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The Banking Union, under way and here to stay
A report by the PwC and IE Business School Centre for the Financial Sector. This report has been coordinated by Luis Maldonado, managing director of the PwC and IE Business School Centre for the Financial Sector
February 2014 Contents
Introduction 4 Executive summary 10 The Single Supervisory Mechanism, the key to the entire process 14 The entrance exam. Crossing the gorge. 22 The SSM from the inside 24 The Single Resolution Mechanism, a crucial component 26 Operations. This is how the SRM will work 32 A Safety Net with Loopholes 34 Emergency liquidity assistance, the taboo last resort 38 The ESM, a cannon of limited use 40 A Single Rulebook to prevent fragmentation 42 Learning from mistakes 47 Conclusions and recommendations 48 References 51
3 Introduction
The European Union’s progress towards Since then, spectacular progress has integration has always been marked by been achieved in a little more than a firm steps and inconsistent political year and a half. Today there is impulses, guided to a large extent by considerable consensus on the developments in the international components that should constitute the economic environment. The banking union: a Single Supervisory implementation of the Economic and Mechanism (SSM) for the entire euro Monetary Union (EMU) and the creation area; a Single Resolution Mechanism of the euro constitute a key – and (SRM), with a single European authority fortunately irreversible – advancement, able to take over a bank’s management, as the European Central Bank reiterated restructure it and even wind up its at the height of the sovereign debt crisis operations if necessary, and a Single in 2012. But the recent financial and Resolution Fund; a Safety Net for bank fiscal crisis has revealed serious deposits that does not distort weaknesses in the European financial competition but prevents fragmentation, system’s architecture. Financial and a Single Rulebook to serve as the fragmentation has been proved to play a legal basis or framework for the entire crucial role in the vicious cycle that process. connects banking systems with sovereign debt. At times of economic difficulty, Not all of these components have their mutual effect is compounded, reached the same degree of potentially leading to acutely critical development, though. The supervisory situations, as was the case in mid 2012. system, which is due to enter into effect in November 2014, is almost completed, European leaders had already warned at and the institutions involved are the turn of the century that adoption of working round the clock on the the euro did not mean the end of the the necessary preparations. The resolution EMU process. Yet no further progress mechanism, which will start operating would be made in the area of monetary in 2015, is backed by an initial until the following crisis, as the then agreement that was confirmed in early president of the European Commission 2014. rightly predicted in 2001, when the single currency came into being: “I am The Safety Net is the slowest in the certain that the euro will require the group, with no expectation of any introduction of new economic policy progress being made in the short term instruments. Today it is politically towards establishing a common deposit impossible to propose such instruments. guarantee fund. Significant progress has But some day there will be a crisis and been achieved, nonetheless, in then they will be created.” Arguably, the harmonising the existing individual turning point came with the European deposit guarantee funds. The Single Council of 29 June 2012, which gave Rulebook is largely laid out, although political approval to the establishment certain important aspects also remain to of a Banking Union and instructed the be resolved. European Commission to submit a concrete proposal (Chart 1).
4 The Banking Union, under way and here to stay Chart 1. Banking Union key milestones.
19–21 March 2013 January 2014 SSM: Final drafting of the European SSM: Single Supervisory Council resolutions as agreed in The Council, Parliament Mechanism December 2012. and the Commission start SRM: Single Resolution negotiating the final Mechanism 22 May 2013 approval of the SRM. SSM: The European Parliament backs EDGF: European Deposit the legislation package but issues a Guarantee Fund number of recommendations. 1 March 2014 21 June 2013 Deadline for approval of the intergovernmental agreement setting SSM: Political agreement within the out the operation of the Single European Council on the Proposal for a Resolution Fund. Regulation of the Council, which assigns 26 July 2012 specific functions to the ECB. 20 March 2014 SSM/SRM/EDGF: The European Council, in collaboration with the Commission, the 15–22 October 2013 SRM: Agreement between the Council Eurogroup and the European Central Bank, SSM: The agreements are formally of Ministers and the European makes a call for Banking Union (“Towards a adopted and published in the Parliament. genuine Economic and Monetary Union”). Official Gazette on 29 October. 23 October 2013 SSM: The ECB begins an overall assessment with a view to assuming a supervisory role. The Risk Assessment Exercise commences on the 128 credit institutions included.
2012 2013 2014
27 June 2013 11 December 2013 March–July 2014 European Council Agreement between the SSM: Asset quality review to identify agreement on the Council, Parliament and capital and provisions needs. Directive the Commission to 12 December 2012 establishing a approve the Bank SSM: The Council agrees framework for the Recovery and Resolution its position on the SSM recovery and Directive. legislative framework. resolution of credit May–October 2014 institutions and 27 November 2012 investment firms. SSM: Stress tests performed on individual banks. SSM: Opinion of the European Central Bank.
12 September 2012 17 December 2013 November 2014 10 July 2013 SSM: The European Commission publishes SRM: Ecofin agreement on SSM: The ECB to assume the the legislation package on the single SRM: The Commission the elements of the Single functions assigned to it by the supervisory system for banking. proposes a Single Resolution Board and Regulation. Resolution Mechanism for Fund. Prior to that, it will release the the Banking Union. Agreement between the results and recommendations European Parliament and to the different banks. the Member States on the new Deposit Guarantee Directive. Source: Prepared in-house.
Introduction 5 Before we go into an in-depth analysis of from having access to the markets. All this each of these components and their has had a negative effect on European implications for financial institutions, we economies’ potential for growth and job will give a brief account of the reasons creation, including Spain. that justify the establishment of a Banking Union. Home bias – the tendency for a country’s savings to finance investment preferably The crisis has revealed that the in that same country – is one of the most architecture of the European financial markedly direct consequences of financial system, built on national supervisors and fragmentation. Affecting interbank national resolution mechanisms, is unable lending and public debt alike, home bias is to guarantee financial stability in an area exacerbated during a crisis and therefore that uses a single currency. The accelerates its effects. connection between sovereign risk and banking risk has demonstrated its clearly All the above have also contributed to the procyclical nature, causing situations in malfunctioning of the European monetary which damage to the financial system has policy transmission mechanism during far exceeded a country’s fiscal capacity the crisis. Since late 2010, interest rates on (the case of Ireland), or where imbalance lending to families and businesses have in public finances and its attending dropped in some large European increase in sovereign spread have economies, but risen in peripheral contributed to a rise in borrowing costs countries (Greece, Portugal, Ireland, Italy and even prevented the soundest banks and Spain).
Chart 2. Mutual contagion between sovereign risk and banking risk.
Spain Ireland 0,6
Net sovereign- 0,4 to-banking contagion 0,2
1E 16
-0,2
Net banking- to-sovereign -0,4 contagion Greece Portugal Ireland Lehman bail-out bail-out Bankia bail-out -0,6
jun-08sep-08dec-08mar-09jun-09sep-09dec-09mar-10jun-10sep-10dec-10mar-11jun-11sep-11dec-11mar-12jun-12 jun-08sep-08dec-08mar-09jun-09sep-09dec-09mar-10jun-10sep-10dec-10mar-11jun-11sep-11dec-11mar-12jun-12
Note on methodology: This indicator represents the difference between the net variation percentage for an equal-weighted index of leading banks’ CDS prices (which is not due to the CDSs’ historical record but to contemporary shocks on sovereign credit risks) and the opposite net variation, i.e. the variation that reflects the impact of shocks affecting financial risk levels on sovereign risk. The indicator is positive when the shocks’ impact on sovereign credit risk levels in relation to financial risk is higher than the opposite effect. The value of this indicator on any given day is estimated based on the information available for the preceding sixty days. The series is also modulated using a sixty-day moving average. Source: O. Arce & S. Mayordomo, 2012, “Credit risk contagion between sectors”, work document.
6 The Banking Union, under way and here to stay A further issue worth noting is loan-to-deposits ratios of their banks’ fragmentation generated by the reaction branches and subsidiaries in other to the crisis, which has added its effects countries. Regulations have been to the existing financial fragmentation. introduced restricting foreign banks’ In the absence of a single resolution freedom of action in a given market. authority, the authorities of the Member New constraints have been put in place States have reacted on the basis of on subsidiary-to-parent cash flows. national mandates that pursue the interests of their respective States and Since the onset of the crisis, the EU has do not necessarily contribute to the instituted measures that were clearly financial stability of the whole. National designed to break the link between supervisors have set limits on the sovereign risk and banking risk and to
Chart 3. Changes in sovereign debt and bank funding 2008–2013 (CDS, basis points as a percentage of debt).
500
OMT
375
250
Bank
125 Sovereing
0 January-08 January-10 January-12 January-13
Source: International Monetary Fund. A Banking Union for the Euro Area 2013.
Chart 4. Interest rates in loans to businesses in Germany, Italy, Spain, Portugal and Ireland. Coefficient of variation 8 50 45 7 40 6 35 30 5 25 4 20 rate Interest
In percentage terms In percentage 3 15 10 2 5 1 0
Jul-10 Jan-04 Feb-05 Mar-06 Apr-07 May-08 Jun-09 Aug-11 Sep-12 Oct-13
Germany Italy Spain Portugal Ireland Source: Funcas. Papeles de la Economía Española. Construir una Unión Bancaria. November 2013
Introduction 7 Chart 5. Sovereign debt of Ireland, Greece, Spain, Italy and Portugal held by national banks, in percentage terms.
100% 90% 80% 70% Ireland 60% Greece 50% Spain 40% Italy 30% 20% Portugal 10% 0% 2010 2011 2012 2013
Source: European Banking Authority (EBA). Report on 2013 EU-wide Transparency exercise.
ensure the proper operation of monetary Although OMTs have so far not been policy. In particular, it is worth noting resorted to, the mere announcement of the ECB’s long-term refinancing the scheme has already produced the operations (LTROs), implemented in late effects sought. 2011 and early 2012 to provide unlimited finance to the European The EU’s institutional fabric has also banking system, and its Outright seen measures designed to improve the Monetary Transactions (OMTs). European framework for
Chart 6. State capital aid to banks in the EU-27.
