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International Association of Risk and Compliance
Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.risk-compliance-association.com
Top 10 risk and compliance management related news stories
and world events that (for better or for worse) shaped the
week's agenda, and what is next
Dear Member,
Do you develop your ILAAP with your ICAAP for the
SREP? Do you follow a “constrained judgement”
approach?
Oh these acronyms… Let’s have a look.
I have just read (three times…) a
really interesting document from the
European Central Bank (ECB), the
“Guide to banking supervision”.
“For the purpose of performing the
Supervisory Review and Evaluation
Process (SREP), the SSM has developed a common methodology for the
ongoing assessment of credit institutions’ risks, their governance
arrangements and their capital and liquidity situation.”
“The SSM SREP encompasses three main elements:
•
a risk assessment system (RAS), which evaluates credit institutions’
risk levels and controls;
•
a comprehensive review of the institutions’ Internal Capital
Adequacy Assessment Process (ICAAP) and Internal Liquidity Adequacy
Assessment Process (ILAAP);
•
a capital and liquidity quantification methodology, which evaluates
credit institutions’ capital and liquidity needs given the results of the risk
assessment.
Both the RAS and capital and liquidity quantification follow a multi-step
approach.”
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“They are built on a “constrained judgement” approach, so as to ensure
consistency across the SSM, while allowing for expert judgement to
consider the complexity and variety of situations within a clear and
transparent framework.”
Did you ask what the SSM is?
The Single Supervisory Mechanism (SSM) comprises the European Central
Bank (ECB) and the national competent authorities (NCAs) of participating
Member States. The SSM is responsible for the prudential supervision of all
credit institutions in the participating Member States.
It ensures that the EU’s policy on the prudential supervision of credit
institutions is implemented in a coherent and effective manner.
Oh, these are difficult days for the European Central Bank (ECB).
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The SSM is responsible for the supervision of around 4,700 supervised
entities within participating Member States.
To ensure efficient supervision, the respective supervisory roles and
responsibilities of the ECB and the NCAs are allocated on the basis of the
significance of the supervised entities.
To determine whether or not a credit institution is significant, the SSM
conducts a regular review: all credit institutions authorised within the
participating Member States are assessed to determine whether they fulfil
the criteria for significance.
A credit institution will be considered significant if any one of the following
conditions is met:
•
the total value of its assets exceeds €30 billion or – unless the total
value of its assets is below €5 billion – exceeds 20% of national GDP;
•
it is one of the three most significant credit institutions established in
a Member State;
•
it is a recipient of direct assistance from the European Stability
Mechanism;
•
the total value of its assets exceeds €5 billion and the ratio of its
cross-border assets/liabilities in more than one other participating Member
State to its total assets/liabilities is above 20%.
Read more at Number 3 below. Welcome to the Top 10 list.
Best Regards,
George Lekatis
President of the IARCP
General Manager, Compliance LLC
1200 G Street NW Suite 800,
Washington DC 20005, USA
Tel: (202) 449-9750
Email: [email protected]
Web: www.risk-compliance-association.com
HQ: 1220 N. Market Street Suite 804,
Wilmington DE 19801, USA
Tel: (302) 342-8828
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Implementing the regulatory reform agenda the pitfall of myopia
Speech by Mr Stefan Ingves, Chairman, Basel
Committee on Banking Supervision and Governor,
Sveriges Riksbank at the Federal Reserve Bank of
Chicago
“The subject of this conference is indeed very timely
- six years after the outbreak of the financial crisis, there has been
substantial progress in the post-crisis regulatory reform agenda, with a
number of important milestones reached.”
Topical developments on
pensions: an EIOPA perspective
Gabriel Bernardino
Chairman of EIOPA
9th European Pension Funds Congress, Frankfurt am Main
“This event has become a key annual gathering where different
stakeholders debate the future of pensions in the EU, the ways to deal with
the challenge of an ageing society and deliver safe, sustainable and
adequate pensions for EU citizens.”
ECB - Guide to banking
supervision
This guide is fundamental to the
implementation of the Single
Supervisory Mechanism (SSM),
the new system of financial
supervision comprising, as at
November 2014, the European
Central Bank (ECB) and the national competent authorities (NCAs) of euro
area countries.
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Monetary Policy Accommodation, Risk-Taking,
and Spillovers
Governor Jerome H. Powell
Global Research Forum on International
Macroeconomics and Finance, Washington, D.C.
“The Federal Reserve's monetary policy is motivated by the dual mandate,
which calls upon us to achieve stable prices and maximum sustainable
employment.
While these objectives are stated as domestic concerns, as a practical
matter, economic and financial developments around the world can have
significant effects on our own economy and vice versa.
Thus, the pursuit of our mandate requires that we understand and
incorporate into our policy decision-making the anticipated effects of these
interconnections.”
Shadow banking - what kind of regulation for
the (European) shadow banking system?
Notes by Mr Pentti Hakkarainen, Deputy Governor of
the Bank of Finland, for the panel discussion at the
SAFE Summer Academy 2014 "Shadow Banking:
Evolution, Background, Perspectives", Brussels
“I will not go too much into the details of the definition
and coverage of the shadow banking system as it has been a topic of another
discussion earlier today.
Let me just say that it is very important to have a clear understanding of
what we are talking about and hence what we potentially try to regulate and
supervise.
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Big Bang banking union - what can we expect?
Speech by Dr Andreas Dombret, Member of the
Executive Board of the Deutsche Bundesbank, at the
Euro Finance Week, Frankfurt am Main
“The British astronomer Martin Rees once said: "We
can trace things back to the earlier stages of the Big
Bang, but we still don't know what banged and why it
banged.
That's a challenge for 21st century science.”
Taking stock of the global role of the Renminbi
Speech by Benoît Cœuré, Member of the Executive
Board of the ECB, at the European-Chinese Banking
Day, Frankfurt.
“As a major economy, the euro area is naturally affected
by this process. The rise of China has been
astonishing.”
“In October 2013, the ECB signed a bilateral currency swap arrangement
with the PBC with maximum sizes of 45 billion euros when euro are
provides euros to the PBC and 350 billion yuan when yuans are provided to
the ECB.”
Economic outlook, monetary policy, and credit
ratings
Speech by Mr Már Guðmundsson, Governor of the Central
Bank of Iceland, at the Chamber of Commerce Monetary
Policy Meeting, Reykjavik
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Introductory remarks at the EP’s Economic
and Monetary Affairs Committee
Speech by Mario Draghi, President of the ECB
This year has once again been a year of profound
change for the euro area and for the Union as a
whole.
It was a year of legislative and institutional progress on many fronts, as
2014 saw the birth of banking union with the agreement of the Single
Resolution Mechanism, the start of the Single Supervisory Mechanism and
the successful conclusion of the comprehensive assessment of banks’
balance sheets.
What legacy for the future of Mauritius?
Address by Mr Rundheersing Bheenick,
Governor of the Bank of Mauritius, at the
Annual Dinner in honour of Economic
Operators, Pailles
"At this stage of the development of our
country, the best contribution that the Central
Bank can make is to keep inflation low, stable, and predictable as the
foundation for a fairer and more equal society."
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Implementing the regulatory reform agenda the pitfall of myopia
Speech by Mr Stefan Ingves, Chairman, Basel
Committee on Banking Supervision and Governor,
Sveriges Riksbank at the Federal Reserve Bank of
Chicago
The subject of this conference is indeed very timely six years after the outbreak of the financial crisis,
there has been substantial progress in the post-crisis regulatory reform
agenda, with a number of important milestones reached.
Therefore, now is a good time to take a step back and ask how the different
bits and pieces of the regulatory framework fit together.
And, more specifically - have the vulnerabilities revealed in the crisis been
adequately addressed? Are additional adjustments still necessary?
Or, conversely, have we gone too far and created a regulatory
Frankenstein's monster that no-one has full control over and that stifles
lending and economic growth?
This latter view is one that I sometimes hear when meeting representatives
of the banking industry.
The feeling seems to be that we are overwhelming the financial system with
a regulation tsunami with too many reforms being implemented too soon.
This will lead to unacceptable consequences in the form of higher funding
costs, reductions in market liquidity with market-makers pulling out of
markets, collateral shortages; and many banking activities simply
disappearing, or moving to the so called shadow banking sector.
And indeed - the financial crisis has led to a comprehensive response from
regulators and policymakers across the world.
Compared to the pre-crisis era, international banks will face:
- substantially higher capital requirements,
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- higher demands on the quality of capital,
- a leverage ratio,
- an international liquidity framework, with both short-term and structural
liquidity requirements (I am proud to note that the Basel Committee, less
than a week ago, published the final standard for the net stable funding
ratio, NSFR), and
- a regulatory framework for global systemically important banks (G-SIBs).
When you add to this ongoing work related to reducing RWA variability
and disclosure, you end up with a pretty impressive list - a list that
represents an unprecedented leap forward in terms of global banking
regulation.
So then, how do I see this?
Do I claim to know how all these new rules will play out together?
Am I confident that there will be no inconsistencies and contradictions? No,
definitely not.
We have every reason to be humble in this respect. Monitoring and
assessing the effects of reforms will therefore be imperative.
Will the reforms be costly for banks in the short term? Yes, they will.
Will banks have to adjust their activities? Yes, a return to pre-crisis
banking behaviour is neither appropriate nor viable.
Do I therefore think that regulation has gone too far and that parts should
be undone? No, not at all.
In this presentation I will try to explain why I think this is so. I will also
speak about what is still lacking and the regulatory challenges we face
ahead.
Why we shouldn't back-track on regulation
There are several reasons why I don't think the regulatory agenda has gone
too far.
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First of all, my experience is that important regulatory and structural
reforms are all too often hindered by myopia.
People tend to focus on costs and pains in the short run, leaving aside the
longer term gains that reforms aim to achieve.
The perceived short-term costs are simply much easier to sell politically,
compared to the abstract benefits of lowering the risk of crises.
This is especially so, since the benefits may accrue only to future
generations - a group that has difficulties making its voice heard in today's
policy debate.
This time has been no exception: for years, people shied away from
necessary actions to strengthen the financial system.
When the crisis hit, perceptions changed, providing a window of
opportunity for regulatory reforms that were long overdue.
However, we must not begin to close this window and lose sight of why we
are undertaking these reforms.
Let me start with a reminder of the regulatory framework before the crisis.
Both Basel I and II included a risk-weighted capital adequacy framework.
However, for the last 20 years banks' balance sheets ballooned, while their
equity failed to take off.
For example, from 1993 to 2008 the total assets of a sample of what we call
global systemically important banks saw a twelve-fold increase (increasing
from $2.6 trillion to just over $30 trillion).
But the capital funding these assets only increased seven-fold, (from $125
billion to $890 billion).
Put differently, the average risk weight declined from 70% to below 40%.
The problem was that this reduction did not represent a genuine reduction
in risk in the banking system.
To take an even more concrete example from my own country: during the
past twenty years or so, the risk weights for retail mortgages in the major
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Swedish banks have decreased from 50% to 35% with the adoption of Basel
II (from Basel I) and further, to about 6% when banks themselves were
allowed to model risk weights.
In equity terms, this means that instead of SEK 17,000 of their own equity
to fund a mortgage of 1 million, banks' models implied that SEK 1,200 was
enough.
In retrospect, it is clear that the decrease in risk weights did not reflect
actual risks and banks therefore needed more capital.
Furthermore, although it is a historical fact that banks' problems often
start in the form of liquidity constraints, there were no global liquidity
regulations for banks prior to the crisis.
This meant that banks could rely heavily on very short-term market funding
to finance highly illiquid and long-term assets.
This worked fine during the Great Moderation, but unfortunately with the
collapse of Lehman Brothers another old truism suddenly came to life:
"markets function the worst when you need them the most".
Against this background, it is quite embarrassing that so few could see the
crisis coming.
From a regulatory point of view, all the ingredients were there, or rather
they were lacking.
And this is the first point I want to make - the regulatory framework was
unsatisfactory and becoming more so the more complex the financial
system became.
Then, turning to my second point, which is: The costs of financial crises are
huge.
This is true in general, but especially so for the recent one.
For example, according to a recent study by IMF economists, in a sample of
countries representing just over 50% of world GDP, the total amount of
government recapitalisation, asset purchases and guarantees during the
period 2007-2011 amounted to nearly $5 trillion.
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This is equivalent to 16% of the GDP of these economies, or nearly $5,000
per citizen.
But, this is only a lower bound of the cost of the crisis.
If we also include the impact on GDP and the loss of production relative to
its pre-crisis trend, the costs rise.
This has been showed by several studies, including the one just mentioned
by IMF economists, which estimates that banking crises that occurred
between 1970 and 2000 are resulting in output losses of more than 20% on
average if we look at all countries, and more than 30% of GDP in advanced
economies.
These results are in line with the BIS finding that the median discounted
cumulative loss of output over the course of a crisis in the same period was
about 19% of pre-crisis GDP.
Now, the question of exactly how much regulation leads to the optimal
outcome in terms of long-term growth is, of course, debatable.
But let me underline that ambitious attempts have been made by the BIS,
but also the OECD and others, to assess the net effect of recent regulatory
reform measures, and the results generally point in one direction: that the
net effect of reforms is positive.
