guidelines and handbook in EBA

• Coordination of SSM positions in the EBA• Revised voting rules in the EBA

The effects of the SSM on convergence in the EU28

• The ECB is working on an internal SSM Supervisory Manual: Will cover the general principles, processes, procedures and

methodologies for supervising significant and less significant institutions.

Focus will amongst other things be on the Supervisory Review and Evaluations Proces covering the risk assessment system, the methodology for quantification of capital and liquidity buffers and how to integrate with stress test outcomes.

Will be based on EBA Guidelines on SREP and Pillar 2. Will be published as a comprehensive public version.

• But what will be the practice? An average of German and French practice, with an italian twist? A new and different approach to supervision?

6. The will to act

IMF staff position note:

• Supervisors must be willing and empowered to take timely and effective action, to intrude on decision-making, to question common wisdom, and to take unpopular decisions.

• Developing this “will to act” is a more difficult task and requires that supervisors have a clear and unambiguous mandate, operational independence coupled with accountability, skilled staff, and a relationship with industry that avoids “regulatory capture.”

• These essential elements of good supervision need to be given as much attention as the regulatory reforms that are being contemplated at both national and international levels.

Handbooks, Manuals and guidelines cannot replace the will to act

The will to act – The Danish track record

• Hands-on approach, Credit review file-by-file

• No supervisory forebearance

a number of banks closed due to inspections of loan books by FSA

In 2/3 of the inspections, the Danish FSA concludes that there should be higher impairment charges

• Accounting rules prevent “bad” forebearance by banks

• Also intrusive approach in other areas: Risk weights Funding and liquidity

Summing up regarding supervision

• Significant convergence for all 28 EU-countries in the coming years

• Very difficult at the current stage to make firm predictions on future supervisory approach to supervision in the SSM and possible spill-over effects

• A credible supervisory regime in Denmark