Distribution by country In EUR billions As a percentage of GDP (in percentage terms) Germany 285,46 United Kingdom 140,11 30 Spain 54,17 Ireland 46,41 25 Netherlands 41,44 Greece 35,71 20 Belgium 24,03 Portugal 18,39 15 Austria 9,83 Denmark 6,38 Italy 2,60 10 Luxembourg 2,50 France 2,20 5 Latvia 1,46 Slovenia 1,04 0 Lithuania 0,69 Sweden 0,65 Italy Spain Latvia France Austria EU-27 GreeceIreland EU 27 672,89 Slovenia LithuaniaDenmarkSlovakia Belgium GermanyPortugal Euro areaLuxembourg 17 Netherlands United Kingdom
Source: Aid provided to the Spanish financial sector in the context of the European Union. Joaquín Maudes. Funcas Spanish Economic and Financial Outlook. October 2013.
8 The Banking Union, under way and here to stay macroprudential supervision, including to financial institutions not directly the creation of the European Systemic supervised by the ECB. These include Risk Board (ESRB), the European banks from non-euro area Member System of Financial Supervisors (ESFS) States that have not sought to take part and the European Supervision in the Banking Union, but also small Authorities (ESAs), whose area of banks falling under the jurisdiction of responsibility extends to banking, national supervisory authorities on insurance and securities. account of their size.
However, these are merely stopgap As the Banking Union is irreversibly set measures. The Banking Union must in motion, the role of the European tackle the root of the problem by Banking Authority becomes clearer. It is implementing the necessary also becoming apparent that other ESAs institutional and operational reforms to (insurance and, above all, markets and enable European integration to be securities) should likewise play a key completed. part in the new financial map of Europe.
Significant headway has been made in Lastly, it is worth raising the question of establishing a Banking Union to round whether this is the end of the road that off and put real sense into the monetary leads to European integration, and when union, but several challenges still lie will the time be right for further ahead. Firstly, uneven progress in the advances towards political and fiscal development of the different union. The “Four Presidents’ Report” components that make up the process (signed in 2012 by Herman Van poses the risk of an unfinished Banking Rompuy, president of the European Union, unable to defeat the prevailing Council, in collaboration with Jose fragmentation. Secondly, one Manuel Durao Barroso, president of the consequence of the Banking Union will European Commission, Jean Claude be speedier consolidation of the banking Juncker, president of the Eurogroup, sector, so particular attention will need and Mario Draghi, president of the to be paid to the increase in systemic European Central Bank) states that the risk this may entail. Thirdly, there is Banking Union is part of a far more considerable uncertainty surrounding ambitious project that proposes new how supervision will be coordinated and measures for budgetary harmonisation what resolution mechanisms will apply and common decision-making.
Introduction 9 Executive summary
“It is better to take small steps in the right direction than to take a great step in the wrong direction” (Chinese proverb)
“Once we accept our limits, we go beyond them” (Albert Einstein)
The Banking Union is under way. The 1) The Single Supervisory project, which has been referred to as Mechanism (SSM). The SSM is the the EU’s most ambitious initiative since key to the entire process. The crisis the euro was introduced, enters into taught us that financial regulation operation this year. Its prime purpose is alone is not enough, and that to remedy the problems detected in the supervisory mechanisms must be European banking system during the harmonised to deliver certainty to the financial crisis (e.g. market markets about the real condition banks fragmentation, distortion of lending are in and the policies being adopted to circuits, impaired monetary policy correct potential imbalances. Its set-up, transmission, uncoordinated responses which is almost completed (the SSM at the national level, etc.), and in will enter into operation in November particular to break the link between 2014) guarantees harmonised sovereign risk and banking risk, which supervision criteria for all banks in the has proved to have the potential to euro area and any other EU Member generate a vicious cycle. The aim is to States that wish to be included. suppress or limit the drain on the public However, supervisory action will purse caused by crisis episodes in the function under a two-level scheme: the banking sector, which have cost huge ECB will directly supervise the largest amounts of taxpayers’ money in recent banks (some 130), and the national years. authorities will handle smaller institutions. Given that the SSM’s Will the Banking Union succeed in operating principles have been solving all these problems? In its current adopted from the English-speaking state, its design is complex and world, they will be in sharp contrast to incomplete, with some gaps still the supervisory models currently showing through. A look at the bigger existing in several European countries, picture, however, reveals that the including Spain. Before the system Banking Union represents a definite enters into operation in 2014, a contribution to stability and consistency number of tests and assessments will in the financial system, particularly in be performed to ensure that the largest the medium-to-long term and therefore banks are in good solvency conditions marks a major advancement in the and thus dispel any doubts on the part process of European integration. of investors.
The project is based on the following 2) The Single Resolution four pillars: Mechanism (SRM). A vital
10 The Banking Union, under way and here to stay complement to the Single Supervisory natural objective would be to Mechanism, the SRM represents a establish a Single Deposit Guarantee considerable advancement in the Fund to supplement the Single process towards risk mutualisation Resolution Fund, but this option has among EU banks. Though expected to been ruled out by a group of core euro enter into operation in 2015, area countries firmly opposed to implementation of its key functions sharing bank deposit risks with other will begin in 2016. The SRM will have Member States. The Safety Net strong powers to decide on how to therefore relies on national deposit deal with non-viable banks, albeit guarantee funds. The harmonising subject to a complex decision-making impulse, which crystallised into a process. The mechanism provides a directive in 2009, standardised the bail-in procedure whereby creditors minimum required coverage for and shareholders assume losses in guaranteed deposits at 100,000 what amounts to a first line of defence euros. It also succeeded in setting a in the event of difficulties. If that series of time-bound objectives for buffer proves insufficient, the Single maximum payment periods and fund Resolution Fund will step in, with the financing. However, there are still financial industry bearing the cost. differences among the protection Having secured the risk-sharing schemes of the individual Member commitment required to set up this States with the potential to generate fund is one of the Banking Union’s competitive advantages and chief breakthroughs. But the SRF will disadvantages that are independent not be established in full from the of an institution’s solvency. Moreover, start. It will be built up from the resources contributed by national contributions provided by the funds could prove insufficient to national funds over a period of eight tackle systemic crises. years up to a total of EUR 55 billion in 2024. Risk mutualisation will also be 4) The Single Rulebook. A set of a gradual process, spanning ten harmonised prudential rules created years. One point of uncertainty in this as an effort to correct the fragmented respect is what will happen if all the adaptation of the Basel III criteria available resources are depleted. A (international banking supervision number of public-funded financing recommendations) into national schemes have been provided for this legislations. To achieve this, a directly extreme scenario, but the creation of applicable regulation has been an instance of last resort has been introduced (the Capital Requirements postponed until 2024. Regulation, which entered into force on 1 January 2014) setting out the 3) The Safety Net. The third pillar of procedure for adaptation of the the Banking Union is the creation of a criteria. As the provisions of such Safety Net, which will be chiefly – regulations do not need to be though not exclusively – aimed at implemented into domestic law, the safeguarding bank deposits, a key discretionary scope of national element of system stability. The authorities is minimal. The
Executive summary 11 Regulation governs critical aspects of insuring bank debt compared with supervisory standardisation, non-bank debt. Both these indicators including levels of capital, liquidity correlate with bank solvency. The CDS and leverage. Some matters, however, index for Europe’s 25 leading banks, still resist regulatory harmonisation. which gauges their credit risk, in Authorisation procedures, capital January 2014 reached its lowest point buffers and sanctions are among the since March 2010. Sovereign debt costs areas where national lawmakers have from peripheral countries have also liberty to manoeuvre. This increases dropped significantly, including Spanish the difficulty of establishing a set of debt, although recent turmoil in common rules for all EU Member emerging countries’ currency markets States. has distorted that trend.