In addition, let me also underline that the Basel Committee has not been
blind and deaf to the worries expressed by the industry about excessive
regulation.
Many adjustments have been made, not least when it comes to the new
liquidity regulation.
It is also standard procedure that new regulations are subject to industry
consultation and in many cases additional discussions also take place with
the industry itself, as well as with investors, to avoid unintended
consequences.
In this context, however, let me remind us all that the reactions we get
from the banking industry are sometimes slightly biased, if I dare say so.
A telling example is the lobbying effort during the design of the Basel II
framework.
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As part of that work, in 2003 the Committee consulted on a new
securitisation framework, which, with the benefit of hindsight, turned out
to be very weak.
Yet the comments from the industry on the proposed securitisation
framework were in general quite alarming.
Allow me to quote just a couple of the replies to the consultation proposal
that the Committee received (all of which are publicly available):
One bank wrote: "The prescribed risk weightings for securitisation
exposure(s)-result in excessive risk weights compared to the economic risks
of securitisation tranches, particularly for retail and mortgage portfolios." –
This particular bank happened to incur $24.7 billion in losses from CDOs
during the crisis.
Another bank wrote: "If adopted, the current proposal for securitisation
will materially impair the ability of banks to distribute risk from their own
balance sheets into the capital markets." - This bank incurred USD 13
billion losses in Q1 2008 and USD19 billion in writedowns on real estate
and related structured credit positions.6
Let me emphasise that there is nothing special with these two examples.
I can assure you that there are many more similar examples to quote - the
message being that the proposed reforms were overly restrictive, would
damage the market and reduce activity.
This illustrates that we need perspective when assessing the feasibility of
reforms.
To sum up so far: yes, there has been a strong regulatory reaction to the
crisis, but as I see it, this is appropriate, given
- the pre-crisis regulatory framework,
- the costs crises give rise to, and
- the efforts that the Basel Committee has made to mitigate risks of
unintended consequences,
The problem is that myopic observers tend to forget these aspects.
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Are we there yet? What are the remaining challenges?
I would now like to change perspective slightly and ask, are we there yet?
Have our efforts done the trick, or are there still challenges to be tackled?
Well, from a Basel Committee perspective I am pleased to be able to say
that the Basel III framework is now agreed - in principle.
This is a major achievement that all participating parties should be proud
of.
If I widen the scope, beyond the Basel III framework, and look at other
parts of the reform agenda, it is obvious that the work on ending the "too
big to fail" problem has been difficult, and that some work still remains to
be done.
However, the reason we have not yet reached our goal is not lack of effort,
but simply that the resolution of very large, cross-border banks is not easy.
The main remaining issue here concerns how to ensure that global
systemically important banks have sufficient capacity to absorb losses in
resolution, without having to ask tax-payers to foot the bill.
This work goes under the name of T-LAC, or total loss absorbing capacity.
I find it reasonable to believe that there will be an agreement on a
consultative document to be published in the context of the G20 summit in
Brisbane.
So, viewed against the broad regulatory reform agenda put in place as a
reaction to the crisis, it is fair to say that we are indeed seeing some light at
the end of the tunnel.
The main pieces are starting to come in place.
Unfortunately, concluding the post crisis reform agenda does not mean
that we can lie down, relax and declare "mission accomplished".
We need to look closely at the regulatory framework, remind ourselves of
the reasons we put these measures in place, and ask whether they are
delivering the right outcomes.
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And here I would like to focus on the interlinked issues of implementation
and calibration.
Let me start with some reflections on implementation.
For some time now, the Basel Committee has engaged in the process of
monitoring and assessing how members implement what has been agreed
by the Committee.
The assessment work is carried out on a jurisdictional as well as on a
thematic basis.
In the jurisdictional assessment we look at how Committee members have
implemented the Basel standard - determining whether or not it is a fair
reflection of the Basel III requirements.
After an assessment has been thoroughly debated in the Committee, the
final assessment becomes public.
The assessments, and the publication of the results, have proved to be a
powerful tool.
To date, more than 200 adjustments have been made by member
jurisdictions in response to findings raised by the assessment teams.
In addition, the process has also generated a positive feedback loop,
meaning that the lessons learnt from assessments are used to improve and
clarify the standards.
So far, the assessments have concentrated on the capital framework, but
from 2015 onwards the scope of this work will widen further to include the
implementation of the liquidity coverage ratio and the SIB-requirements.
However, for the new, stricter requirements to bring the benefits we are
aiming for, it is important that they be properly reflected, not only in
national legislation, but also at the level of individual banks.
To use an analogy of car safety, if we are now providing banks with air bags,
in the form of higher capital requirements, it is important that those airbags
are actually activated in case of an accident.
For this to happen, the sensors need to be functioning and well-calibrated.
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For banks, this means that risk weights need to signal appropriately the
risks that individual banks actually face.
This aspect is captured in the Committee's thematic assessments.
To put it simply, in these assessments we examined whether the banks'
risk-weighted assets could be trusted.
The results showed that banks' risk-weighted assets differ to an extent that
goes well beyond what can be explained by business models and historical
experiences.
If we just take the banking-book results, two banks with exactly the same
assets could report capital ratios that differ by as much as 4 percentage
points.
The potential for differences this wide, particularly as they are derived
from only a part of a bank's business, weakens confidence in the
measurement of bank capital.
Of course, this was not a total surprise.
It was a reflection of what I mentioned earlier: that internally-modelled risk
weights lead to capital not keeping pace with asset expansion.
This has undermined the confidence in banks and the credibility of the
concept of banks' internally-modelled risk weights.
Ensuring consistency in the implementation of risk-based capital standards
will therefore be a key factor in restoring confidence in banks.
The Committee is thus assessing bank capital ratios with a view to ensuring
that they appropriately reflect the risks that banks face.
There should be "truth in advertising" for the regulatory ratios that banks
present.
To achieve this, the regulatory framework needs to deliver readily
comprehensible and comparable outcomes.
In my view, these assessments, both the jurisdictional and the thematic that
compares risk-weighted assets, are absolutely vital for achieving our goals.
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This will be an important focus for the Committee in the coming years.
I would now like to take a step further and focus on the link between
implementation and how the system should be calibrated.
Because my view is that there are a number of trade-offs at play here, which
need to be taken into account.
For instance, if we don't implement the necessary changes and succeed in
properly restoring the credibility of risk-weighted capital ratios, a more
important role will have to be played by other parts of the regulatory
system, such as the leverage ratio.
For now, our working hypothesis is a regulatory minimum leverage ratio of
3%, but to me this is more of a place-holder.
What the final outcome should be will depend on the calibration of the
whole regulatory framework, in which the risk weights and leverage ratio
are important pieces.
An important element in this calibration will be transparency - the more
transparent banksare with methods and models to calculate risk weights,
the better it will be for the credibility of the system as such.
If we widen the perspective further, I think there is also an interesting issue
of calibration linked to the concept of going-concern capital requirements
on the one hand, and gone-concern capital requirements on the other.
When we discuss appropriate levels of TLAC we should keep in mind that
the less we strengthen the credibility of the system for going concern capital
requirements, the higher banks' gone-concern capacity to absorb losses will
have to be.
Concluding remarks
So, to wrap up: I see no reason to pull the brake on regulatory reforms. We
must not lose sight of the long-term benefits of limiting the costs to society
that financial crises cause.
And, although a lot has been achieved, challenges still remain - especially
when it comes to implementation, implementation monitoring and
calibration of the whole framework.
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As I said earlier, I do not know with full certainty how all the different parts
of the reforms will play out together.
This further underlines the necessity to constantly monitor what is
happening, very much in line with what the organisers of this conference
are doing.
And as financial systems have an amazing ability to reinvent themselves,
regulatory reform is a never-ending task.
Therefore, we need forums such as this conference to evaluate where we
are, and where we should be going - hopefully, then, we won't have to make
regulatory leaps quite as far as we were forced to this time.
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Topical developments on
pensions: an EIOPA perspective
Gabriel Bernardino
Chairman of EIOPA
9th European Pension Funds Congress, Frankfurt am Main
Ladies and Gentlemen,
I would like to congratulate Pensions Europe for organising for the ninth
time the European Pension Funds Congress here in Frankfurt as part of the
Euro Finance Week.
This event has become a key annual gathering where different stakeholders
debate the future of pensions in the EU, the ways to deal with the challenge
of an ageing society and deliver safe, sustainable and adequate pensions for
EU citizens.
I would also like to thank Pensions Europe for the opportunity to speak to
you today.
In my intervention I will talk about EIOPA’s vision, strategy and objectives
on pensions and how we are implementing it.
The percentage of the EU population that is covered by decent pension
systems is still too low.
We are indeed facing an EU pension’s landscape in need of reforms.
Reforms require choices and courage.
The European pension’s landscape we are facing is very heterogeneous,
with public pay-as-you-go, occupational, and personal pension vehicles
playing a very different role in the 28 Member States.
Despite such diversity that understandingly reflects the different cultures
and traditions, pension systems have one thing in common.
They are all facing tremendous challenges to deliver on their promises.
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Challenges like longevity growth, a sluggish economic environment, low
employment, budget deficits and debt burdens, low interest rates, volatility
of asset values.
Public pay-as-you-go pension schemes face an increasing expenditure,
meaning growing pressure on public finances and on the younger
generations, and are affected by lower contributions due to higher
unemployment.
Reforms of public pension systems are introduced as part of current
initiatives to restore confidence in government finances.
On the other side, private funded schemes are affected by the volatility of
asset values and by reduced returns which lower the funding ratios in
defined benefit schemes and diminish the ultimate value of pensions paid
by defined contribution schemes.
These effects are not always transparent to members and beneficiaries,
contributing to an environment of lack of confidence.
To ensure that citizens will have a chance to maintain appropriate
standards of living in their retirement it is self-evident that we need a
comprehensive package of reforms.
Changes to ensure the future sustainability of public pay-as-you-go pension
systems need to be accompanied by reforms incentivising the creation of
funded complementary private schemes be it 2nd pillar occupational
pensions or 3rd pillar personal pensions.
From a policy perspective this should be the first strategic priority at
national and EU level.
I believe that an important strategy to achieve this goal is to provide a
robust and proportionate EU regulatory framework capable of regaining
the trust and confidence of EU citizens in private complementary pension
savings.
This regulatory framework needs to deliver on three fundamental
objectives:
Enhanced sustainability, strong governance and full transparency. These
are the fundamental building blocks of EIOPA’s pensions’ vision.
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Enhanced sustainability, because the first step to ensure protection of
members and beneficiaries is to make sure that any pension scheme
disposes of sufficient assets to fulfil its liabilities within a realistic valuation
scenario.
The QIS that we performed last year showed that pension funds in many
member states have vulnerabilities. Local measurements sometimes
provide a more optimistic view on pension funds solvency than applying a
more realistic measurement.
In these cases, the reliance on future payments by the sponsoring
employers is very large. We need to recognise this and assess if this
dependency is sustainable in the long run.
Strong governance, because pensions deserve to be governed by fit and
proper persons, with the appropriate skills, experience and integrity;
because conflicts of interest need to be identified and managed in order to
make sure that Board Members act in the sole interest of members and
beneficiaries; because strong risk management capabilities and robust
internal controls are fundamental to deliver to pensioners the promises
made or the expectations created.
Full transparency, because if we want to regain trust of citizens we cannot
hide anymore behind “jargon”; in the digital era we cannot justify
difficulties of providing information; we need to provide full disclosure of
all costs, be it investment or transaction costs; we need to give members
and beneficiaries a full picture of the returns that they get on their pension
products.
In all our work we recognise that pensions are different from other areas.
Pensions are different because of their “embeddedness” in social and labour
law; because of their social objectives; because of their particular
governance, involving employers and social partners; different because of
their unique distribution of risks.
But, in spite of these differences, members and beneficiaries are citizens
who deserve adequate protection, who have the right to know the
sustainability of the promises that are made to them, who need to
understand the risks that they are running, the costs that they are paying,
who deserve that pension funds are properly governed and that pension
schemes have a high degree of quality.
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So pension funds need specific regulation that takes into account these
differences and that’s what EIOPA has been advocating and practising.
•
By developing an innovative “Holistic Balance Sheet” approach that
takes into consideration all benefit adjustment and security mechanisms,
such as sponsor support and pension protection schemes, capturing the
specificities of pension funds in the various member states;
•
By recommending an upgrade in the governance of pension funds,
reinforcing the importance of proper risk management and control
functions, while applying due proportionality to avoid undue burden and
costs to smaller schemes;
•
By advocating the development of a Key Information Document that
should provide standardised information on contributions, costs and
charges, investment options and expected benefits.
But also recognising that “too much” information kills information and that
we should adopt a layering approach where members will receive simple
and comparable information on the key elements and would have easy
access if they wish to all the other more detailed material.
As a result of all of this work we have now a proposal from the EU
Commission to adjust the IORP Directive covering governance and
transparency requirements that we very much welcomed.
To improve IORPs' decision-making much stronger governance is needed.
Robust governance is, in my view, crucial to protect the interests of
members and beneficiaries.
EIOPA welcomes the Commission’s proposal which ensures a comparable
level of governance principles regarding fit and proper requirements for
boards of trustees and sound remuneration policies.