Given this combination of advances and However, the short timespan examined difficulties, will the Banking Union and the abundance of details to be settled actually work? So far, the markets in 2014 make this a strictly provisional appear to believe it will. At the time of assessment. Any forecast on the project’s completing this report, the cost of success must take into consideration a insuring bank debt has fallen since an number of variables and determinants. agreement on the Bank Resolution Mechanism was concluded last • Firstly, time. The Banking Union December, as has the risk premium of needs time to mature and resolve
12 The Banking Union, under way and here to stay its innate inefficiencies. Risk across the board and the Banking mutualisation is a gradual process Union would not be fully prepared that will only become fully effective to absorb the impact of a systemic after eight years. In addition, the crisis, particularly during the initial entry into effect of the Single stages of the process. Resolution Mechanism in 2016 will mark the beginning of an almost • The third decisive factor for the two-year period in which the project’s outcome is staff selection, Banking Union’s basic structure as it will determine the extent to will not be fully deployed. which the people managing the Banking Union are able to take • Secondly, results will depend on decisions swiftly, independently how the economy performs over the and free from any national next few years. If growth is interests. Though the decision- reasonable, the system’s initial making procedure is quite complex, faults will dilute themselves and in the event of an emergency, the the Banking Union will be sufficient necessary steps would presumably to protect the financial system from be taken by the most competent potential strain in individual banks and best informed officials. and prevent contagion to the rest of the sector. But if growth fails, banks’ problems would spread
Executive summary 13 The Single Supervisory Mechanism, the key to the entire process
The Single Supervisory Mechanism weighted assets). The purpose of the SSM (SSM) is a European system of financial is to deliver certainty on banks’ real supervision that encompasses the ECB condition and predictability on the and the competent national authorities of mechanisms available to correct the participating Member States. Due to potential non-compliance. become effective in November 2014, it is the key component that will open the One system, two levels. The SSM door to the EU’s Banking Union. Its will have jurisdiction over all financial importance lies not so much in its institutions from euro area countries and supervisory role – which is generally in from non-euro-area EU countries that line with the classical scheme of have agreed to take part in the project. authorisation, monitoring and correction However, supervisory action will – as in its uniformity across the whole function under a two-level scheme: euro area. A single mechanism is less susceptible to the interests of individual 1. The ECB will supervise the largest or countries or banks, and is therefore most relevant banks (defined as crucial to restore confidence and ensure “significant credit institutions”) taxpayers’ funds are properly managed. directly and continuously. To be classified as significant, an institution As pointed out in the introduction, one of must meet any of the following the triggers of the financial crisis was conditions: (i) the total value of its investors’ distrust of the information assets exceeds EUR 30 billion, (ii) the released by banks, whether on account of ratio of its total assets over national transparency issues or inconsistencies in GDP exceeds 20%, unless their total key indicators and criteria (e.g. risk- value is less than EUR 5 billion, or (iii)
14 The Banking Union, under way and here to stay The Single Supervisory Mechanism, the key to the entire process
the ECB or the national authorities credit institutions. Nonetheless, the consider the institution to be of ECB can at any time decide to exercise significant relevance to the domestic direct supervision of any non- economy. Institutions that have significant institution if it deems it received funds from the EU’s financial necessary to ensure the consistent assistance bodies will also be directly application of general supervisory supervised, regardless of their size. In criteria. Rather than a supervisor, the all cases, a minimum of three banks ECB might best be seen as a from each participating country will be supervisors’ supervisor where this included in this group. Some 130 group of banks is concerned. institutions (accounting for almost 85% of consolidated bank assets in the Why this two-level approach to euro area) meet at least one of these supervision? The reasons are both conditions and will therefore be subject practical and political. Firstly, the ECB will to the ECB’s direct oversight. More than concentrate its supervisory efforts on the 90% of Spanish banks will be placed largest banks, as it is physically impossible under direct ECB supervision based on to handle all of the euro area’s great quantification of their consolidated quantity of banks directly. Added to this, assets. In Germany, this proportion national central banks have extensive amounts to 65% (see Chart 8). experience supervising their own institutions, which constitutes an 2. Non-significant institutions (some assurance of efficient performance. 6,000) will be supervised by the Secondly, this arrangement satisfies a national authorities, subject to the group of countries that prefer to keep their harmonised criteria that apply to all smaller, non-significant banks under the
The Single Supervisory Mechanism, the key to the entire process 15 supervision of national central banks. decentralised supervisory model to a Their stance is predicated on the idea that system where planning is centralised smaller banks are not systemic and and execution is partially decentralised. therefore do not need the ECB’s direct At the present time, credit institutions in supervision. the EU are supervised at the national level by the competent authorities of the Ultimately, the purpose sought by individual Member States. two-level supervision is not to have two separate models or approaches, but to The ECB will take on its supervisory role apply different degrees of centralisation on 4 November, with the national to the two bank categories. Supervision authorities providing support and criteria must be the same for all banks assistance in the performance of this role. included in the the SSM’s scope. This guarantees what we might call the The change is momentous, not only for the system’s “singleness”, even at the cost of new supervisor but also for the banks adding complexity to its operation. under its jurisdiction. It should be borne in mind that the SSM will be supervising a Based in Frankfurt, the SSM’s workforce wide range of business models, and will be approximately one-thousand institutions using equally diverging strong. Professionals from the euro area’s measurement and valuation criteria (e.g. central banks will make up a large risk-weighted assets, as mentioned above, proportion of the new team, with the or the treatment of impaired loans). remaining positions being covered by Equally relevant is the fact that the new outside staff. supervisory model is not built from scratch, but based on the supervisory The change of model.Institution of practices of all euro area countries and the SSM constitutes a shift from a other developed countries.
Chart 7. Eligible deposits over total assets for the 16 largest banking groups in the EU, in percentage terms.
35% 31,3% 30%
25,8% 25% 23,1% 20,5% 19,6% 20,1% 20% 18,5% 18% 17,7% 17,5% 18,2% 16,5% 15,5% 14,3% 14,6% 15% 12,9% 11,3% 10%
5%
0% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Average
Source: Bankscope Impact Assessment BBR.
16 The Banking Union, under way and here to stay Chart 8. Number of institutions to be supervised by the European Central Bank, by country.
30
25 24
20 No of banks 16 15 15 13
10 7 6 6 5 6 5 4 4 4 3 3 3 3 3 2 1 0
Italy Spain Latvia Malta Malta Austria Cyprus Estonia Finland France Greece Ireland Belgium Alemania PortugalSloveniaSlovakia Luxembourg Netherlands Country
Source: European Central Bank.
In view of the above, the new model Prudential Supervision IV, one of the faces the great challenge of overcoming four DGs that will carry out the SSM’s all those differences, laying down operations (see Box 2).In contrast to the common operational principles, and other three DGs, each of which deals developing a harmonised assessment exclusively with one type of institution, methodology. the remit of DG IV cuts across all bank categories. Its responsibilities cover key As part of this effort for standardisation, aspects of supervisory activity, including the ECB is currently engaged in devising authorisation, methodology, supervision its own supervisory rating system. This quality, risk analysis, crisis management will provide a uniform, structured and the use of sanctions. framework with which to grade financial institutions on the basis of DG IV therefore has an overall view of their risks, in much the same way as the model, which enables it to identify most national supervisory authorities non-compliances more easily and to around the world do. In Spain, this offset any influence supervised methodology is referred to as SABER institutions might exert over the DGs (risk-focused supervision of banking responsible for monitoring specific bank activities, according to its initials in categories. DG IV will have substantial Spanish). human and technological resources at its disposal, as befits its central role The importance of DG IV. From an within the SSM. operational standpoint, it is worth highlighting the particularly prominent A more independent team. Where role that has been assigned to the supervision instruments are concerned, Directorate-General for Micro- new joint inspections of significant
The Single Supervisory Mechanism, the key to the entire process 17 institutions are the most distinctive this is an operational, preventive, element the new model will introduce. strategic supervisory model that relies Instead of ongoing on-site inspections to a greater extent on examination of (where supervisory staff are internal control and governance than on permanently present inside banks), accounts auditing. which are a key part of the oversight model in several countries including The new model is thus more akin to the Spain, the SSM favours joint supervisory practices of English-speaking countries, teams, where local supervisors will such as the UK and the US, than to those provide approximately 80% of applied for instance in Spain and Italy. It inspection staff and the ECB will is interestingly paradoxical that the new provide 20%. Each team will be headed supervisory model, which has been by a coordinator appointed by the ECB’s designed in the euro area, is largely central authority, who will report to the inspired by the principles that guide Supervisory Board, and a deputy supervisory systems in non-euro coordinator representing the national countries, even if some central European supervision authority. countries (most notably, Germany) apply broadly the same practices as the This combination firstly ensures that the US and the UK. national central banks’ first-hand knowledge of the situation on the Side by side, not intertwined. ground will not go unused. Secondly, it Another significant feature of the SSM is strengthens the inspection team’s its independence. Although the new independence, as the presence of supervisory system lies within the Frankfurt-based supervisors provides operational orbit of the ECB, the new assurance that no undue influence will model clearly establishes that it will be exercised by the supervised function separately and independently institutions. from the ECB’s own monetary policy. This separation is intended to prevent A panoramic picture. Inspections conflicts of interests emerging between having a primarily thematic or the two spheres of decision-making, horizontal focus will also play an which often feed back on each other. For important role in the new model, example, a change in euro area interest providing comparative analyses of rates – the main instrument of monetary certain aspects of the financial system, policy – will necessarily affect European such as interest rate risk, capital banks’ interest rate risk and, adequacy, earnings predictability, consequently, their supervision. There governance standards, etc. This are also examples of the reverse: if a approach to inspection enables bank that has received ECB loans is supervisors to obtain something akin to classified as non-viable and is therefore a panoramic picture of a bank’s made subject to the resolution performance and the weaknesses that mechanism, the ECB could find itself affect specific aspects of its having to absorb losses as part of its own management. It is therefore a tool to monetary policy operations. smooth the path of harmonisation. How will the separation between the Inspiration from the English- two policies be ensured? The most speaking world. What do all the relevant provision states that the elements of the new supervisory model Supervisory Board (see Box 2), which is add up to? Any complex system lends the management body of the SSM, will itself to many interpretations on its operate separately from the ECB’s design, but experts tend to agree that Governing Council, and it will even have
18 The Banking Union, under way and here to stay the autonomy to report to the European Resolution Mechanism, which is a Parliament. Additionally, if the vital complement of unified Governing Council has to discuss supervision, will create an matters pertaining to supervision, it will institutional framework where be required to do so with a separate non-viable banks will be more likely agenda in a meeting specifically to be resolved through sale of their focusing on those issues. In the event of operations to other banks, as has any disagreements, the SSMs Mediation been the case in the US. Panel will be called on to resolve them. Separation is also physical, with the 2. Gradual reduction of the industry’s staff responsible for the two policies size and its influence on the working in two different buildings. European economic fabric. The crisis has shown that the industry suffers According to the Vice-President of the from excess capacity (assets have ECB, Vitor Constancio, the ultimate goal dropped by 12% since 2008). Unified is to build a “more advanced system” supervision will encourage banks to using “all modern methods” to design a adjust their balance sheets and “forward-looking risk-based model”. reduce their risk exposure in order to make their business models more A new scene in the industry. The secure and sustainable over time. A new supervisory mechanism is not the smaller financial industry could only piece in the puzzle, and its effects lessen its weight in financing the on the European financial system will economy at large. Currently, 50% of only come into their own when the other lending to European businesses two pillars of the Banking Union are in comes from banks, compared with motion and have been fine-tuned to only 25% in the US. some extent. Having said this, the financial sector tends to agree that the Instruction manual for banks: consequences that are integral to unified start with a clean slate. The new supervision (i.e. harmonised criteria, supervisory model is, first and foremost, greater transparency for investors, new. This means financial institutions improved reliability of banks’ internal must make a fresh start in their relations models, no barriers for cross-border with the SSM. The following is a list of transactions, no competitive practical recommendations for adapting disadvantages, etc.) will naturally set a to the new state of affairs: whole new scene in the industry, with two major trends expected to emerge: • Decide which is the best way to channel the bank’s relationship with 1. Restructuring and consolidation in the new supervisor and act the banking sector, particularly via accordingly. This may involve mergers and acquisitions. Over the qualified personnel travelling to last five years, corporate deals have Frankfurt to mitigate the “long- been few and far between in Europe, distance syndrome” caused by the partly as a result of institutions’ new set-up, without neglecting the mistrust of one another. Single national authorities. supervision will presumably restore trust in the financial sector, • Change the bank’s organisational encourage banks to consider structure. The new supervisory model consolidation as a way to become requires all banks to develop a clear more profitable businesses and shed risk-appetite framework and have it off excess capacity in the industry as approved by the Board of Directors. a whole. Additionally, the Single The framework will set the bank’s
The Single Supervisory Mechanism, the key to the entire process 19 policies on capital planning, risk • Explain the bank’s business model management and control and internal exhaustively. Do not assume any part auditing. Banks will also need to renew of it is already known or unimportant. their vision on aspects including Past practices and experiences are corporate organisation transparency, now irrelevant. responsibilities and accountability of the Board of Directors, approach to • Invest in human and technological conflicts of interest, appointments, resources. The new supervision model audit commissions and the compliance focuses on ongoing evaluation, and function. every bank will have to establish a
20 The Banking Union, under way and here to stay function dedicated to dynamic to a dynamic perspective. This solvency. Increased resources will also requires banks to develop complex have to be assigned to internal models that include capital objectives auditing, and risk assessment will for different risk scenarios. Each bank have a greater role than verification. must also develop its own benchmarking process to better • Maximise attention to planning understand the global situation and capital and liquidity (the criteria that have the information needed to will be used to measure European interact with the supervisor. banks against one another) according
The Single Supervisory Mechanism, the key to the entire process 21 The entrance exam: crossing the gorge
Before the Single Supervisory Mechanism becomes effective on 4 3. A stress test, performed in November 2014, all the institutions cooperation with the European placed under the direct supervision of Banking Authority. This will provide the European Central Bank, i.e. some a view of the future in terms of 130 banks classified as significant, institutions’ capacity to absorb losses including 16 Spanish banks, will have in two different scenarios (baseline their balance sheets subjected to a and adverse) based on a three-year comprehensive assessment. The aim is horizon. Two common equity tier 1 to dispel any doubts investors may have capital thresholds have been set: 8% on the soundness of the leading banks in for the baseline scenario and, most the euro area by carrying out an importantly, 5.5% for the adverse exercise in transparency and scenario. How sovereign debt comparability. portfolios are treated is a key aspect of this stress test. The ECB has finally This process, which is considered decided to subject sovereign debt to decisive for the European financial stress (at credit or market risk, system’s stability, comprises three depending on the portfolio clearly distinct parts. They are, in concerned). Level 3 – i.e. non-liquid chronological order: – assets will also be valued. This stress test will be the great 1. An assessment of risk from a thermometer that ultimately decides supervisory perspective. This will which institutions need to focus on aspects such as liquidity, recapitalise, as it would be possible leverage and funding. Specifically, it for a bank to meet the minimum will include a quantitative and solvency requirements but fail the qualitative analysis based on stress test, in which case it would backward- and forward-looking have to find more capital. The stress information aimed at assessing a test will be performed in October bank’s intrinsic risk profile, its 2014 at the latest, with data as of 31 position in relation to peers and its December 2013. vulnerability to a number of exogenous factors. The purpose of the comprehensive assessment – data collection for which is 2. An asset quality review (AQR). This already well under way – is to appraise broad review of banks’ balance sheets each bank by combining the results of as of 31 December 2013 will focus on the three parts of the review. This credit and market exposures, on- and appraisal will lead to supervisory action, off-balance sheet positions and including additional capital domestic and non-domestic requirements (and/or other reparative exposures. In this phase, 8% is the measures) for banks that fail to meet the magic number, as it is the minimum specifications. threshold for top quality capital. The AQR is expected to be completed by It is easy to see why the process is next June. regarded as a gorge that must be
22 The Banking Union, under way and here to stay traversed on the road to Banking Union. which came into force last August and On the one hand, the assessment must are partly based on the Spanish bank be strict. Otherwise, the process would restructuring experience. The rules lose credibility as a whole and the Single provide a restructuring procedure that Supervisory Mechanism would be includes burden sharing by shareholders wrong-footed from the start. On the and creditors. However, the fact that it is other hand, if the exam is too stringent, a general procedure, rather than one some banks could end up in a difficult expressly designed for the position, which would erode the comprehensive assessment, could create system’s reputation and increase the risk distrust among investors and undermine of instability. its own credibility.
Another risk facing the comprehensive During the months in which the assessment is the absence of an assessment is being performed, we may instrument specifically designed to see some adverse effects, such as credit restore capital and restructure banks tightening. Banks will tend to clean up that fail to meet solvency requirements their balance sheets and sell off assets as and are unable to do so themselves. If it they prime themselves for the exam, becomes necessary to inject public causing lending to contract. If this risk money, the regulatory reference must actually materialises, the ECB will have inevitably be the new European to take action to boost liquidity in the Commission rules on state aid to banks, markets.
The Single Supervisory Mechanism, the key to the entire process 23 The SSM from the inside
Internal organisation Each DG will have a director-general Supervisory Board. The internal (Ramón Quintana, from Spain, has been body responsible for planning and chosen for that role at DG II) and there implementing supervisory policy. It will will also be six deputy directors-general be formed by a chair (Daniele Nouy, (Margarita Delgado, also from Spain, from France), a vice-chair (Sabine will be at DG I) and several division and Lautenschläger, a German member of section heads. the ECB Executive Committee), four ECB representatives and one representative The supervisory model from the national competent authority Harmonised assessment of each participating Member State. methodology. The methodology, Decisions will be taken by simple which is currently at the design stage, majority. will contain a mix of technical characteristics taken from different Steering Committee. This smaller supervisory models. The result will take body will support the Supervisory account of the supervisory rating system Board. Its chair will be the chair of the (many national supervisors have unique Supervisory Board and it will have a methods in place to rate their banks), its maximum of ten members, including a consequences (intensity of supervision vice-chair and an ECB representative. and early corrective measures) and the stress placed on quantitative models, Mediation Panel. The body among other aspects. The model being responsible for ensuring separation developed by the ECB encompasses: between monetary policy and supervisory tasks, resolving differences • Supervised aspects. Ten categories of between the Supervisory Board and the risks, controls and financial ECB’s Governing Council. It will be fundamentals will be assessed: composed of one member from each business and profitability, credit, participating Member State. market, operational, interest rate, internal governance, capital position, Directorates-general. There will be liquidity, concentration and four DGs, with the following insurance. responsibilities: • Metrics for assessment of the different I. Supervise the operations of the risk categories. Supervisory rating will largest banks (approximately 30 in be determined by a combination of number). standard quantitative ratios with II. Supervise all other significant banks thresholds. (approximately 100). III. Oversee non-significant banks in the • Scale. Four risk levels will be system, which the ECB has established (low, low-medium, responsibility over even though it medium-high and high), along with does not supervise them directly. their corresponding control ratings IV. Supervision standards, methodology (strong, adequate, inadequate and and quality control. weak).
24 The Banking Union, under way and here to stay • Expert judgement. The extent to inspections, remote monitoring, briefing which the SSM’s judgement can alter sessions, etc.), although they will be the results of a bank’s semi-automatic combined differently from other models. assessment will be established. There will be some scope for discretion, The new concept of joint inspections particularly to downgrade ratings. will be introduced, which involves both professionals from the national • The SSM’s risk appetite. The supervisory authorities (approximately consequences for banks of having a 80%) and from the central authority in given rating will be determined. There Frankfurt (20%) taking part in the will be different types of inspections. Greater emphasis will also consequences: intensity of be placed on primarily thematic or supervision, capital and liquidity horizontal inspections, i.e. those requirements, internal control and designed to evaluate specific aspects of corporate governance measures, etc. all institutions in the system. Top rating institutions will be subject to a lower intensity of inspection. Inspection will be preventive, focusing assessing potential risks ex ante in • Sources of information. Supervision preference to those that have actually will draw on the system of financial materialised. reporting and own resources which banks are required to put in place in Capital adequacy projections and 2012, on the capital self-assessment self-assessment reports will also be used report, on the solvency and liquidity as part of the inspections. projections, and on data collected in the performance of supervision (e.g. Funding. The SSM’s costs will be inspections, meetings, etc.). covered by the supervised institutions by paying a yearly fee. Institutions from Supervisory mechanisms and non-participating Member States that tools. The SSM will use conventional have branches in participating Member supervision instruments (in situ States will also be required to pay this fee.