Through stronger governance IORPs will too improve their
decision-making as they are required to prepare a Risk Evaluation.
The Risk Evaluation for Pensions will stimulate IORPs to identify, manage
and control their risks both in the short- and long-term.
The Risk Evaluation should also be proportionate to the nature, scale and
complexity of the risks inherent in the IORP’s activities.
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By making IORPs more aware of their commitments to their beneficiaries,
the preparation of the Risk Evaluation will help them make better informed
decisions about investments in long-term assets.
Furthermore, IORPs should enhance transparency towards members and
beneficiaries on the key features of occupational pension schemes, in
particular of Defined Contribution schemes.
Also in Defined Benefit plans, the financial situation of IORPs and how it
affects benefits should be understandable to a member.
Therefore, we welcome the Commission’s proposal for an annual Pension
Benefit Statement.
We need to provide standardised and simplified information to active
scheme members on contributions, costs and charges, investment options
and expected benefits.
Nevertheless a balance needs to be found on the amount of information
given and on the capacity of members to digest and use appropriately that
information.
I am confident that the ongoing and future discussions in the EU Council
and the EU Parliament will allow for some further refinements that will
contribute to achieve the defined goals, in particular concerning the
Pension Benefit Statement.
On the solvency side, we all recognised that further work was needed to
develop a robust and tested proposal.
Recently EIOPA published a consultation paper on further technical work
on the holistic balance sheet to gather input from stakeholders.
The paper constitutes a further step in EIOPA’s work on a risk-based
framework for occupational pension funds.
EIOPA is undertaking this work on its own initiative, in its role as
independent advisor to the European political institutions.
The consultation paper proposes improved definitions and methodologies
to value the holistic balance sheet, covering areas such as the valuation of
sponsor support, the benefit reduction mechanisms and discretionary
decision-making processes and the definition of contract boundaries.
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Most importantly, the paper consults on different possible uses of the
holistic balance sheet within a supervisory framework, ranging from an
instrument to establish funding requirements to a risk-management and
transparency tool to assess the long-term sustainability of IORPs.
The scope of this consultation paper is broader than previous work done by
EIOPA in this area.
There are indeed various ways to shape a market-consistent and risk-based
supervisory framework.
The consultation paper not only considers the holistic balance sheet being
used to set solvency capital requirements at the EU level, but also to
establish minimum funding requirements and as a risk management tool to
assess the sustainability of pension funds.
I would like to emphasise that using the holistic balance sheet as a risk
management tool should in my view not be a requirement without
consequences.
First of all, the outcomes of assessments should be disclosed to raise
awareness about the financial situation of the pension fund and, where
necessary, stimulate reforms.
Secondly, if it was concluded that the pension fund is providing
unsustainable pension promises, I believe that national supervisory
authorities should be empowered to take supervisory action, using a flexible
approach.
We are not promoting an EU ‘one size fits all’ approach.
A common prudential regime should have built-in flexibility to deal with a
wide range of occupational pension schemes in Member States.
I would like to emphasize that any supervisory framework should in my
view be sufficiently flexible to also avoid short-term, pro-cyclical
investment behaviour of pension funds during adverse market
developments.
It is also essential for me that the holistic balance sheet can be implemented
in a proportionate way and without imposing high costs on pension
funds.
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The consultation paper proposes that pension funds with strong sponsors
may establish the value of sponsor support as a ‘balancing item’.
I am convinced that such an approach will considerably simplify the
valuation of the holistic balance sheet for a large number of pension funds.
In addition, it provides the right incentives by requiring pension funds with
weak sponsors to do more detailed assessments.
The further work on the holistic balance sheet has to be tested through a
quantitative assessment.
EIOPA expects to publish draft technical specifications for such an
assessment by early 2015.
Our final aim is to deliver robust, tested proposals to the EU political
institutions by the end of 2015, beginning of 2016.
I want to thank all stakeholders for the level of engagement and
contributions received in our previous consultations.
I believe that we showed that we take consultations seriously and that we
are ready to listen, discuss and evolve in our proposals, remaining faithful
to our vision, but using pragmatic and proportionate solutions.
Please continue to engage with us in this important consultation.
Your views, positions and suggestions will be duly considered and will
increase the quality of our work and its adherence to reality.
Remaining vigilant to the risk of financial instability is important as well to
EIOPA.
One of the lessons from the recent global financial crisis is the need to
understand and assess the interplay between the financial sector and
economic stability as well as the transmission mechanisms between
different market participants.
Recent events have highlighted the need for supervisors to remain vigilant
about systemic risk and the importance of expanding the scope of stress
tests.
EIOPA is now preparing a pensions stress test. We are taking a two-stage
approach: preparatory work in 2014 and running the stress test in 2015.
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Our aim is to develop a stress test framework that is appropriate and
suitable for pension funds.
An important part of the preparatory work is to gain insight in the role of
IOPRs in financial stability.
To analyse transmission channels of IORPs to financial markets, EIOPA
started a data collection exercise covering a sample of defined benefit,
hybrid and defined contribution schemes in Member States with a
significant IORP sector.
This exercise will allow us to assess the pro-cyclicality of pension funds
investment behaviour during the past decade, including the financial crisis
in 2008.
We would be very grateful for the participation of pension funds in this
exercise.
The stress test will assess the resilience and the behaviour of IORPs in
adverse market developments, such as a prolonged low interest
environment or a sudden material reassessment of risk premia.
It will also incorporate stresses in longevity as one of the major risks in
pension funds overall financial condition.
Our intention is that the pension stress test will cover IORPs that provide
defined benefit schemes as well as the ones that finance hybrid or defined
contribution plans.
We will conduct the stress test in parallel with the quantitative assessment
on the solvency side in order to avoid the duplication of calculations.
This will limit to the extent possible the burden on pension funds and
supervisory authorities.
But our work on delivering on the three objectives mentioned before is also
more and more focused on defined contribution plans.
We are looking at costs and charges in the occupational defined
contribution world and at different best practices to establish default
options.
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As part of the construction of a more integrated Europe we all should show
readiness to implement a truly internal market for private pensions.
EU citizens are increasingly mobile: 6.6 million EU citizens live and work in
a member state other than their own.
That is already 3.1% of workers in the EU.
A further 1.2 million live in one EU country but work in another.
How many of these millions have been able easily to transfer their pension
rights?
How many of their employers have been able easily to establish a
pan-European pension scheme?
Of course, questions of cross-border pension rights are not the only issue
which determines whether someone works in another Member State.
But they may play an increasing role in whether or not a citizen can stay for
the long term in another Member State.
And even if it is not the primary consideration in deciding to work abroad,
the individual should be able to avail of coherent and continuing pension
arrangements while abroad.
And those arrangements should be similar to the way that can be achieved
by staying at home.
An important step towards facilitating worker mobility in the EU was taken
earlier this year when the European Parliament and the Council adopted
the ‘Directive on minimum requirements for enhancing worker mobility by
improving the acquisition and preservation of supplementary pension
rights’.
The Directive does not foresee any minimum requirements concerning the
transferability of supplementary pension rights.
Nevertheless, pension transferability remains an important aspect of
worker mobility, and Member States are encouraged to improve the
transferability of vested pension rights.
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In this context, EIOPA received last June a formal Call for Advice from the
Commission to provide an overview of the existing arrangements for
transfers of acquired supplementary pension rights between occupational
pension schemes in different Member States.
In addition, the Commission asked EIOPA to highlight any good practices
related to the transfers of acquired supplementary pension rights as well as
identify the main obstacles/difficulties affecting (or preventing) transfer,
both within countries and across borders.
EIOPA will provide its response to the Commission's Call for Advice by the
middle of next year.
Finally EIOPA is also working on personal pensions.
Following the publication of our preliminary report "Towards an EU single
market for personal pensions", EIOPA received last July a Call for Advice
from the Commission with a view to support the development of an
EU-wide framework for personal pension products.
EIOPA will explore how the development of simple, standardised and fully
transparent personal pension products could help to reduce costs and
mitigate miss-selling.
We are also keen on finding a proportionate regulatory treatment to these
products to ensure that there are no “excessive burdens” for market
participants.
A single market for personal pensions can be advantageous for consumers,
providers, and for the broader EU economy.
EU citizens will have the opportunity to participate in different schemes
across Europe according to their preferences and needs, in particular with
respect to investment strategies.
Developing a truly internal market for pensions can increase member
protection, transparency and be the catalyst for better outcomes for
citizens, through economies of scale.
Pension providers will also have the opportunity to achieve economies of
scale, especially in the case of standardised products, which allow for
successful cross-border selling.
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Overall, the EU economy could benefit from personal pensions becoming a
main driver for sustainable long-term investments, contributing to the
Capital Markets Union.
As you see EIOPA has a clear vision on pensions, important objectives to
achieve and a comprehensive work plan for the coming years.
We will continue to extensively involve our Occupational Pension
Stakeholder Group that gives an excellent contribution to EIOPA, by
providing advice and challenge in a cooperative way.
We will continue to engage with all stakeholders in a clear and transparent
manner.
To conclude, creating sustainable and adequate pension systems will be one
of the major challenges for Europe in the coming years.
It is a goal worthy of all the efforts.
At the EU level, EIOPA will continue in its efforts to ensure that:
•
EU citizens are well informed about their private pension schemes,
get a fair deal and can trust that the promises made to them will be fulfilled;
•
Financial markets are stable and resilient to shock;
•
The internal market is well-functioning and contributes to a
strong EU economy.
EIOPA is committed to creating a sustainable, safe and adequate pension
system through a robust and proportionate EU regulatory framework.
Not for the sake of regulations or supervision, these are only tools for a
more important goal: creating real benefits for the EU, its economy,
businesses and citizens.
When will we witness a sustainable, safe and adequate European pension
system? I don’t know.
Progress may happen slower than we wish, but when it happens it might go
much faster than we expected.
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I like to end by quoting Barack Obama who said: “If you're walking down
the right path and you're willing to keep walking, eventually you'll make
progress”.
Thank you.
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ECB - Guide to banking
supervision
Foreword
This guide is fundamental to the
implementation of the Single
Supervisory Mechanism (SSM),
the new system of financial supervision comprising, as at November 2014,
the European Central Bank (ECB) and the national competent authorities
(NCAs) of euro area countries.
It explains how the SSM functions and gives guidance on the SSM’s
supervisory practices
The SSM, which officially entered into operation in November 2014, is itself
a step towards greater European harmonisation.
It promotes the single rulebook approach to the prudential supervision of
credit institutions in order to enhance the robustness of the euro area
banking system.
Established as a response to the lessons learnt in the financial crisis, the
SSM is based on commonly agreed principles and standards.
Supervision is performed by the ECB together with the national supervisory
authorities of participating Member States.
The SSM will not “reinvent the wheel”, but aims to build on the best
supervisory practices that are already in place.
It works in cooperation with the European Banking Authority (EBA), the
European Parliament, the Eurogroup, the European Commission, and the
European Systemic Risk Board (ESRB), within their respective mandates,
and is mindful of cooperation with all stakeholders and other international
bodies and standard-setters.
The SSM is composed of the ECB and the NCAs of participating Member
States and therefore combines the strengths, experience and expertise of all
of these institutions.
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The ECB is responsible for the effective and consistent functioning of the
SSM and exercises oversight over the functioning of the system, based on
the distribution of responsibilities between the ECB and NCAs, as set out in
the SSM Regulation.
To ensure efficient supervision, credit institutions are categorised as
“significant” or “less significant”: the ECB directly supervises significant
banks, whereas the NCAs are in charge of supervising less significant banks.
This guide explains the criteria used to assess whether a credit institution
falls within the significant or less significant institution category.
This guide is issued in accordance with the Interinstitutional Agreement
between the European Parliament and the ECB.
The procedures described in the guide may have to be adapted to the
circumstances of the case at hand or the necessity to set priorities.
The guide is a practical tool that will be updated regularly to reflect new
experiences that are gained in practice.
This guide is not, however, a legally binding document and cannot in any
way substitute for the legal requirements laid down in the relevant
applicable EU law.
In case of divergences between these rules and the guide, the former
prevail.
1
Introduction
1
The Single Supervisory Mechanism (SSM) comprises the ECB and
the national competent authorities (NCAs) of participating Member States.
The SSM is responsible for the prudential supervision of all credit
institutions in the participating Member States.
It ensures that the EU’s policy on the prudential supervision of credit
institutions is implemented in a coherent and effective manner and that
credit institutions are subject to supervision of the highest quality.
The SSM’s three main objectives are to:
•
ensure the safety and soundness of the European banking system;
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•
increase financial integration and stability;
•
ensure consistent supervision.
2
On the basis of the SSM Regulation, the ECB, with its extensive
expertise in macroeconomic policy and financial stability analysis, carries
out clearly defined supervisory tasks to protect the stability of the European
financial system, together with the NCAs.
The SSM Regulation and the SSM Framework Regulation provide the legal
basis for the operational arrangements related to the prudential tasks of the
SSM.
3
The ECB acts with full regard and duty of care for the unity and
integrity of the Single Market based on the equal treatment of credit
institutions with a view to preventing regulatory arbitrage.
Against this background, it should also reduce the supervisory burden for
cross-border credit institutions.