The Single Supervisory Mechanism, the key to the entire process 25 The Single Resolution Mechanism, a crucial component
The agreement in principle to create a used, as in the SSM. Banks classified as Single Resolution Mechanism (SRM) significant (some 130), which are institutes a common architecture for directly supervised by the ECB, will be restructuring troubled and non-viable subject to the Single Resolution Board, banks. Whereas in this sense the SRM is while all other banks will remain under genuinely a single mechanism, it is not the jurisdiction of national resolution so clear whether its two constituents authorities. However, the Board will also are: the Single Resolution Board, take over any resolution process if use of which would better be described as the Single Resolution Fund is needed, multiple given its composition and regardless of the bank. decision-making process, and the Single Resolution Fund, which will exist This operating scheme is crucial to alongside the national funds for a ensure consistency with the SSM. transitional period of eight years (see Moreover, it provides an incentive to information attached). non-euro area EU countries to join the Banking Union process, as all banks The SRM will have the same scope of from participating countries can benefit application as the Single Supervisory from the Single Resolution Fund’s Mechanism (SSM), with the same assistance. structure. The system will have jurisdiction over all banks in the It is not the purpose of the common participating countries (euro area resolution framework to salvage a countries and any other EU Member non-viable bank that has failed as States that request to be included), institution – an ambition that has cost although a two-level scheme will be taxpayers dearly in the past. Neither is it
26 The Banking Union, under way and here to stay The Single Resolution Mechanism, a crucial component
the point to wind up such banks in a large profits in times of boom take disorderly way, as this often causes a responsibility for the losses when things strong systemic impact. The aim is start going badly, and give the managers rather to streamline the bank, isolate of financial institutions the right the diseased parts to protect the healthy incentives for sound running of their while enabling it to maintain its operations. essential functions, including the payment system, in order to preclude The SRM will have strong powers and contagion and preserve stability in the competences, as legally provided in the financial system. Bank Recovery and Resolution Directive, which is now in the final stage Who will fund the restructuring of its approval. process? As we will see below, the common procedure includes a model The SRM relies on four basic where shareholders and creditors instruments to pursue its aims: constitute the first loss-absorbing buffer. As a second line of defence, the banking • Sale of assets. The Resolution industry will cover the cost of the Board has the power to sell part of a process through its contributions to the business without the shareholders’ resolution fund. Support from public consent. funds will only be available as a last resort, which will significantly reduce • Transfer to a bridge bank. A business the cost of bank bail-outs to the may be transferred in part or in full to a taxpayer. The goal is to improve market bank controlled by the authorities, discipline, ensure those who appropriate which will continue to offer essential
The Single Resolution Mechanism, a crucial component 27 financial services while the situation is assets (known as the minimum resolved. requirement) before the resolution fund steps in. • Segregation of assets. Toxic assets may be transferred to an independent Guaranteed deposits (up to 100,000 vehicle or bad bank. euros) and some liabilities (e.g. employees’ fixed salaries and pension • “Bail-in”. A process whereby a failing funds, items related to critical goods and or non-viable bank’s shareholders and services, and debt instruments with a creditors assume losses. remaining maturity of less than seven days) are excluded from the bail-in and Bail-in is the key to the restructuring are therefore untouchable. The SRM can process. By imposing a scale of seniority also at its own discretion exclude 5% of to decide which shareholders and total liabilities from bail-in to preserve creditors will assume the costs and in financial stability. what order, it creates a clear perception of the risks attached to an institution’s This scheme ensures investors will be liabilities. Under the Bank Recovery and first hit in any restructuring process, Resolution Directive, shareholders will thus avoiding or limiting bail-outs, be the first in line to bear losses (equity which have been frequently resorted to is wiped out or diluted to assume the in the banking crises of recent decades, first losses). Next, debt held by creditors usually at the expense of the taxpayer. is converted to shares or written down, including bonds and hybrids (e.g. A further distinctive feature of the new preferred stock). Lastly, deposits worth resolution framework, which is also more than 100,000 euros, with those inspired by the Recovery and Resolution held by individuals and SMEs having Directive, is that all banks will be seniority over those held by large required to draw up recovery plans on companies. In any event, shareholders how to deal with emergency situations. and creditors will have to assume a The leading banks are already preparing minimum loss of 8% of the bank’s these recovery plans, which will be liabilities or 20% of its risk-weighted updated on a yearly basis. Institutions
Chart 9. Operation of the bank resolution and recovery scheme
Guaranteed deposits Excluded
Other instruments subject to bail-in. Liabilities Once the minimum requirement instruments (8%) have absorbed losses, the Resolution Assets Authority may exclude liabilities worth up to 5% of the value of total assets. Liabilities excluded on a discretionary basis 3% of total 8% of total assets: minimum Excluded assets requirement. (The first instruments to absorb losses.) 5% of total Capital Contable assets This scheme is based on an example bank with a capital amounting to 5% of its total assets.
Source: Prepared in-house.
28 The Banking Union, under way and here to stay will have to provide full details of their the importance of this agreement is to internal structure, specify which parts imagine what would have happened if of their businesses are not essential, and no deal had been reached. A further establish a system of firewalls that can positive aspect of the agreement is the be quickly activated if its financial acknowledgement of the need for position deteriorates significantly. This common backstops to act as an element process of preparing for the worst is of last resort if the instruments put into based on the principle that any bank, place by the SRM fail to deliver the however robust and solvent it may seem, expected results. Although no actual is exposed to crisis situations (we have effective measures have as yet ensued, seen some recent examples of this) and the commitment is nonetheless real and therefore may have to be restructured. If will presumably eventually materialise necessary, the recovery plan would to complete the resolution framework. serve as a guide for the Single Resolution Mechanism, providing the Two challenges. While considerable information it needs to act swiftly and progress has been achieved, the new decisively. As a complement to the mechanism also offers significant recovery plan, the SRM will prepare a challenges: resolution plan, which it would implement if an institution were to meet 1. The decision-making process is the first the conditions for resolution. Both challenge posed by the agreement, as plans together constitute a bank’s its complexity may prove a hindrance “living will”. in difficult situations requiring a rational, impartial, confidential and A major conceptual advance. Will this urgent response. The final layout, system resolve future banking crises? which involves the Single Resolution The mere talk of creating a Single Board, the ECB and the European Resolution Mechanism is already a Council, gives the participating major advance in the Banking Union countries the last word in certain cases. process, in so far as it constitutes the This may generate interference in the essential crowning complement of the process and reinforce – rather than Single Supervisory Mechanism. The break – the link between sovereign risk agreement is also particularly valuable and bank risk. There is also some given the difficult circumstances in uncertainty surrounding the decision- which it has been reached, with some making timeframe. Decisions issued by Member States expressing misgivings the resolution authority theoretically about committing to such a risk-sharing become effective within a maximum of structure. This complex and imperfect 24 hours. However, the Council of – yet common – system provides the Ministers can oppose decisions or system with a single set of rules that all propose amendments, subject to a troubled and non-viable banks can previous proposal from the receive similar treatment. The case of Commission. Implementation can Cyprus, where the EU had to improvise therefore be delayed for longer than a late response to the problems affecting one weekend, which is the period its financial system, is a good example of considered reasonable to avoid market the drawbacks of not having a uniform disturbances. This high-speed resolution framework. The SRM’s mechanism may have its drawbacks if creation will send a message to the the Council, in agreement with the markets about the euro area countries’ Commission, uses its veto rights determination to put an end to the preventively, bearing in mind that it culture of using public money to bail out only has one day to analyse a decision banks. The best way to fully appreciate by the Single Resolution Board.
The Single Resolution Mechanism, a crucial component 29 2. The second challenge is the absence of certain conditions, as was the case in an appropriate backstop to handle a Spain in 2012. The efficiency of these scenario in which the resources mechanisms has been called into available become exhausted during the question, particularly recourse to the course of the restructuring process. ESM, which is already a possibility and Three avenues for additional funding reinforces the link between sovereign will be available during the eight-year risk and banking risk. An explicit transitional period in which the Single commitment has been made, however, Resolution Fund will gradually be built to establish a backstop in 2024, up with contributions from the although its specifications have not individual national funds. Firstly, a been negotiated. It is now a blank page national fund may borrow money from that will have to be written over the its own government. Secondly, it may next few years. The markets have also borrow from another European fund. voiced doubts about whether the Single Thirdly, the European Stability Resolution Fund, which is expected to Mechanism (ESM) may inject money reach 55 billion euros in 2024, will be into the country concerned subject to sufficiently endowed.
30 The Banking Union, under way and here to stay 300 looking for a place to work. Banking Authority, the agency created The Single Resolution Mechanism will in 2011 to coordinate local supervisors. need sufficient resources to work efficiently, autonomously and The impact on banks: more than proactively. In principle it is envisaged just money. Credit institutions in the to have a workforce of 300 professionals, euro area will finance the Single sourced from the national resolution Resolution Fund as it is gradually built up. authorities, including the Fund for But bearing in mind that the transitional Orderly Bank Restructuring (FROB) in period will last for ten years and that the Spain. Where the new body will have its ultimate goal is not too ambitious (1% of head office has not yet been decided. guaranteed deposits, i.e. some 55 billion The key debate is whether it should be euros), the contributions paid will not based in Germany – with the guarantee destabilise the industry’s balance sheets, of effective communication with the although they do require an effort. In any Frankfurt-based ECB and SSM on the event, the expected improvement in upside, and a highly concentrated financial stability and investor confidence financial power on the downside – or would, if they finally materialise, more elsewhere, which would result in less than repay the industry’s contributions. interaction but more independent But the SRM means something more than judgement and a certain degree of money for financial institutions. Firstly, all decentralisation. Neither has an participating banks are required to draw agreement been reached on who will be up a comprehensive recovery plan, which executive director, although there is must be examined and approved by the some consensus among member supervision authority. Secondly, the countries that the position should be seniority order established by the bail-in held by a prominent personality in mechanism is a key factor in determining European politics. It does seem clear the structure of a bank’s liabilities, which that the SRM will have agency status may even affect its composition and cost. (the administrative rank of independent Furthermore, bail-in criteria also bodies established to help implement influence investors’ decisions, as they will European institution policies concerned avoid putting money into the 8% with specific areas), and will thus share minimum requirement, which is a bank’s the same standing as the European first loss-absorption buffer.
The Single Resolution Mechanism, a crucial component 31 Operations. This is how the SRM will work
The Single Resolution Mechanism funds or when more than EUR 5,000 (SRM) will become operational on 1 million has been used in a calendar January 2015 and its main powers will year. In these cases, a double majority come into force on 1 January 2016. The will be required: two thirds of the SRM, whose scope of action board members representing at least encompasses all the countries covered 50% of the contributions. The plenary by the Single Supervisory Mechanism session is also entitled to oppose the (SSM), is composed of: resolutions of the executive session in certain important decisions, in this • The Single Resolution Board case by simple majority. (SRB). This will have wide-reaching powers to restructure banks. At the • The Single Resolution Fund request of the ECB or at its own (SRF). The commitment establishes initiative, it will be able to subject a that the fund will initially consist of bank in difficulty to a restructuring national compartments (the funds programme, ascertain which tools already constituted in the need to be used in each case and avail participating countries), which will of the Single Resolution Fund, of mutualise (merge into the common which it is the owner and fund) gradually over a transition administrator. The decisions of the period of eight years until they SRB will come into force within 24 completely disappear. In the first year, hours after their approval, unless the 40% of the funds from national Council of Ministers, at the proposal compartments will mutualise: in the of the European Commission, rejects second year 20% and the remainder them or proposes amendments. The over the following six years. The SRB will be composed of an executive objective is that at the end of this director, four directors and the phase, the single fund will represent representatives of the national an amount equal to 1% of the resolution authorities of the guaranteed deposits, i.e. participating countries. It will operate approximately EUR 55,000 million. with two formats: executive and The fund will be financed by the plenary. In the executive format, banking industry at national level. where decisions shall be taken with regard to individual banks, the The agreement also includes the executive director, the four directors design of a backstop in the event the and the representatives of the affected available financing runs out. During countries will intervene; the ECB and the transition phase the funds will be the European Commission will able to obtain bridge financing from participate as permanent observers. national sources (backed by bank During the plenary session, the Board contributions) or the European will take the general decisions, those Stability Mechanism (ESM)). In the involving liquidity support exceeding latter case, the current procedure will 20% of the capital of the Single apply, i.e. the countries and not the Resolution Fund, those affecting banks will request assistance from the recapitalisations exceeding 10% of the ESM, like in the case of Spain. The
32 The Banking Union, under way and here to stay possibility of lending also exists between different national compartments. Once the eight-year transition phase has concluded, a common support mechanism will come into force, which will be able to lend to the common fund and whose costs will be reimbursed by the banks through levies. The nature and characteristics of this common support mechanism will be developed during the transition phase.
In order to guarantee the member states’ budgetary sovereignty, the Single Resolution Mechanism will be unable to take decisions requiring extraordinary contributions from the States without its prior approval.
The Single Resolution Mechanism, a crucial component 33 A Safety Net with Loopholes
Banking Union was theoretically However, the fact that the creation of a conceived following the creation of single deposit guarantee fund has three new decision-making structures: a vanished from the political agenda does Single Supervisory Mechanism, a Single not mean that it is inappropriate for the Resolution Mechanism and a Safety Net, completion of Banking Union. Deposit the mainstay of which is the protection guarantees are a key factor for the of bank deposits through deposit stability of the financial system, since guarantee funds. The first two they largely prevent or limit banking structures are duly on course and we are panics that are typical of banking crises. familiar with their schedule and main National deposit guarantee funds characteristics. currently exist, financed by banks that carry out that function, but the creation Conversely, the third pillar of single supervisory and resolution (using classic EU terminology), is mechanisms in the eurozone calls for further from becoming a reality. this singularity to also apply naturally to Although progress has been made in asset protection schemes. harmonising the national funds to guarantee bank deposits, the objective In this respect, a hypothetical Single of creating a single deposit guarantee Deposit Guarantee Fund, supported by fund has gradually fallen off the national funds, would act as a sponge to agenda. The reason for its exclusion absorb the losses incurred in a banking from debate is the firm refusal by a crisis, irrespective of the solvency of the group of Central Eurozone countries to country in which they occurred. Also, in share bank deposit risk with other combination with the Single Resolution member states. Fund, which will also be financed
34 The Banking Union, under way and here to stay A Safety Net with Loopholes
through contributions from the finance The conclusion from the foregoing is industry, it would help create a dense that the Safety Net on which Banking fabric of guarantees, thereby affording Union lies contains certain loopholes credibility and strength to the Banking that can blur the final outcome of the Union project. project and, in particular, it does not support the objective of breaking the However, it is also true that the creation cycle that feeds back to sovereign and of a European Deposit Guarantee Fund, bank risk. albeit desirable, is not absolutely vital for the Safety Net. Once the guaranteed Where we are: half way there. If deposits have been excluded from the we assume that the creation of a Single bail-in process and the cornerstone of Deposit Guarantee Fund is now a the Single Resolution Fund has been laid political utopia, we must ask to what down, resorting to the deposit extent can the current asset protection guarantee funds will be more unlikely, schemes in force in the eurozone thereby curbing the need for (although limited or incomplete), mutualisation. support the Banking Union project. The national deposit guarantee funds are In addition to the lack of a single deposit currently half way between guarantee fund, the creation of a fragmentation and harmonisation. The backstop has also been poorly resolved, 2009 Directive unified the minimum which could be used if the costs of the coverage level of guaranteed deposits, crisis exceed the funds envisaged in the which is probably the most sensitive mechanisms (see previous chapter on criteria in the event of a banking crisis. Single Resolution Mechanism). Therefore, at present, all national funds
A Safety Net with Loopholes 35 must guarantee minimum deposits of differences, especially with regard to EUR 100,000 per saver and bank. their financing. Most of the countries (including Spain) are constituted using Also, in December 2013 the European ex ante contributions, whereas a small Council and the European Parliament group of members (including the UK reached an agreement to review the and Italy) operate ex post and Directive and establish harmonised contributions are requested when the deadline and financing objectives. The fund runs low. There are also agreement reduces the maximum considerable differences with regard to deadline in which depositors can receive the percentages of coverage, eligible their money from 20 to 7 working days, deposits, contributions and obligations in three stages: 15 days from 2019, 10 of the banks and size of the funds. days from 2021 and 7 days from 2024. The review also establishes an ex ante This biodiversity of national funds contribution target (periodic preventive creates an asymmetrical network, with financing) of 0.8% of the covered coexisting systems that have a resistance deposits, to be carried out in ten years, capacity against very different situations with contributions weighted by the risk of risk, giving banks in certain countries of each bank. In its 2010 Directive competitive advantages or proposal, the European Commission had disadvantages regardless of their level of suggested a contribution of 1.5%. solvency.
Despite these harmonisation Aside from fragmentation and its achievements, there are approximately negative corollary with respect to the forty different protection schemes link between sovereign and banking throughout the European Union risk, perhaps the most noteworthy (countries like Germany or Austria have matter regarding the current situation of more than one), with significant protection schemes in Europe is that
36 The Banking Union, under way and here to stay appropriation to them might not be emergency situations to finance national enough in order to deal with systemic funds in trouble. The ESM would crises. In general, national funds are therefore adopt the role of last port of prepared to cushion the impact of the call in the event of systemic shock. demise of a medium-sized bank, but no more than that. This suggests the need The banks feel every single to create adequate cross-financing pinch. The obvious impact on the instruments that can resolve generalised banks, which finance the deposit crisis situations in a member state. guarantee funds, is that the strengthening of the asset protection What we need: robust financing and mechanisms will presumably involve an a containment barrier. Given that there increase in their contributions to the is dual evidence to support that the system, with the concomitant adverse creation of a single deposit guarantee effect on their profits. In the current system does not currently appear on the situation of the Spanish and European agenda and that the appropriation to industry, marred by a decline in national funds might not be enough, a profitability, any pinch of profits is pragmatic approach would be to try to painful, but it will not have a significant strengthen the Safety Net through the impact on their income statement. establishment of a powerful backstop, which would act as a larger containment barrier and which would be activated when the fund or national funds have completely run dry. In 2013 the International Monetary Fund IMF) proposed the possibility of making the EUR 500,000 million European Stability Mechanism (ESM) available in
A Safety Net with Loopholes 37 Emergency liquidity assistance, the taboo last resort
One of the levers of the financial therefore, find themselves in a system’s safety net is emergency complicated financial situation. liquidity assistance (ELA), which has become, de facto, the banks’ lender of The national central banks provide last resort during difficult times. It lifelines in situations of extreme involves loans given by national central difficulty. However, emergency liquidity banks to banks that cannot resort to the assistance may not fit in with the main ECB in order to obtain liquidity because objective of Banking Union, which is to they lack adequate collateral and, break the bond between sovereign and
Figure 10. EU eurosystem exposure of 17 countries. September 2012
Bundesbank Eurosystem ELA to credit Eurosystem Bundesbank SMP trends exposure loans in euros institutions exposure exposure (% of GDP) Austria 17.4 0.0 0.0 17.4 4.7 0.2 Belgium 39.7 2.1 0.0 41.9 11.3 0.4 Cyprus 3.7 10.2 0.0 13.9 3.8 0.1 Estonia 0.0 0.0 0.0 0.0 0.0 0.0 Finland 3.7 0.0 0.0 3.7 1.0 0.0 France 176,5 0.0 0.0 176.5 47.8 1.8 Germany 76.8 0.0 0.0 76.8 20.8 0.8 Greece 30.3 100.6 35.8 166.6 45.1 1.7 Ireland 79.1 40.0 17.0 136.1 36.8 1.4 Italy 276.7 0.0 96.2 372.9 100.9 3.8 Luxembourg 5.0 0.0 0.0 5.0 1.4 0.1 Malta 0.6 0.0 0.0 0.6 0.2 0.0 Netherlands 27.7 0.0 0.0 27.7 7.5 0.3 Portugal 54.9 0.0 21.5 76.3 20.7 0.8 Slovakia 2.6 0.0 0.0 2.6 0.7 0.0 Slovenia 3.9 0.0 0.0 3.9 1.0 0.0 Spain 399.9 0.7 39.7 440.3 119.2 4.5 Total 1.198.6 153.7 210.2 1.562.5 422.9 15,9
Source: European Central Bank, national banks and Citi Research estimates
38 The Banking Union, under way and here to stay banking risk. To the extent that such liquidity is provided by national central banks (and appears on their balance sheets) and in certain cases also has a State guarantee, what is happening is exactly the opposite: the bond between country and banking risk is being strengthened. This impact, together with the fact that it is not obligatory to publish information on how it is instrumented, has almost made emergency liquidity assistance become a taboo issue in negotiations for the implementation and development of Banking Union.