The ECB considers the different types, business models and sizes of credit
institutions as well as the systemic benefits of diversity in the banking
industry.
4
In carrying out its prudential tasks, as defined in the SSM Regulation,
the ECB applies all relevant EU laws and, where applicable, the national
legislation transposing them into Member State law.
Where the relevant law grants options for Member States, the ECB also
applies the national legislation exercising those options.
The ECB is subject to technical standards developed by the European
Banking Authority (EBA) and adopted by the European Commission, and
also to the EBA’s European Supervisory Handbook.
Moreover, in areas not covered by this set of rules, or if a need for further
harmonisation emerges in the conduct of the day-to-day supervision, the
ECB will issue its own standards and methodologies, while considering
Member States’ national options and discretions under EU legislation.
5
This guide sets out:
•
the supervisory principles of the SSM;
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•
the functioning of the SSM, including:
•
the distribution of tasks between the ECB and the NCAs of the
participating Member States;
•
the decision-making process within the SSM;
•
operating structure of the SSM;
•
the supervisory cycle of the SSM;
•
the conduct of supervision in the SSM, including:
•
authorisations, acquisitions of qualifying holdings, withdrawal of
authorisation;
•
supervision of significant institutions;
•
supervision of less significant institutions;
•
overall quality and planning control.
2
Supervisory principles
6
In the pursuit of its mission, the SSM constantly strives to maintain
the highest standards and to ensure consistency in supervision.
The SSM benchmarks itself against international norms and best practices.
The revised Basel Committee’s Core Principles for Effective Banking
Supervision as well as the EBA rules form a sound foundation for the
regulation, supervision, governance and risk management of the banking
sector.
7
The SSM approach is based on the following principles, which inspire
any action at the ECB or centralised level and at the national level, and
which are essential for an effective functioning of the system.
These principles underlie the SSM’s work and guide the ECB and the NCAs
in performing their tasks.
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Principle 1 – Use of best practices
The SSM aspires to be a best practice framework, in terms of objectives,
instruments, and powers used.
The SSM’s evolving supervisory model builds on state-of-the-art
supervisory practices and processes throughout Europe and incorporates
the experiences of various Member States’ supervisory authorities to ensure
the safety and soundness of the banking sector.
The methodologies are subject to a continuous review process, against both
internationally accepted benchmarks and internal scrutiny of practical
operational experience, in order to identify areas for improvements.
Principle 2 – Integrity and decentralisation
All participants in the SSM cooperate to achieve high-quality supervisory
outcomes.
The SSM draws on the expertise and resources of NCAs in performing its
supervisory tasks, while also benefiting from centralised processes and
procedures, thereby ensuring consistent supervisory results.
In- depth qualitative information and consolidated knowledge of credit
institutions is essential, as is reliable quantitative information.
Decentralised procedures and a continuous exchange of information
between the ECB and the NCAs, while preserving the unity of the
supervisory system and avoiding duplication, enable the SSM to benefit
from the national supervisors’ closer proximity to the supervised credit
institutions, while also ensuring the necessary continuity and consistency of
supervision across participating Member States.
Principle 3 – Homogeneity within the SSM
Supervisory principles and procedures are applied to credit institutions
across all participating Member States in an appropriately harmonised way
to ensure consistency of supervisory actions in order to avoid distortions in
treatment and fragmentation.
This principle supports the SSM as a single system of supervision.
The principle of proportionality (see Principle 7) is applied.
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Principle 4 – Consistency with the Single Market
The SSM complies with the single rulebook.
The SSM integrates supervision across a large number of jurisdictions and
supports and contributes to the further development of the single rulebook
by the EBA, while helping to better address systemic risks in Europe.
The SSM is fully open to all EU Member States whose currency is not the
euro and who have decided to enter into close cooperation.
Given its central role in the SSM, the ECB contributes to further
strengthening the convergence process in the Single Market with respect to
the supervisory tasks conferred on it by the SSM Regulation.
Principle 5 – Independence and accountability
The supervisory tasks are exercised in an independent manner.
Supervision is also subject to high standards of democratic accountability to
ensure confidence in the conduct of this public function in the participating
Member States.
In line with the SSM Regulation, there will be democratic accountability at
both the European and national levels.
Principle 6 – Risk-based approach
The SSM approach to supervision is risk-based. It takes into account both
the degree of damage which the failure of an institution could cause to
financial stability and the possibility of such a failure occurring.
Where the SSM judges that there are increased risks to a credit institution
or group of credit institutions, those credit institutions will be supervised
more intensively until the relevant risks decrease to an acceptable level.
The SSM approach to supervision is based on qualitative and quantitative
approaches and involves judgement and forward-looking critical
assessment.
Such a risk-based approach ensures that supervisory resources are always
focused on the areas where they are likely to be most effective in enhancing
financial stability.
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Principle 7 – Proportionality
The supervisory practices of the SSM are commensurate with the systemic
importance and risk profile of the credit institutions under supervision.
The implementation of this principle facilitates an efficient allocation of
finite supervisory resources.
Accordingly, the intensity of the SSM’s supervision varies across credit
institutions, with a stronger focus on the largest and more complex
systemic groups and on the more relevant subsidiaries within a significant
banking group.
This is consistent with the SSM’s risk-based and consolidated supervisory
approach.
Principle 8 – Adequate levels of supervisory activity for all credit
institutions
The SSM adopts minimum levels of supervisory activity for all credit
institutions and ensures that there is an adequate level of engagement with
all significant institutions, irrespective of the perceived risk of failure.
It categorises credit institutions according to the impact of their failure on
financial stability and sets a minimum level of engagement for each
category.
Principle 9 – Effective and timely corrective measures
The SSM works to ensure the safety and soundness of individual credit
institutions as well as the stability of the European financial system and the
financial systems of the participating Member States.
It pro-actively supervises credit institutions in participating Member States
to reduce the likelihood of failure and the potential damage, with a
particular focus on the reduction of the risk of a disorderly failure of
significant institutions.
There is a strong link between assessment and corrective action.
The SSM’s supervisory approach fosters timely supervisory action and a
thorough monitoring of a credit institution’s response.
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It intervenes as early as possible, thus reducing the potential losses for the
credit institution’s creditors (including depositors).
However, that does not mean that individual credit institutions cannot be
allowed to enter resolution procedures.
The SSM works with other relevant authorities to make full use of the
resolution mechanisms available under national and EU law.
In the event of a failure, resolution procedures as provided by the Bank
Recovery and Resolution Directive are applied to avoid, in particular,
significant adverse effects on the financial system and to protect public
funds by minimising reliance on extraordinary public financial support.
3
The functioning of the SSM
8
The SSM combines the strengths of the ECB and the NCAs.
It builds on the ECB’s macroeconomic and financial stability expertise and
on the NCAs’ important and long-established knowledge and expertise in
the supervision of credit institutions within their jurisdictions, taking into
account their economic, organisational and cultural specificities.
In addition, both components of the SSM have a body of dedicated and
highly qualified staff. The ECB and the NCAs perform their tasks in
intensive cooperation.
This part of the guide describes the distribution of supervisory tasks, the
organisational set-up at the ECB, and the decision-making process within
the SSM.
3.1
The distribution of tasks between the ECB and NCAs
The SSM is responsible for the supervision of around 4,700 supervised
entities within participating Member States.
To ensure efficient supervision, the respective supervisory roles and
responsibilities of the ECB and the NCAs are allocated on the basis of the
significance of the supervised entities.
The SSM Regulation and the SSM Framework Regulation contain several
criteria according to which credit institutions are classified as either
significant or less significant (see Box 1).
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Box 1
Classification of institutions as significant or less significant
To determine whether or not a credit institution is significant, the SSM
conducts a regular review: all credit institutions authorised within the
participating Member States are assessed to determine whether they fulfil
the criteria for significance.
A credit institution will be considered significant if any one of the following
conditions is met:
•
the total value of its assets exceeds €30 billion or – unless the total
value of its assets is below €5 billion – exceeds 20% of national GDP;
•
it is one of the three most significant credit institutions established in
a Member State;
•
it is a recipient of direct assistance from the European Stability
Mechanism;
•
the total value of its assets exceeds €5 billion and the ratio of its
cross-border assets/liabilities in more than one other participating Member
State to its total assets/liabilities is above 20%.
Notwithstanding the fulfilment of these criteria, the SSM may declare an
institution significant to ensure the consistent application of high-quality
supervisory standards.
The ECB or the NCAs may ask for certain information to be submitted (or
resubmitted) to help facilitate the decision.
Through normal business activity or due to exceptional occurrences (e.g. a
merger or acquisition), the status of credit institutions may change.
If a group or a credit institution that is considered less significant meets any
of the relevant criteria for the first time, it is declared significant and the
NCA hands over responsibility for its direct supervision to the ECB.
Conversely, a credit institution may no longer be significant, in which case
the supervisory responsibility for it returns to the relevant NCA(s).
In both cases, the ECB and the NCA(s) involved carefully review and
discuss the issue and, unless particular circumstances exist, plan and
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implement the transfer of supervisory responsibilities so as to allow for a
continued and effective supervision.
To avoid rapid or repeated alternations of supervisory responsibilities
between NCAs and the ECB (e.g. if a credit institution’s assets fluctuate at
around €30 billion), the classification has a moderation mechanism:
whereas the shift in status from less significant to significant is triggered if
just one criterion is met in any one year, a significant group or credit
institution will only qualify for a reclassification as less significant if the
relevant criteria have not been met over three consecutive calendar
years.
Institutions are notified immediately of the SSM’s decision to transfer
supervisory responsibilities from the NCA to the ECB, or vice versa: prior to
the adoption of the decision, the ECB gives the institution the opportunity
to provide written comments.
During the transition, institutions receive regular updates as needed and
are introduced to their new team of supervisors.
Once the transition is complete, a formal handover meeting is organised for
representatives from the supervised institution and the outgoing and
incoming supervisors.
_________________________
10
The ECB directly supervises all institutions that are classified as
significant (see Figure 1), around 120 groups representing approximately
1,200 supervised entities, with the assistance of the NCAs.
The day-to-day supervision will be conducted by Joint Supervisory Teams
(JSTs), which comprise staff from both NCAs and the ECB (see Box 3).
The NCAs continue to conduct the direct supervision of less significant
institutions, around 3,500 entities, subject to the oversight of the ECB.
The ECB can also take on the direct supervision of less significant
institutions if this is necessary to ensure the consistent application of high
supervisory standards.
11
The ECB is also involved in the supervision of cross-border
institutions and groups, either as a home supervisor or a host supervisor in
Colleges of Supervisors (see Box 2).
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Moreover, the ECB participates in the supplementary supervision of
financial conglomerates in relation to the credit institutions included in a
conglomerate and assumes the responsibilities of the coordinator referred
to in the Financial Conglomerates Directive.
Box 2 – Colleges of Supervisors
Established in accordance with the Capital Requirements Directive (CRD
IV), Colleges of Supervisors are vehicles for cooperation and coordination
among the national supervisory authorities responsible for, and involved in,
the supervision of the different components of cross-border banking
groups.
Colleges provide a framework for the supervisors and competent
authorities to carry out the tasks referred to in CRD IV, for example
reaching joint decisions on the adequacy of own funds and their required
level and on liquidity and model approvals.
Within the SSM, the ECB may have the following roles in supervisory
colleges for significant banking groups:
•
home supervisor for colleges that include supervisors from nonparticipating Member States (European colleges) or from countries outside
the EU (international colleges);
•
host supervisor for colleges in which the home supervisor is from a
non-participating Member State (or a country outside the EU).
Where the ECB is the consolidating or home supervisor, it acts as chair of
the college, both in European and international colleges.
The NCAs of the countries in which the banking group has an entity
participate in the college as observers.
This means that the NCAs continue their regular participation in, and
contribution to, the college’s tasks and activities and receive all
information, but do not take part in decisions or voting procedures.
When the ECB acts as a host supervisor, the NCAs of the countries in which
the banking group has an entity generally participate in the college as
observers, unless the group has less significant entities in their respective
countries, i.e. entities that are not under the ECB’s direct supervision, in
which case the NCAs continue to participate as members.
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The EBA and the Basel Committee have issued guidelines/principles for the
operational functioning of the colleges.
12
Against this background, the ECB is responsible for the direct
supervision of around 120 groups, which together account for almost 85%
of total banking assets in the euro area.
Supervised credit institutions that are considered less significant are
supervised directly by the relevant NCAs under the overall oversight of the
ECB.
This structure for banking supervision adequately reflects the SSM
Regulation.
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All credit institutions under the SSM’s supervision are subject to the same
supervisory approach.
13
3.2
Decision-making within the SSM
The Supervisory Board plans and carries out the SSM’s supervisory tasks
and proposes draft decisions for adoption by the ECB’s Governing Council.
The Supervisory Board is composed of the Chair and Vice-Chair, four
representatives of the ECB, and one representative of the NCAs in each
participating Member State, usually the top executive of the relevant NCA
responsible for banking supervision.
The Supervisory Board’s draft decisions are proposed on the basis of
thorough, objective, and transparent information, bearing in mind the
interest of the EU as a whole.
The Supervisory Board operates in a way that ensures its independence.