These disadvantages have led to a debate in the European Union on the possibility that these operations might cease to be performed by national central banks and be performed exclusively by the ECB. Consequently, regulations for granting liquidity would need to be modified, as well as changes to guarantees requested from banks.
Figure 10 shows the concentration of emergency liquidity assistance operations in three countries (Greece, Ireland and Cyprus), as a reflection of the weakness of their respective financial systems in September 2012.
A Safety Net with Loopholes 39 The ESM, a cannon of limited use
The European Stability Mechanism (ESM) In June 2012 the eurozone heads of is an intergovernmental organisation State or Government approved the use created by the European Council in March of the ESM as a direct recapitalisation 2011, which operates as a permanent instrument for troubled banks, up to a mechanism to safeguard financial stability maximum of EUR 60,000 million, in the eurozone. This mechanism came thereby considerably broadening its into force on 1 July 2012, has a budget of scope of action. EUR 500,000 million and is Monetary Union’s most powerful weapon to assist However, political debate in the countries in financial crisis. ESM support European Union (negotiations are is conditional upon the assumption of a currently underway) has so far prevented number of financial and economic policy that possibility from materialising, which commitments by the country receiving would significantly strengthen the assistance. eurozone’s financial safety net. One group of central countries blocked its Bearing those objectives in mind, at the application because it considers that if close of the edition of this report, the the ESM assists specific banks, its EMS and its predecessor, the European financial position (and rating) would Financial Stability Facility (EFSF) weaken, given that providing money had paid out EUR 320,000 million, EUR to a State, which in most cases have 41,300 of which was received mechanisms to guarantee its return, by Spain to recapitalise its banks (see is not the same as providing money to figure 11). a bank in crisis.
Figure 11. ESM, EFSF and IMF financial assistance programme (in thousands of millions of euros).
Country Greece Ireland Portugal Spain Cyprus Economic Economic Economic Balance of Financial assistance to Type adjustment adjustment adjustment payments recapitalise banks programme programme programme Supervised by EC, ECB and IMF EC, ECB and IMF EC, ECB and IMF EC, ECB and IMF EC, ECB and IMF Amount 246,3 85 78 100 10 committed 215,4 62,7 71,0 4,9 41,3 Paid (ESM/EFSF: (ESM/EFSF: (ESM/EFSF: (ESM/EFSF: (ESM/EFSF:41,3) 185,5 IMF: 28,9) 40,2 FMI: 28,9) 46,9 FMI: 24,1) 4,6 FMI: 0,3) Assistance as 110,3% 39,2% 42,3% 4,3% 27,8% a % of GDP
Source: Economic Governance Support Unit of the European Parliament and proprietary preparation.
40 The Banking Union, under way and here to stay The difficulties in extending the ESM’s Figure 12. Capital contribution from ESM members, in thousands of millions of assistance function to banks were euros. revealed during the Minsters of Economy Capital and Finance meeting held in Brussels on Paid capital in ESM % ESM subscription in Member thousands of contribution/ 18 December, which laid down the pillars participation thousands of millions of euros GDP for the constitution of the Single millions of euros Resolution Mechanism (SRM). During Austria 2,78% 19,48 2,22 0,006% this meeting, no agreement was reached Belgium 3,48% 24,34 2,77 0,007% regarding the use of the ESM as a Cyprus 0,20% 1,37 0,16 0,008% backstop, failing all other bank restructuring options. The ESM will not Estonia 0,19% 1,3 0,15 0,008% be used to directly recapitalise the banks Finland 1,80% 12,58 1,43 0,007% deemed weak during the tests France 20,39% 142,7 16,31 0,007% performed in 2014, prior to the entry into Germany 27,15% 190,02 21,72 0,007% force of the Single Supervisory Greece 2,82% 19,71 2,25 0,010% Mechanism, or after that date, upon Ireland 1,59% 11,14 1,27 0,007% constitution of the Bank Resolution Fund. Italy 17,91% 125,39 14,33 0,008% A loan may be requested from the ESM as Luxembourg 0,25% 1,75 0,2 0,004% a solidarity fund when all other options Malta 0,73% 0,51 0,06 0,008% have failed, but only as a mechanism to Netherlands 5,72% 40,02 4,57 0,007% assist countries, not banks, i.e. under the Portugal 2,51 17,5 2 0,011% same conditions as before Banking Union Slovakia 0,82% 5,77 0,66 0,008% was approved. Slovenia 0,43% 2,99 0,34 0,008%
Spain 11,90% 83,32 9,52 0,008% However, the ESM could potentially be the last port of call in 2024, when the Eurozone 100% 700 80 0,007%
Bank Resolution Fund fully becomes a Source: ESM common instrument. However, that assumption will be discussed by eurozone member states in coming years, and it will remain to be seen how it is finally articulated. At the December meeting, the Economy and Finance ministers only undertook to develop a backstop over the next eight years which, if needed, will lend money to the Resolution Fund and will be reimbursed by the banking sector and they did not indicate whether the ESM will intervene in this assistance programme, as seems logical.
A Safety Net with Loopholes 41 A Single Rulebook to prevent fragmentation
Another pillar of Banking Union is the information). The greater or lesser Single Rulebook, although its rigour of national regulations affects importance is frequently bank solvency and can create underestimated in the process as a competitive advantages and whole. The single rulebook is a group of disadvantages and uncertainties among harmonised prudential rules that the investors, especially during times of European Union institutions must crisis. respect, in order to ensure uniform compliance with Basel III criteria (global The Single Rulebook fills in these gaps capital standard agreements) and largely resolves regulatory throughout all member states. fragmentation. It has instrumented the adaptation of Basel III to European This regulatory uniformity, which seems regulations through rules that can be basic in any harmonisation process, as applied directly, without the need of proposed by Monetary Union, has been transposition or intervention of member frequently breached in the past. The state authorities. This has the advantage underlying difficulty with European of significantly reducing the number of regulations, whose application is based options of national discretion. Also, a on the transposition of directives to regulation is subject to the same national legislation (in certain cases European process of approval as a quite discreetly) has enabled many directive, which ensures that the countries to interpret the common decision is fully democratically regulatory body of banking supervision controlled. Consequently, the Capital as they see fit. This has led to a different Requirements Regulation (CRR) came playing field (see accompanying into being, which supplements the
42 The Banking Union, under way and here to stay A Single Rulebook to prevent fragmentation
fourth version of the Capital Progress with exceptions. Despite Requirements Directive (CRD IV) and this progress, the Capital Requirements which is applicable from 1 January Directive contains some European 2014. This new approach is a key factor regulatory areas, where national in the banking union process, since it legislators still have a margin of discretion favours market discipline and to impose different criteria. These areas, competition between banks by where the prescription capacity for establishing a more uniform and clear countries is low, relate to the powers and regulatory framework. Thus, the Single responsibilities of national authorities, Rulebook will enable the banking sector such as authorisation procedures, the to be: establishment of capital buffers, supervision and sanctions. The directive • More resistant. The uniform also contains risk control requirements application of prudential measures associated with national corporate laws will strengthen banks’ solvency. and corporate governance laws.
• More transparent. European banks Conversely, the Capital Requirements will be more comparable among each Regulation, which applies directly to other, which will favour the decisions member states, regulates regulatory of supervisors, depositors and decisions regarding capital, liquidity investors. and leverage requirements. Figure 13 summarises this distribution of powers: • More efficient. Banks will not have to adapt to 28 different types of The Single Supervisory Mechanism legislation. (SSM) must split hairs in order to
A Single Rulebook to prevent fragmentation 43 Chart 13. Distribution of national and community powers of the new regulation.
Directive Regulation (Provisions associated with national laws, (Detailed and highly-prescriptive provisions that scantly prescriptive) create a Single Rulebook) Access and development of banking Capital activities Exercise of freedom of establishment and Liquidity free movement of services Prudential supervision Leverage Capital buffers Counterparty credit risk Corporate governance High-risk operations Sanctions Dissemination and disclosure requirements
Source: European Commission anf proprietary preparation.
manage this distribution of powers, European legislation and whose especially in areas where the regulation coverage must be determined by leaves national authorities with a very national supervisors to prevent high margin of discretion. In Spain, for contingencies in the country. One example, the banks apply different specific example is sector concentration provisioning criteria to other EU risk which, in Spain, is measured in members. accordance with specific ratios and requires an additional capital buffer. The most significant case relates to the generic provision, which is an These national provisions, which entail instrument with a countercyclical exceptions or flexibility in the component that does not exist in other framework of the single rulebook, have member states, as it arises not as a result reason to exist in a scenario in which of non-payment already observed in economic cycles are not fully relation to loans, but rather it is based synchronised. In order to address such on the historical experience of arrears asymmetries, EU countries retain the and losses in previous crises. In 2007 possibility of establishing certain these provisions totalled EUR 25,836 requirements that enable prudential million. The single supervisor must supervisory criteria to be adapted to the decide whether to maintain these reality of each one. provisions or, conversely, eliminate or modify them in a certain manner, which The Single Supervisory Mechanism would free up a significant volume of (SSM) must also tackle the difficult resources which, up until now, were task of combining historical national accumulated to cover future losses. supervision models that differ greatly Although to date, this amount has been in terms of characteristics and levels reduced to EUR 3,292 million, it is of requirements. In the case of Spain, obvious that any decision regarding for example, banks are subjected to these provisions can have a very stricter valuation with regard to the significant impact. density of assets compared to other countries (the relationship between The same phenomenon occurs in risk-weighted assets and the total relation to the risks covered by the balance sheet), which is key in so-called Pillar II measures, i.e. measuring capital adequacy and, in circumstances that are not regulated by short, bank solvency.