14
The decision-making process is based on a “non-objection”
procedure (see Figure 2).
If the Governing Council does not object to a draft decision proposed by the
Supervisory Board within a defined period of time that may not exceed ten
working days, the decision is deemed adopted.
The Governing Council may adopt or object to draft decisions but cannot
change them.
The ECB has created a Mediation Panel to resolve differences of views
expressed by the NCAs concerned regarding an objection by the Governing
Council to a draft decision of the Supervisory Board.
15
The ECB has also established an Administrative Board of Review to
carry out internal administrative reviews of decisions taken by the ECB in
the exercise of its supervisory powers.
Any natural person or supervised entity may request a review of an ECB
decision, which is addressed to them, or is of direct and individual concern.
The Administrative Board of Review may also propose to the Governing
Council that it suspend the application of the contested decision for the
duration of the review procedure.
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The Board is composed of five independent members who are not staff of
the ECB or an NCA.
A request for a review of an ECB decision by the Administrative Board of
Review does not affect the right to bring proceedings before the Court of
Justice of the EU.
3.3
Operating structure of the SSM
16
The ECB has established four dedicated Directorates General
(DGs) to perform the supervisory tasks conferred on the ECB in
cooperation with NCAs (see Figure 3):
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•
DGs Micro-Prudential Supervision I and II are responsible for the
direct day- to-day supervision of significant institutions;
•
DG Micro-Prudential Supervision III is responsible for the oversight
of the supervision of less significant institutions performed by NCAs;
•
DG Micro-Prudential Supervision IV performs horizontal and
specialised tasks in respect of all credit institutions under the SSM’s
supervision and provides specialised expertise on specific aspects of
supervision, for example internal models and on-site inspections.
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•
Additionally, a dedicated Secretariat supports the activities of the
Supervisory Board by assisting in meeting preparations and related legal
issues.
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17
DG Micro-Prudential Supervision I is responsible for the supervision
of the most significant groups (around 30); DG Micro-Prudential
Supervision II is in charge of the remaining significant groups.
The day-to-day supervision of significant groups is conducted by Joint
Supervisory Teams (JSTs), supported by the horizontal and specialised
expertise divisions of DG Micro-Prudential Supervision IV (see Box 3).
18
Ten horizontal and specialised divisions of DG Micro-Prudential
Supervision IV support JSTs and NCAs in the conduct of supervision of
both significant and less significant credit institutions.
These ten divisions are: Risk Analysis, Supervisory Policies, Planning and
Coordination of Supervisory Examination Programmes, Centralised
On-site Inspections, Internal Models, Enforcement and Sanctions,
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Authorisations, Crisis Management, Supervisory Quality Assurance, and
Methodology and Standards Development.
The horizontal divisions interact closely with the JSTs in, for example,
defining and implementing common methodologies and standards, offering
support on methodological issues and helping them to refine their
approach.
The aim is to ensure consistency across the JSTs’ supervisory approaches.
19
The SSM actively fosters a common supervisory culture by bringing
staff from various NCAs together in the JSTs, in the context of the
supervision of less significant institutions, and in the horizontal and
specialised divisions.
In that respect, the ECB also plays a role in organising staff exchanges
between NCAs as an important tool for achieving a sense of commonality of
purpose.
This shared culture is the foundation of consistent supervisory practices
and approaches throughout the participating Member States.
20
The supervisory tasks are supported by the ECB’s “shared services”,
including services for human resources, information systems,
communications, budget and organisation, premises and internal audit,
and legal and statistical services.
The SSM is thus able to exploit operational synergies while keeping the
required separation between monetary policy and banking supervision.
21
3.4
The supervisory cycle
The process for the supervision of credit institutions can be envisaged as a
cycle (see Figure 5): regulation and supervisory policies provide the
foundation for supervisory activities and for the development of
supervisory methodologies and standards.
22
The methodologies and standards underpin the day-to-day
supervision that is carried out to the same high standards across all credit
institutions.
Through various channels, including the SSM’s participation in
international and European fora, the lessons learnt in the course of
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supervision and the performance of quality assurance checks feed back into
the definition of methodologies, standards, supervisory policies and
regulation.
23
Experience gained from the practical implementation of the
methodologies and standards feeds through to the planning of supervisory
activities for the forthcoming cycle.
This planning also incorporates the analysis of key risks and vulnerabilities
and strategic supervisory priorities. The supervisory cycle is set out in more
detail below.
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3.4.1 Supervisory policies
The European banking regulatory framework follows the Basel Accords and
is harmonised through the single rulebook, which is applicable to all
financial institutions in the Single Market.
The ECB’s Supervisory Policies Division assists in developing statutory
prudential requirements for significant and less significant banks on, for
example, risk management practices, capital requirements and
remuneration policies and practices.
The Supervisory Policies Division coordinates the SSM’s international
cooperation and participates actively in various global and European fora,
such as the EBA, the European Systemic Risk Board (see Box 4), the Basel
Committee on Banking Supervision and the Financial Stability Board.
The Supervisory Policies Division supports the JSTs’ work in the Colleges of
Supervisors by setting up and updating cooperation agreements.
Additionally, the Division will establish and coordinate cooperation with
non-participating Member States and with countries outside the EU, for
example by concluding Memoranda of Understanding.
The Supervisory Policies Division launches and coordinates these activities
in close cooperation with all stakeholders, such as other ECB business
areas, other banking supervision DGs and the NCAs.
Box 4
bodies
Cooperation with other European institutions and
To create a safer and sounder financial sector, new rules have been
implemented and new institutions and bodies have been established since
2007, within both the EU and the euro area.
As a key element of this new institutional framework, the SSM cooperates
closely with other European institutions and bodies as explained below.
European Systemic Risk Board
The European Systemic Risk Board (ESRB) is tasked with overseeing risks
in the financial system within the EU as a whole (macro-prudential
oversight).
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If the ECB uses the macro-prudential instruments defined in the CRD IV or
the Capital Requirements Regulation (CRR), either at the request of the
national authorities or by deciding to adopt stricter measures than the ones
adopted at the national level, it needs to take the ESRB’s recommendations
into account.
A close cooperation between the ECB and the ESRB and the development of
information flows is mutually beneficial: it improves the ESRB’s ability to
effectively identify, analyse and monitor EU-wide systemic risks, while the
SSM may take advantage of the ESRB’s expertise, which goes beyond the
banking sector and covers the entire financial system, including other
financial institutions, markets and products.
European Banking Authority
The ECB closely cooperates with the European Supervisory Authorities,
especially the European Banking Authority (EBA).
As banking supervisor, the SSM should carry out its tasks subject to, and in
compliance with, the EBA’s rules.
The SSM is involved in the EBA’s work and contributes significantly to
supervisory convergence by integrating supervision across jurisdictions.
Single Resolution Mechanism
The Single Resolution Mechanism (SRM) is one of the components of the
banking union, alongside the SSM and a common deposit guarantee
scheme.
It is set to centralise key competences and resources for managing the
failure of any credit institution in the participating Member States.
The SRM complements the SSM; it will ensure that if a bank subject to the
SSM faces serious difficulties, its resolution can be managed efficiently with
minimal costs to taxpayers and the real economy.
The interaction and cooperation among resolution and supervisory
authorities is the key element of the SRM.
Thus, the resolution authorities, the ECB and NCAs will inform each other
without undue delay on the situation of the credit institution in crisis and
discuss how to effectively address any related issues.
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The SSM will assist the SRM in reviewing the resolution plans, with a view
to avoiding a duplication of tasks.
European Stability Mechanism
With the establishment of the SRM, the European Stability Mechanism
(ESM) will be able to recapitalise institutions directly (the credit institution
would have to be – or be likely to be in the near future – unable to meet the
capital requirements established by the ECB in its capacity as supervisor,
and the institution must pose a serious threat to the financial stability of the
euro area as a whole or of its Member States).
The functioning of the recapitalisation tool necessitates effective
cooperation and the development of robust information flows between the
SSM, the ESM and the national resolution authorities.
If an ailing credit institution that is directly supervised by the ECB needs to
be recapitalised, the ECB will be responsible for compiling the necessary
information.
For institutions that it does not directly supervise, the ECB, on notification
of the petition for direct ESM support, must immediately start preparations
to assume direct supervision of the respective credit institution.
The ECB will also actively participate in the negotiations with the ESM and
the management of the ailing credit institution regarding the terms and
conditions of the recapitalisation agreement.
3.4.2 Methodology and standards development
Supervisory methodologies and standards of the highest quality are
essential to achieve consistent and efficient supervisory outcomes.
The ECB has established a dedicated Methodology and Standards
Development Division, which regularly reviews and develops supervisory
methodology.
Supervisory methodologies and standards may also evolve from work by
international standard-setting bodies on harmonising financial sector
regulations or from work by EU authorities on developing a single rulebook.
The ECB may issue its own regulations, guidelines and instructions on
supervisory methodologies and common standards, taking into account the
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developments in international and European regulations and the role of the
EBA in establishing the single rulebook to ensure harmonised supervisory
practices and consistency of supervisory outcomes within the SSM over
time.
The common set of methodologies and standards covers topics such as the
details of the Supervisory Review and Evaluation Process (SREP) and the
notification and application procedures for supervised entities.
30
3.4.3 The Supervisory Review and Evaluation Process
For the purpose of performing the Supervisory Review and Evaluation
Process (SREP), the SSM has developed a common methodology for the
ongoing assessment of credit institutions’ risks, their governance
arrangements and their capital and liquidity situation.
The methodology benefits from the NCAs’ previous experience and best
practices and will be further promoted and developed by the JSTs and the
ECB horizontal divisions.
The SSM SREP is applied proportionately to both significant and less
significant institutions, ensuring that the highest and most consistent
supervisory standards are upheld.
31
As defined in CRD IV, the SREP requires that the supervisors
(for significant institutions, the JSTs; for less significant institutions, the
NCAs under the overall oversight of the ECB) review the arrangements,
strategies, processes and mechanisms implemented by the credit
institutions and evaluate the following:
•
risks to which the institutions are or might be exposed;
•
risks that an institution poses to the financial system in general;
•
risks revealed by stress testing, taking into account the nature, scale
and complexity of an institution’s activities.
32
The SSM SREP (see Figure 6) encompasses three main elements:
•
a risk assessment system (RAS), which evaluates credit institutions’
risk levels and controls;
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•
a comprehensive review of the institutions’ Internal Capital
Adequacy Assessment Process (ICAAP) and Internal Liquidity Adequacy
Assessment Process (ILAAP);
•
a capital and liquidity quantification methodology, which evaluates
credit institutions’ capital and liquidity needs given the results of the risk
assessment.
33
Both the RAS and capital and liquidity quantification follow a
multi-step approach.
They aim to produce supervisory assessments rooted in quantitative and
qualitative analysis.
They rely on a wide range of backward and forward- looking information
(e.g. probability of default, loss given default, stress tests).
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They are built on a “constrained judgement” approach, so as to ensure
consistency across the SSM, while allowing for expert judgement to
consider the complexity and variety of situations within a clear and
transparent framework.
34
The risks to which credit institutions are exposed are assessed by risk
levels and by the corresponding risk controls/risk mitigation measures.
Institutions’ business risk and profitability, as well as their internal
governance and overall risk management, are assessed from a more holistic
perspective.
All assessments are then integrated into an overall assessment.
35
The SSM follows a risk-based approach while focusing on compliance
with regulatory requirements.
It also respects the principle of proportionality, taking into account an
institution’s potential impact on the financial system, its intrinsic riskiness
and whether it is a parent entity, subsidiary or solo institution.
This results in a differentiated frequency and intensity for the institution’s
risk profile assessment within the year.
The risk profile assessment in turn may result in a wide range of
supervisory actions and measures, including short-term ones that are taken
immediately by the relevant JST and more long-term ones that are covered
by the SREP report and annual supervisory planning.
There is a direct link between an institution’s overall risk profile assessment
and the level of supervisory engagement.
36
Traceability and accountability are key features of the entire
supervisory assessment process.
The capital requirements defined under Pillar 1 of the Basel Accords are
minimum requirements that credit institutions must fulfil at all times.
Therefore, the SSM constantly monitors the institutions’ compliance with
the requirements and also considers Pillar 1 capital requirements as a floor.
Internal models, which institutions – subject to supervisory approval – are
allowed to use to calculate capital requirements for Pillar 1 risks, are
regularly reviewed by the SSM.
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37
Furthermore, credit institutions may be required to hold additional
capital and liquidity buffers for risks that are not, or not fully, covered by
Pillar 1.
To this end, credit institutions must use their internal assessment and
calculation methods, specifically their Internal Capital Adequacy
Assessment Process (ICAAP) and Internal Liquidity Adequacy Assessment
Process (ILAAP).
Credit institutions are required to carefully document these processes and
calculations.
They are also required to create adequate governance structures to ensure
that their ICAAP/ILAAP outcomes are reliable.
Therefore, a comprehensive review of the ICAAP/ILAAP is performed as
part of the SREP.
38
As recommended by the EBA Guidelines, the SSM strives to take
adequate SREP decisions using a wide range of information coming from
several building blocks.
These include the credit institutions’ regular reports, ICAAP/ILAAP, the
institutions’ risk appetite, supervisory quantifications used to verify and
challenge the credit institutions’ estimates, risk assessment outcomes
(including risk level and control assessments), the outcome of stress tests,
and the supervisor’s overall risk priorities.
39
Supervisory quantifications calculated for assessing institutions’
capital and liquidity needs, as well as ICAAP and ILAAP, play a key role in
anchoring the process.
40
The SSM uses both top-down and bottom-up supervisory stress tests
as part of the capital and liquidity adequacy assessments.
Stress tests are a key forward-looking tool for assessing institutions’
exposure and resilience to adverse but plausible future events.
They can also be used to test the adequacy of credit institutions’ risk
management procedures, their strategic and capital planning and the
robustness of their business models.
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41
Based on all the information reviewed and evaluated during the
SREP, the SSM makes the overall assessment of the capital and liquidity
adequacy of the credit institution and prepares SREP decisions (see Figure
6).
At the end of the process, it takes an overall view on the adequate level of
capital and liquidity for an institution.
SREP decisions may also include qualitative measures, for instance to deal
with shortcomings in institutions’ risk management.
The outcome of this analysis and any necessary corrective actions are
presented to the credit institution and the credit institution is given the
opportunity to comment in writing to the ECB on the facts, objections and
legal grounds relevant to the ECB’s supervisory decision.
Where appropriate, specific meetings can be organised with the credit
institution to discuss the outcomes and corrective actions to be taken.
42
The outcome of the SREP for significant credit institutions is
submitted to the Supervisory Board.
For institutions with subsidiaries in non-SSM EU countries, the SREP
decision will be taken jointly by all of the relevant competent authorities.
43
The result of the SREP is also a key input for the SSM’s strategic and
operational planning.
In particular, it has a direct impact on the range and depth of off-site and
on-site activities that are carried out for a given institution.
This planning is defined annually and revised on a semi-annual basis.
44
3.4.4 Risk analysis
As a natural complement to the JST’s day-to-day analysis of a credit
institution’s risks, risks are also analysed horizontally by a dedicated Risk
Analysis Division, which provides benchmarking and contextual
information to line supervisors.
45
The assessment of the risks facing credit institutions requires
an understanding of the external context in which they operate.
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The Risk Analysis Division hence also considers system-wide risks, such as
those arising from international imbalances or excessive risk concentration
potentially leading to sectorial bubbles (e.g. residential or commercial real
estate). Its risk analysis also draws on analyses performed by other ECB
business areas, particularly macro- prudential analysis.
Sectoral analysis also facilitates the understanding of key market
developments.
46
Risk analyses performed by JSTs and by the dedicated Risk
Analysis Division complement each other.
The Risk Analysis Division monitors the overall risk environment of the
SSM and delivers timely and in-depth risk analyses across institutions.
JSTs are an important source of institution-specific information for the
Risk Analysis Division.
47
Adequate, reliable and up-to-date supervision and risk analysis
is based on accurate supervisory data.
The ECB therefore maintains close cooperation with the NCAs and their
reporting units, which are the first receivers of supervisory reporting data.
The ECB’s reporting and statistics units performs its own quality checks
before the data are used for supervisory and risk analysis purposes and for
decision-making.
The SSM reporting schedule defines the reporting timelines and formats,
taking into account the harmonised requirements applicable across the EU.
4
The conduct of supervision in the SSM
48
The SSM Regulation speaks about creating a “truly integrated
supervisory mechanism”.
In practice, this implies, first of all, that key processes are generally the
same for all credit institutions – regardless of whether they are significant
or less significant – and involve both the ECB and the NCAs.
It also implies a single supervisory approach.
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Each credit institution that is covered by the SSM is supervised according to
the same methodology and with due respect to the principle of
proportionality.
The common procedures applying to both significant and less significant
institutions, and the approaches to the supervision of both categories, are
set out below.
4.1 Authorisations, acquisitions of qualifying holdings,
withdrawal of authorisations
49
The ECB has the power to grant and withdraw the
authorisation of any credit institution and to assess the acquisition of
holdings in credit institutions in the euro area.
This is done jointly with the NCAs.
The ECB also must ensure compliance with EU banking rules and the EBA
regulation and applies the single rulebook.
Where appropriate, it may also consider imposing additional prudential
requirements on credit institutions in order to safeguard financial stability.
The ECB’s Authorisation Division is responsible for these tasks.
50
The SSM Regulation has established a number of procedures,
known as the “common procedures”, which ultimately are decided on by
the ECB, regardless of the significance of the credit institution concerned.
These are the procedures for authorisations to take up the business of a
credit institution, withdrawals of such authorisations and the assessment of
acquisitions of qualifying holdings.
The SSM Framework Regulation sets out how the ECB and the NCAs are
involved in these common procedures (see Figure 7).
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4.1.1 Granting of authorisations and acquisitions of qualifying
holdings
51
The SSM common procedures are governed by the following key
principles:
•
Applications for authorisations and notifications of an acquisition of
a qualifying holding are always sent by the applicant entity to the relevant
NCA: for the granting of new banking licences, this is the NCA of the
Member State where the new credit institution is to be established; for
intended acquisitions of qualifying holdings, the relevant NCA is the NCA of
the Member State where the institution being acquired is established.
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•
The NCA notifies the ECB of receipt of an application for
authorisation within 15 working days.
As regards notification of an intention to acquire a qualifying holding, the
NCA notifies the ECB of such notification no later than five working days
following its acknowledgement of receipt to the applicant.
A common procedure cannot be finalised until the required information has
been submitted.
Applicants should therefore ensure that their applications are complete and
well structured.
If the first review of an application reveals omissions or inconsistencies, the
receiving NCA immediately asks the applicant to make the necessary
amendments.
•
Once applications have been submitted and their completeness
verified, they are subject to a complementary assessment by the receiving
NCA, the ECB and any other NCAs concerned.
The assessment seeks to ensure that all relevant parties gain a thorough
understanding of the business model and its viability.
To this end, the assessment covers all the criteria set out in relevant
national and EU laws.
52
If the NCA is satisfied that the application complies with national
conditions for authorisations, it proposes to the ECB a draft decision
containing its assessment and recommendations.
As regards qualifying holdings, the NCA proposes a draft decision to the
ECB to oppose or not to oppose the acquisition.
The final decision on the approval or rejection rests thereafter with the ECB
following the usual decision-making procedure.
If an application is to be rejected or additional conditions need to be
imposed, it will become the subject of a hearing procedure.
Once a final decision has been reached, the applicant is notified by either
the NCA processing the application (in the case of licensing applications) or
the ECB (in the case of intended acquisitions of qualifying holdings).
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53
4.1.2 Withdrawal of authorisations
Both the ECB and the NCAs of participating Member States where an
institution is established have the right to propose the withdrawal of a
banking licence.
NCAs can propose a withdrawal upon the request of the credit institution
concerned or, in other cases, on its own initiative in accordance with
national legislation.
The ECB can initiate a withdrawal in cases set out in the relevant EU laws.
The ECB and the relevant NCAs consult on any proposals for the
withdrawal of a licence.
These consultations are intended to ensure that, before a decision is taken,
the relevant bodies (i.e. NCAs, national resolution authorities and the ECB)
have sufficient time to analyse and comment on the proposal, raise
potential objections and take the necessary steps and decisions to preserve
the going concern or resolve the institution, if deemed appropriate.
54
Following the consultation, the proposing body composes a
draft decision explaining the rationale behind the proposed withdrawal of
the licence and reflecting the results of the consultation.
Thereafter, the final decision rests with the ECB.
55
Before a draft decision proposal is submitted to the ECB, the
supervised institution in question is prompted to provide its own views on
the matter and is given the right to be heard by the ECB.
Once taken, the ECB’s final decision is notified to the respective credit
institution, the NCA, and the national resolution authority.
4.2
Supervision of significant institutions
56
4.2.1 Supervisory planning
The planning of supervisory activities is decided through a two-step
process: strategic planning and operational planning.
Strategic planning is coordinated by the ECB’s Planning and Coordination
of Supervisory Examination Programmes Division.
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It encompasses the definition of the strategic priorities and the focus of
supervisory work for the following 12 to 18 months.
More specifically, it takes into account factors such as the assessment of
risks and vulnerabilities in the financial sector, as well as guidance and
recommendations issued by other European authorities, in particular the
ESRB and the EBA, findings of the JSTs through the SREP and priorities
highlighted by the relevant NCAs.
The strategic plan frames the nature, depth and frequency of activities to be
included in the individual Supervisory Examination Programmes (SEPs),
which are defined for each significant institution.
57
Operational planning is conducted by the JSTs under the
coordination of the ECB’s Planning and Coordination of SEPs Division.
JSTs produce individual SEPs, which set out the main tasks and activities
for the following 12 months, their rough schedules and objectives, the need
for on-site inspections, and internal model investigations.
The Planning and Coordination of SEPs Division, along with the relevant
horizontal functions and NCAs, coordinates the allocation of SSM resources
and expertise to ensure that each JST has the capacity to carry out the
annual supervisory tasks and activities.
Although the main items of individual SEPs are discussed with the credit
institution beforehand, JSTs are always able to perform ad hoc tasks and
activities that are not part of the supervisory plan, especially to address
rapidly changing risks at individual institutions or at the broader system
level.
58
activities.
There are several tools for conducting the basic supervisory
In their day-to-day supervision, the JSTs analyse the supervisory reporting,
financial statements and internal documentation of supervised institutions;
hold regular and ad hoc meetings with the supervised credit institutions at
various levels of staff seniority; conduct ongoing risk analyses and ongoing
analysis of approved risk models; and analyse and assess credit institutions’
recovery plans.
Box 5 explains the regulations regarding the language the institution can
use in its communication with the ECB.
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4.2.2 General process requests, notifications and applications
The general process regarding requests, notifications and applications (i.e
“permission requests”) for significant credit institutions is described in
Figure 8.
The procedure starts when a credit institution files a permission request.
The JST – where applicable, in close cooperation with the relevant
horizontal division – checks if the permission request includes all relevant
information and documents.
If necessary, it can request additional information from the credit
institution.
The JST and the relevant horizontal division check that the request meets
the supervisory requirements set out in the respective legislation, i.e. EU
laws or its national transposition.
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Once the analysis has been completed and a decision taken, the ECB
notifies the applicant of the outcome.
For other processes – such as passporting, the approval of internal models
and the appointment of new managers – different procedures have to be
followed. These are described in more detail below.
61 4.2.3 Right of establishment of credit institutions within the
SSM
If a significant13 institution in a participating Member State wishes to
establish a branch within the territory of another participating Member
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State via passporting procedures14, it has to notify the NCA of the
participating Member State where it has its head office and provide the
necessary documentation.
On receipt of this notification, the NCA immediately informs the ECB’s
Authorisation Division, which then assesses the adequacy of the
administrative structure in light of the activities envisaged.
Where no decision to the contrary is taken by the ECB within two months of
receipt of the credit institution’s notification, the significant institution may
establish the branch and commence its activities.
A credit institution in a participating Member State wishing to establish a
branch or exercise the freedom to provide services within the territory of a
non- participating Member State informs the relevant NCA of its intention.
On receipt of such notification from a significant institution, the relevant
NCA immediately informs the ECB, which then carries out the required
assessment.
62
4.2.4 Internal models
CRD IV establishes two different types of supervisory activities related to
internal models used for calculating minimal capital requirements: those
concerned with the approval of such models (or material changes /
extensions thereof) and those concerned with ongoing model supervision.
63
The general procedure for the approval of internal models for
the calculation of minimum capital requirements under the CRR for
significant and less significant banks encompasses different steps, involving
the JST as the contact point for the significant institutions, supported by
the ECB’s Internal Models Division.
For less significant institutions, NCAs are the contact point. Where
appropriate, discussions are held with the credit institution to address
critical points and to establish the operational schedule of the approval
process.
64
The JST, supported by the ECB’s Internal Models Division,
checks if the credit institution complies with the legal requirements and the
relevant EBA Guidelines.
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At this stage, credit institutions need to be prepared for intensive
interaction and collaboration to make the process smooth and efficient for
all parties.
This process comprises a range of tools, including off-site and on-site
evaluations.
These activities are carried out by a dedicated project team responsible for
the entire model assessment process.
Project teams can consist of members of the JSTs, experts from the ECB’s
horizontal divisions and dedicated model experts from the NCAs, and are
led by project managers who report to the JST coordinator.
65
On the basis of the project team’s report, the JST, supported by
the ECB’s Internal Models Division, prepares a proposal for a draft decision
for approval by the Supervisory Board and the Governing Council.
The proposal comprises the JST’s views on the authorisation (or refusal) of
the use of internal models to calculate the capital requirements. Conditions,
such as additional reporting requirements as well as additional supervisory
measures, may be attached to the authorisation.
66
Furthermore, the objective of ongoing model supervision is to
keep a close watch on a credit institution’s permanent compliance with
applicable requirements.
It comprises the analysis of risk, capital or other reports on model aspects,
the analysis of credit institutions’ model validations and the assessment of
(immaterial) model changes.
In addition, a full review of internal models with a special focus on
appropriateness in the light of best practice and changes to business
strategies takes place regularly, at least every three years.