44 The Banking Union, under way and here to stay With regard to supervisory tasks, the crisis, particularly those relating to SSM will be faced with the challenge of capital inadequacy, both in terms of harmonising practices without relaxing quantity and quality. The new them in countries with stricter prudential rules, inspired by the Basel regulations. Also, the new mechanism is III agreements, impose stricter criteria faced with the initial difficulty of on capital reserves and liquidity levels coordinating, with limited resources, and also strengthen the banks’ ability to the supervision of a very large number manage the risks associated with their of banks in many countries, which can activities. lead to the risk of a decrease in supervision intensity during the Other basic regulations. If the transition phase. legislative package that composes the Capital Requirements Directive and the Overall, we can affirm that the new Capital Requirements Regulation forms legal framework on which the European the spinal cord of the Single Rulebook, banks’ supervisory requirements are the Banking Union process is also based addresses some of the weaknesses supported by two other main basic shown by the banks during the financial regulations:
A Single Rulebook to prevent fragmentation 45 • The Bank Recovery and Resolution rules for the granting of public aid to Directive (BRRD). This is at the final banks. phase of definitive approval and is used as a legal basis for certain • The Safety Net, based on the fundamental Single Resolution protection of bank deposits, which is a Mechanism instruments, such as the key factor in the stability of the bail-in, a recapitalisation system financial system. The net is currently based on the orderly assumption of composed of highly diverse national losses by shareholders and creditors, funds that also share the criteria of except for deposits of less than EUR guaranteeing deposits under EUR 100,000. The bail-in is the first 100,000. Progress has also been made backstop to prevent a troubled or in harmonising financing and the unviable bank from requiring public payment period of national funds. fund assistance. In any case, any However, political differences in the public assistance given to a bank will European Union have halted the be subject to European Union state aid progression of the creation of a single regulations. In August 2013 the deposit guarantee fund, which is not European Commission updated its expected to change in the short term.
46 The Banking Union, under way and here to stay Learning from mistakes
The problems arising from the lack of postponed la application of the new regulatory uniformity in the European regulations and benefitted from that Union came under the spotlight during competitive advantage in the capital the financial crisis. This occurred, for markets for many months. example, in the case of asset securitisation transactions (a Situations of inequality also arose in mechanism allowing illiquid receivables relation to the definition of capital to be transformed into marketable established in Basel III and replicated in securities), which played a decisive role the European directive. Transposition to in the explosion of the crisis. Although the respective national legislation led to the framework of the Basel II a wide variety of interpretations, some agreements and Capital Requirements of which were clearly wrong, obliging Directive 1 (CRD I) envisaged the risks the European Commission to initiate associated with these transactions and infringement proceedings for certain imposed specific capital requirements countries extended over several years, on banks, many member states availed in order to force compliance with the of temporary opt-out clauses, thus directive’s criteria. A similar case refers preventing the transposition of the to the requirements for implementing general regulations. In a globalised internal risk models, whose importance market such as the securitisation for anticipating situations of stress and market, the cross-border groups did not maintaining appropriate capital levels have any major problems in taking was another lesson we learned from the advantage of this regulatory loophole financial crisis. Their adaptation also led and issuing their securities in the to situations of inequality among countries that had not adopted the new various member states and, as a result, requirements. In the light of that similar exposure levels had very discrimination, the European different capital requirements assigned authorities strengthened the second to them. version of the directive in order to sanction the countries with low capital This is precisely one of the issues that requirements, but some member states the ECB will shortly address.
A Single Rulebook to prevent fragmentation 47 Conclusions and recommendations
The Banking Union project potentially different consecutive tests that will be has a huge positive impact on the conducted before November 2014. Economic and Monetary Union project, This assessment will provide an with which it will gain in terms of overall valuation of each bank’s density and depth. Also, its appropriate degree of solvency, which could implementation will ideally serve as a require capital replenishment or other vaccine against future banking crises, measures for restructuring purposes. by limiting the contagion effect typical In this respect, the decisions adopted of episodes of instability and minimising in respect of the banks’ government its impact on the taxpayers’ pockets, debt securities is vital, which will who have recently witnessed in ultimately be subjected to stress tests. astonishment bailouts of European banks that have required massive public • Furthermore, the banks will have to assistance. adapt to an operative, preventive and strategic supervision model that is The project will also help transfer more reliant on internal control, monetary policy in a better manner and, governance and solvency reviews in particular, interest rate policy to the from a dynamic standpoint, rather actual economy, which in recent years than on accounting reviews. The new has been affected by distortion caused model will require substantial by fragmentation of financial systems, changes in the bank’s internal giving rise to situations of organisation and, in particular, will discrimination in credit-granting make it obligatory to establish a clear circuits. However, Banking Union will risk appetite framework. This also have significant consequences for framework will include capital the banks themselves, paving the way planning, risk management and for a brand new phase in which they will control and internal audit policies. probably have to modify their strategy, The banks will also have to take into resources, internal organisation and account that supervision criteria will even their business models, which could emanate directly from Frankfurt, lead to an in-depth restructuring of the causing national authorities to remain European financial map. These in the shadow during the process. repercussions can be summarised and grouped into two short-term scenarios, • The banks must pay utmost attention in accordance with the project’s to capital and liquidity criteria operating schedule. planning (and not just compliance), which will determine comparisons Short-term repercussions (up with other European banks. until 2016). This is undoubtedly the Accordingly, the banks will have to critical phase for banks, which must develop complex models that include immediately face important challenges: capital objectives in various risk scenarios. • The first challenge will be the exhaustive assessment of the main • The adaptation process will demand European banks, including three investment in human and technology
48 The Banking Union, under way and here to stay resources. The location of such which parts of their businesses are resources is also subject to debate. The essential and establish a firewall banks must decide whether it is system should their position convenient to relocate executive significantly deteriorate. If this occurs, employees to Frankfurt in order to the recovery plan would serve as a curtail the effects of being remotely guide for the Single Resolution distanced from the supervisor. In the Mechanism, which would be equipped very short-term, the banks face a with the necessary information to serious problem involving the drain of restructure the bank in an urgent and qualified professionals. Not only do decisive manner. the banks have to fight among themselves in order to attract talent in • In the medium term, the banking a skewed labour market, where sector is expected to undergo a demand clearly outweighs supply, process of restructuring and they also compete with the concentration, especially through supervisory authorities themselves, mergers and acquisitions. Over the which also need to extend and past five years, corporate transactions enhance their teams. in Europe have been very scarce, partly as a result of mistrust among Medium- and long-term banks. If Banking Union succeeds in repercussions (from 2016 rebuilding trust in the finance onwards). The entry into force of the industry, as expected, this will enable new resolution framework largely the banks to propose consolidation determines the medium and long-term formulas in order to boost their effects. The consequences for banks are profitability levels. as follows: • In the long term, we should bear in • Creditor seniority established in the mind that the European finance bail-in, which will be activated in industry is heading towards a gradual 2016, is a key component in each reduction in terms of its size and bank’s liabilities structure and can influence on the economic fabric. affect its composition and cost. The bail-in criteria will also most likely The crisis has shown us that the influence investor decisions, which sector has excess capacity and the will attempt to avoid risking money unification of supervision will urge per the 8% minimum requirements, banks to adjust their balance sheets which is a bank’s first loss absorbency and reduce their risk exposure in buffer. order to develop business models that are safer and more sustainable over • All the banks must prepare recovery time. plans, revisable each year, in order to cater for hypothetical emergency This reduction in the size of the situations. Such plans oblige banks European finance industry could to provide an exhaustive detail of mean that its activities might lose their internal structure, to identify sway in the financing of the economy.
Conclusions and recommendations 49 Economic effort. A problem affecting take into account that during the all the phases of the system’s financing 2008-2012 period, the annual profit process. Single supervisory activities, from operations of European banks centred at the ECB will be funded by the amounted to an average of banks, which will pay a levy for the approximately EUR 270,000 million service. However, the finance industry (0.76% of their assets). In any case, the will also fund the new Single Resolution potential benefits of Banking Union will Fund (which will be foreseeably foreseeably and easily offset the constituted gradually between 2016 and industry’s contributions to the system 2024, up to a total of EUR 55,000 overall, in terms of stability, robustness million), the bridging loans for national and efficiency. funds, as well as the future and still undetermined backstop, which will be A more ambitious project. created in 2024, as well as the deposit Banking Union will probably change the protection scheme network. Although face of the European finance industry. It they have been deferred, these could also act as a driver in the long contributions imply that significant integration process of Economic and efforts must be made by European Monetary Union. Will it stop there or banks. will it form part of a more ambitious harmonisation project progressing However, we should not think that such towards fiscal and political union? The efforts will alter the balance of the debate, emanating from the deepest industry’s income statement. We must notion of Europe, is on.
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54 The Banking Union, under way and here to stay
A report by the PwC and IE Business School Centre for the Financial Sector
The PwC and IE Business School Centre for the Financial Sector is a joint project between the two institutions to create a leading body to research and spread financial information, analysing the challenges facing entities in Spain and the rest of the world as they move through their on-going transformation process. The centre is a unique entity in Spain and independent of credit entities.
The initiative began in 2010, right when the Spanish financial sector was being restructured and consolidated, and since then it has witnessed key events, such as the sector’s recapitalization and a significant drop in the number of players.
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© 2014 Centro del Sector Financiero de PwC e IE Business School. This document has been prepared by the PwC and IE Business School Centre for the Financial Sector and the content reflects exclusively and solely the author’s opinion.