The reviews are conducted by the JST, where necessary with the support of
the Internal Models Division. The annual benchmarking required by Article
78 of the CRD is performed by the EBA and the SSM as competent
authority.
67 4.2.5 Assessment of the suitability of members of
management bodies
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The fit and proper assessment of the members of the management body of
significant and less significant institutions is a key part of supervisory
activities.
The members need to be of sufficiently good repute and to possess
sufficient knowledge, skills and experience to perform their duties.
In the case of an initial authorisation (licensing) of a credit institution, the
fit and proper assessment is performed as part of the authorisation
procedure.
68
Changes to the composition of the management body of a
significant institution are declared to the relevant NCA, which then informs
the relevant JST and the ECB’s Authorisation Division, which, together
with the staff of the NCA, collects the necessary documentation (which may
include an interview with the nominated candidate).
With the assistance of the NCA, the JST and the Authorisation Division
jointly carry out the assessment and then present a detailed proposal to the
Supervisory Board and Governing Council for a decision.
69
4.2.6 On-site inspections
The SSM carries out on-site inspections, i.e. in-depth investigations of
risks, risk controls and governance with a pre-defined scope and time frame
at the premises of a credit institution.
These inspections are risk-based and proportionate.
70
The ECB has established a Centralised On-site Inspections
Division, which is – among other things – responsible for planning the
on-site inspections on a yearly basis.
71
The need for an on-site inspection is determined by the JST in
the context of the SEP and scheduled in close cooperation with the ECB’s
Planning and Coordination of SEPs Division.
The scope and frequency of on-site inspections are proposed by the JST,
taking into account the overall supervisory strategy, the SEP and the
characteristics of the credit institution (i.e. size, nature of activities, risk
culture, weaknesses identified). In addition to these planned inspections,
ad hoc inspections may be conducted in response to an event or incident
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which has emerged at a credit institution and which warrants immediate
supervisory action.
If deemed necessary, follow-up inspections may be carried out to assess a
credit institution’s progress in implementing remedial actions or corrective
measures identified in a previous planned or ad hoc inspection.
72
In general, the purpose of on-site inspections is to:
•
examine and assess the level, nature and features of the inherent
risks, taking into account the risk culture;
•
examine and assess the appropriateness and quality of the credit
institution’s corporate governance and internal control framework in view
of the nature of its business and risks;
•
assess the control systems and risk management processes, focusing
on detecting weaknesses or vulnerabilities that may have an impact on the
capital and liquidity adequacy of the institution;
•
examine the quality of balance sheet items and the financial situation
of the credit institution;
•
assess compliance with banking regulations;
•
conduct reviews of topics such as key risks, controls, governance.
73
Different types of inspections can be carried out by the ECB.
Whereas full-scope inspections cover a broad spectrum of risk and activities
of the credit institution concerned in order to provide a holistic view of the
credit institution, targeted inspections focus on a particular part of the
credit institution’s business, or on a specific issue or risk.
Thematic inspections focus on one issue (e.g. business area, types of
transactions) across a group of peer credit institutions.
For example, JSTs may request a thematic review of a particular risk
control or the governance process across institutions.
Thematic reviews may also be triggered on the basis of macro-prudential
and sectoral analyses that identify threats to financial stability on account
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of weakening economic sectors or the spread of risky practices across the
banking sector.
74
The composition of the team – in terms of size, skills, expertise and
seniority – will be tailored to each individual inspection.
The staffing of inspection teams is looked after by the ECB in close
cooperation with the NCAs.
The head of the inspection team (head of mission) and inspectors are
appointed by the ECB in consultation with the NCAs.
Members of the JST may participate in inspections as inspectors, but not as
heads of mission, to ensure that on-site inspections are conducted in an
independent manner.
Where necessary and appropriate, the ECB can call on external experts.
The outcome of on-site inspections is reflected in a written report on the
inspected areas and findings.
The report is signed by the head of mission and sent to the JST and the
NCAs concerned.
Based on the report, the JST is responsible for preparing recommendations.
The JST then sends the report and recommendations to the credit
institution and, in general, calls for a closing meeting with the institution.
75
Under the SSM Regulation, the ECB may at any time make use of its
investigatory powers vis-à-vis less significant banks.
These powers include the possibility to conduct on-site inspections.
76
4.2.7 Crisis management
With the transposition of the Bank Recovery and Resolution Directive
(BRRD) into national law, the ECB as a banking supervisor will be enabled
to react in a timely manner if a credit institution does not meet, or is likely
to breach, the requirements of CRD IV and will ensure that credit
institutions establish reliable recovery plans.
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77
The ECB has established a Crisis Management Division, tasked
with supporting the JSTs in times of crisis.
The ECB’s Crisis Management Division is also reviews the significant
supervised credit institutions’ recovery plans and conducts further analysis,
which allows for benchmarking, quality control, consistency checks and
expert support to the JSTs.
With regard to resolution planning, the SSM has a consultative role under
the BRRD and the SRM Regulation.
The Crisis Management Division is a key player in this consultative process.
Moreover, the ECB’s Crisis Management Division and the JSTs will
participate in Crisis Management Groups set up for specific banks (see Box
6).
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4.2.8 Use of supervisory measures and powers
The ECB is empowered to require significant credit institutions in
participating Member States to take steps at an early stage to address
problems regarding compliance with prudential requirements, the
soundness of management, and sufficiency of the coverage of risks in order
to ensure the viability of the credit institution.
Before making use of its supervisory powers with regard to significant
credit institutions, the ECB may consider first addressing the problems
informally, for example by holding a meeting with the management of the
credit institution or sending a letter of intervention.
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The type of action taken depends on the seriousness of the
deficiencies, the required time frame, the degree of awareness at the credit
institution, the capability and reliability of corporate bodies, and the
availability of human, technical and capital resources within the credit
institution.
If the action is based on the national law of a participating Member State,
the respective NCA might be asked for support to ensure that all the legal
prerequisites are covered.
Supervisory powers consist of measures characterised by increasing
intensity in terms of content and form and may imply:
•
the accurate listing of goals and the time frame for their achievement,
while entrusting the credit institution, on its own responsibility, with the
task of identifying the most effective measures without enforcing limits or
rules other than the ones laid down in the legal framework;
•
the adoption of specific measures for prudential purposes, such as
requiring the credit institution to take specific actions concerning
regulatory matters (organisation of risk management and internal controls,
capital adequacy, permissible holdings, limitation of risk, disclosure) or
operational limits or prohibitions;
•
the use of other legal powers of intervention intended to correct or
resolve irregularities, inaction or specific negligence;
•
the obligation for a credit institution to present a plan for restoring
compliance with supervisory requirements.
81
The use of supervisory powers is monitored by means of a timely
assessment by the ECB of the credit institution’s compliance with the
recommendations, supervisory measures or other supervisory decisions
imposed on it.
The follow- up is based on ongoing supervisory activities and on-site
inspections; the ECB will respond if non-compliance is identified.
The monitoring procedures ensure that the ECB adequately addresses any
irregularities or insufficiencies detected in a credit institution in
implementing the supervisory measures, thereby mitigating the risk of
failure of the credit institution.
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82
4.2.9 Enforcement and sanctions
If regulatory requirements have been breached, the supervisor may impose
sanctions on credit institutions and/or their management.
The ECB may impose administrative pecuniary penalties on credit
institutions of up to twice the amount of the profits gained or losses avoided
because of the breach where those can be determined, or up to 10% of the
total annual turnover in the preceding business year.
In addition, in the case of a breach of a supervisory decision or regulation of
the ECB, the ECB may impose a periodic penalty payment with a view to
compelling the persons concerned to comply with the prior supervisory
decision or regulation of the ECB.
The periodic penalty payment will be calculated on a daily basis until the
persons concerned comply with the supervisory decision or regulation of
the ECB, provided that the periodic penalty is imposed for a period of no
longer than six months.
83
The ECB’s Enforcement and Sanctions Division investigates –
in the spirit of transparent investigation and decision-making – alleged
breaches by credit institutions of directly applicable EU law, national law
transposing EU directives or ECB regulations and decisions, observed by a
JST during the day-to-day supervision.
In this case, the JST will establish the facts and refer the case to the
Enforcement and Sanctions Division for follow-up.
The Enforcement and Sanctions Division acts independently from the
Supervisory Board to ensure the impartiality of the Supervisory Board
members when they adopt a sanctioning decision.
The Enforcement and Sanctions Division is also responsible for processing
reports of breaches of relevant EU law by credit institutions or competent
authorities (including the ECB) in the participating Member States.
The ECB has established a reporting mechanism in order to encourage and
enable persons with knowledge of potential breaches of relevant EU law by
supervised entities and competent authorities to report such breaches to
the ECB.
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Such reports on violations are an effective tool for bringing incidents of
business misconduct to light.
85
4.3
Supervision of less significant institutions
The SSM aims to ensure that the EU’s policy relating to the prudential
supervision of credit institutions is implemented in a coherent and effective
manner, that the single rulebook for financial services is applied in the
same manner to credit institutions in all Member States concerned, and
that credit institutions are subject to supervision of the highest quality,
unfettered by non- prudential considerations.
Moreover, the experience of the financial crisis has shown that smaller
credit institutions can also pose a threat to financial stability; the ECB
should therefore be able to exercise supervisory tasks in relation to all
credit institutions and branches, which are established in participating
Member States of credit institutions established in non-participating
Member States.
These objectives can only be achieved through:
•
collaboration in good faith between NCAs and the ECB;
•
an effective exchange of information within the SSM;
•
a harmonisation of both processes and consistency of supervisory
outcomes.
86
NCAs are responsible for the direct supervision of less significant
institutions (with the exception of common procedures, which are a joint
responsibility of the ECB and the NCAs).
They plan and carry out their ongoing supervisory activities according to
the common framework and methodologies created for the SSM.
In doing so, NCAs act in line with the SSM’s overall supervisory strategy,
using their own resources and decision-making procedures.
Ongoing activities include organising meetings with the senior
management of less significant institutions, conducting regular risk
analyses within the country concerned, and planning and carrying out
on-site inspections.
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NCAs will also continue to perform supervision in areas that are not
covered by the SSM Regulation.
87
Even though NCAs have primary responsibility for organising and
conducting the supervision of less significant institutions, ECB staff may
also participate in certain activities, for example on-site inspections.
As well as providing expertise and support to NCAs, this promotes and
facilitates the exchange of staff among NCAs (and between NCAs and the
ECB) and helps to foster a common supervisory culture within the SSM.
88
At the same time, the ECB is responsible for the effective and
consistent functioning of the SSM and is entrusted with an oversight
responsibility to ensure that the supervisory activities carried out by the
NCAs are of the highest quality and that supervisory requirements on all
credit institutions covered by the SSM are consistent.
This task is performed by DG Micro-Prudential Supervision III.
89
DG Micro-Prudential Supervision III achieves these objectives by
applying the supervisory approaches developed by DG Micro-Prudential
Supervision IV for significant credit institutions in a proportional manner.
DG Micro-Prudential Supervision III comprises three divisions:
•
The Supervisory Oversight and NCA Relations Division is responsible
for cooperation with NCAs and oversees their supervisory approaches
vis-à-vis less significant institutions, with the objective of ensuring high
standards of supervision and supporting the consistent application of
supervisory processes and procedures by NCAs, thereby serving as the
primary contact point for NCAs towards the ECB as banking supervisor.
The Division also takes care of the quality assurance regarding the
supervisory processes in NCAs in liaison with DG Micro-Prudential
Supervision IV (horizontal and specialised divisions).
•
The Institutional and Sectoral Oversight Division – in cooperation
with DG Micro-Prudential Supervision IV – monitors specific banking
sub-sectors (e.g. savings banks, cooperative banks) and individual
institutions among the less significant institutions according to their
priority ranking (i.e. risk and impact assessment) and organises thematic
reviews.
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It also evaluates whether the ECB should take over direct supervision of a
specific institution and participates – in cooperation with DG
Micro-Prudential Supervision IV – in on-site examinations of less
significant institutions.
Furthermore, it is responsible for crisis management activities related to
less significant institutions.
•
The Analysis and Methodological Support Division develops and
maintains the methodology – based on the supervisory approach developed
by DG Micro-Prudential Supervision IV – for the classification of less
significant institutions and the application of the RAS and the SREP to
them.
It is also responsible for the regular supervisory reporting on less
significant institutions and for overseeing the risks and vulnerabilities of
banking sub- sectors.
90
The following sections provide an overview of the processes and
procedures carried out by the ECB in relation to the supervision of less
significant institutions.
91
4.3.1 Information gathering
Credit institutions in Europe are interconnected through their mutual short
and long-term lending and their trading activities.
It is important, therefore, that a wider sector-level analysis is performed,
for example to capture possible contagion effects and to assess the kind of
supervisory policy measures the ECB and the NCAs should take with
respect to less significant institutions.
92
To be able to exercise its oversight function and to ensure
financial stability in the euro area, the ECB regularly receives quantitative
and qualitative information on the less significant institutions.
This information is provided using defined reporting procedures between
the ECB and NCAs.
The information received enables the ECB to identify particular risks in
individual institutions and to perform a sector-wide analysis, which in turn
supports the ECB’s overall supervisory objectives.
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Based on the analysis, the ECB can also identify areas where ECB
regulations, guidelines or general instructions are needed to ensure
consistency in supervision and the application of high supervisory
standards.
93
In addition to the regular information received from NCAs
(including supervisory reporting to competent authorities) and taking
account of the principle of proportionality, the ECB may also request
additional information on less significant institutions, generally from
NCAs, as necessary to exercise its oversight task.
94
4.3.2 Oversight activities
The ECB is responsible for conducting the general oversight of the NCAs’
supervisory activities to ensure the adequate and harmonised conduct of
supervision of the less significant institutions.
Oversight activities can be conducted, for example, through reviews of
specific topics (e.g. risk areas) across all or a sample of NCAs.
They provide a targeted insight into the NCAs’ supervision at the level of
individual institutions or classes of similar institutions.
95
Furthermore, NCAs provide material draft supervisory
decisions and procedures to the ECB.
The scope of these decisions and procedures is defined in the SSM
Framework Regulation.
They consist of procedures that have a significant impact on the less
significant institutions and the removal of members of the management
boards of less significant institutions and the appointment of special
managers.
A balance is pursued between providing the ECB with information on NCA
activities crucial to the integrity of the SSM, but avoiding an overflow of
notifications to the ECB.
NCAs must also inform the ECB if the financial situation of a less significant
institution deteriorates rapidly and significantly.
96
NCAs report regularly to the ECB on the less significant
institutions in a format defined by the ECB. In addition, some ex post
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reporting procedures have been established under which NCAs report
regularly on the measures that they have taken and the performance of
their tasks with regard to the less significant institutions.
The ECB also reviews how NCAs apply SSM supervisory standards,
processes and procedures, such as the SREP, with regard to the less
significant institutions.
The oversight of processes includes assessing whether standards are
applied in a harmonised way and checking whether comparable situations
lead to comparable outcomes across the SSM.
The ECB can also recommend changes to areas where further
harmonisation is needed and, where appropriate, may also develop
standards as regards supervisory practices.
The ECB’s oversight activities are a collaborative assessment of whether
and how SSM standards and processes can be improved to reach the
common goal of harmonised and effective supervision across the SSM.
98
4.3.3 Intervention powers of the ECB
The ECB, in cooperation with the NCAs, determines regularly whether an
institution changes its status from “less significant” to “significant” by
fulfilling any of the criteria established in the SSM Regulation (see Box 1) or
vice versa, and decides to take over supervisory responsibilities for
individual less significant institutions from one or more NCAs accordingly
or to end direct supervision.
99
The ECB may also at any time on its own initiative, after
consulting with the NCAs, decide to directly exercise supervision on less
significant institutions, when necessary, to ensure consistent application of
high supervisory standards, for example if the ECB’s instructions have not
been followed by the NCA and thus the consistent application of high
supervisory standards is compromised.
It should be noted that the deterioration of a less significant institution’s
financial condition or the initiation of crisis management proceedings are
not necessarily reasons for the ECB to take over supervision from the
responsible NCAs.
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100 4.4 Overall quality and planning control
The supervision of both significant and less significant institutions requires
overall mechanisms to ensure that the SSM approach to supervision
remains consistent and of the highest quality across all supervised entities.
This implies avoiding distortions between the two sets of credit institutions
while applying supervisory approaches and the principle of proportionality
in a structured way.
101 4.4.1 Quality assurance
The aim of quality assurance is to assess the consistent application of the
common methodological framework and to ensure that it is complied with.
Furthermore, quality assurance monitors the quality of supervisory
practices.
The horizontal quality control of the JSTs is performed by a dedicated
division within DG Micro-Prudential Supervision IV, whereas the quality
assurance of the NCAs’ supervision of the less significant institutions is
carried out by the ECB’s Supervisory Oversight and NCA Relations Division
within DG Micro-Prudential Supervision III.
This is all the more important as the SSM operates across participating
Member States and involves both national supervisors and the ECB.
The main goal of quality assurance is to identify improvement potential for
methodologies, standards and supervisory policies.
103 4.4.2 Planning control
As regards significant institutions, the ECB’s Planning and Coordination of
SEPs Division checks regularly to see whether the tasks specified in the
SEPs have been fulfilled by the JSTs and requests corrective actions if
needed.
For the less significant institutions, supervisory planning is carried out by
NCAs and, when necessary, overseen by DG Micro-Prudential Supervision
III.
Furthermore, SEPs are designed and updated based on the findings made
in previous periods.
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Findings are discussed with the parties involved with a view to improving
and further harmonising future activities.
5
Abbreviations
BRRD Bank Recovery and Resolution Directive
CBSG Cross-Border Stability Group
CMG Crisis Management Group
CRD IV Capital Requirements Directive
CRR Capital Requirements Regulation
EBA European Banking Authority
ECB European Central Bank
ESAs European Supervisory Authorities
ESFS European System of Financial Supervision
ESM European Stability Mechanism
ESRB European Systemic Risk Board
EU
European Union
FSB Financial Stability Board
G-SIFIs
Global Systemically Important Financial Institutions
ICAAP
Internal Capital Adequacy Assessment Process
ILAAP
Internal Liquidity Adequacy Assessment Process
JST
Joint Supervisory Team
MoU Memorandum of Understanding
NCA national competent authority
RAS risk assessment system
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SEP Supervisory Examination Programme
SREP Supervisory Review and Evaluation Process
SSM Single Supervisory Mechanism
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Monetary Policy Accommodation, Risk-Taking,
and Spillovers
Governor Jerome H. Powell
Global Research Forum on International
Macroeconomics and Finance, Washington, D.C.
Our panel's topic--"Monetary Policy Spillovers and Cooperation in a Global
Economy"--is surely a timely one.
I will offer brief introductory thoughts and then discuss some recent
research by Federal Reserve Board economists that has bearing on these
matters.
The Federal Reserve's monetary policy is motivated by the dual mandate,
which calls upon us to achieve stable prices and maximum sustainable
employment.
While these objectives are stated as domestic concerns, as a practical
matter, economic and financial developments around the world can have
significant effects on our own economy and vice versa.
Thus, the pursuit of our mandate requires that we understand and
incorporate into our policy decision-making the anticipated effects of these
interconnections.
And the dollar's role as the world's primary reserve, transaction, and
funding currency requires us to consider global developments to help
ensure our own financial stability.
Since the financial crisis, the Federal Reserve has pursued a highly
accommodative monetary policy, which has had important effects on asset
prices and global investment flows.
With unconventional tools, the scale and scope of these effects were
difficult to predict ex ante.
Nor is it possible to predict with confidence how markets will react day to
day as policy returns to normal.
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The Federal Open Market Committee (FOMC) has gone to great lengths to
provide transparency about its policy intentions.
Yet, since Chairman Bernanke first discussed the end of the asset purchase
program in mid-2013, volatility has surprised both on the upside (the
"taper tantrum") and on the downside (the actual taper and the low
volatility throughout most of 2014).
In my view, while market volatility will continue to ebb and flow, these
fluctuations are not likely to have important implications for policy.
The path of policy will depend on the progress of the economy toward
fulfilment of the dual mandate.
Overall, accommodative monetary policy seems to have provided
significant support for U.S. growth.
And, of course, a strong U.S. economy contributes to strong growth around
the globe, particularly in the emerging market economies (EMEs).
But what of the so-called spillovers in the form of flows into, and out of,
EMEs, whose financial sectors are small compared with global investment
flows?
Such spillovers could merely reflect investor responses to changing
differentials between rates of return abroad and in the United States.
But these spillovers could also reflect shifts in investor preferences for risk.
By design, accommodative monetary policy--whether conventional or
unconventional--supports economic activity in part by creating incentives
for investors to take more risk.
Such risk-taking can show up in domestic financial markets, in the
international investments of U.S. investors, and even, ultimately, in general
risk attitudes toward foreign financial markets.
Distinguishing between appropriate and excessive risk-taking is difficult,
however.
I now turn to some recent research on whether there has been an increase
in the riskiness of our investments abroad and whether such increases
might be traced to the current low-interest rate environment.
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Many studies of the pre-crisis period document the pro-cyclical nature of
bank lending and leverage, and the buildup of risk-taking and leverage by
banks.
It is much harder to find evidence that low interest rates have led to
increased post-crisis risk-taking by U.S. banks.
Growth in overall lending by U.S. banks has been modest at best.
However, some pockets of increased risk-taking by banks and other
investors are observable in domestic markets, such as leveraged loans.
And on the international front, there has been a notable increase in
syndicated loan originations.
Recent research by Board staff, using a database of loans primarily to U.S.
borrowers but also to some foreign borrowers, suggests that lenders have
indeed originated an increased number of risky syndicated loans
post-crisis, based on the assessed probability of default as reported to bank
supervisors (figure 1).
Regression results confirm that the average probability of default is
significantly inversely related to U.S. long-term interest rates.
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This increase in riskiness of syndicated loans post-crisis has been
accompanied by a shift in the composition of loan holders: An increasing
share is now held not by banks but by hedge, pension, and other investment
funds (figure 2).
These nonbank investors also tend to hold loans with higher average credit
risk (figure 3).
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These data suggest that a tougher regulatory environment may have made
U.S.-based bank originators unable or unwilling to hold risky loans on their
balance sheets.
Related work by the same researchers, using a database with
more-extensive coverage of loans to foreign borrowers, shows a similar
pattern of increased risky loan underwriting by international lenders, an
increase that is also significantly inversely related to U.S. interest rates.
Together, these results suggest a potential spillover from accommodative
U.S. monetary policy through increased risk-taking in syndicated loans
globally, although preliminary results also indicate that investors still
require extra return for this extra risk.
Another area in which to look for links between low interest rates and
risk-taking is in cross-border securities purchases.
The role of low interest rates in advanced economies in encouraging capital
flows to EMEs where returns are higher has been a familiar theme.
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And recent studies have found that asset prices in EMEs do respond
systematically to U.S. monetary policy shocks.
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For evidence of increased risk-taking in cross-border investment, let's look
at the composition of U.S. investors' foreign bond portfolios.
Although emerging market bonds remain a relatively small proportion of
the aggregate U.S. cross-border bond portfolio (figure 4), within foreign
government bonds, U.S. investors have modestly shifted their portfolio
shares toward higher-yielding bonds of emerging market sovereigns (figure
5).
Ex post, these portfolio reallocations delivered a higher return to U.S.
investors on this part of their portfolio relative to what they would have
received if they had left portfolio compositions unchanged at the average
shares in 2008 and 2009, but at a cost to the portfolio's credit quality
(figure 6).
Regression results confirm that in choosing among foreign government
bonds, U.S. investors have put more weight on returns since the crisis.
But search for higher returns has not been the only motivation for
international investors post-crisis: Demand for liquid high-grade "safe" or
money-like assets has also increased from foreign official investors for
investment of foreign exchange reserves, from pension funds and other
institutions who face portfolio allocation constraints or regulatory
requirements, and from investment strategies requiring cash-like assets for
margining and other collateral purposes.
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Some shift to safe assets is also seen in U.S. portfolios: U.S. investors
actively rebalanced their holdings of foreign financial sector bonds toward
those with higher credit ratings, but at some cost in returns (figure 7; figure
8).
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Taken together, developments in U.S. bond portfolios do not indicate a
worrisome pickup in risk-taking in external investments.
But it is important to recognize that portfolio reallocations that seem
relatively small for U.S. investors can loom large from the perspective of the
foreign recipients of these flows.
At roughly $400 billion at the end of 2012, emerging market bonds
accounted for a tiny fraction of the roughly $25 trillion in bonds held by
U.S. investors.
But to the recipient countries, these holdings can account for a large
fraction of their bond markets.
Even relatively small changes in these U.S. holdings can generate large
asset price responses, as was certainly the case in the summer of 2013.
Likewise, a reassessment of risk-return tradeoffs could disrupt financing
for projects that are dependent on the willingness of investors to participate
in global syndicated loan markets.
We take the consequences of such spillovers seriously, and the Federal
Reserve is intent on communicating its policy intentions as clearly as
possible in order to reduce the likelihood of future disruptions to markets.
We will continue to monitor investor behavior closely, both domestically
and internationally
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Shadow banking - what kind of regulation for
the (European) shadow banking system?
Notes by Mr Pentti Hakkarainen, Deputy Governor of
the Bank of Finland, for the panel discussion at the
SAFE Summer Academy 2014 "Shadow Banking:
Evolution, Background, Perspectives", Brussels
A viable and well-functioning shadow banking system is
beneficial for the real economy
Before going to the actual topic of today's panel and presenting some
thoughts on regulation of the (European) shadow banking system, let me
start with a few words on how I see the shadow banking system.
I will not go too much into the details of the definition and coverage of the
shadow banking system as it has been a topic of another discussion earlier
today.
Let me just say that it is very important to have a clear understanding of
what we are talking about and hence what we potentially try to regulate and
supervise.
I would like to highlight that I see many benefits in a viable and
well-functioning shadow banking system.
Shadow banking is a modern, sophisticated, and complementary way to
share risks efficiently.
It is also an alternative way to allocate resources in the economy outside the
regular banking sector, upon which we here in Europe are particularly
dependent.
We may even be too dependent on banks according for example to the
Advisory Scientific Committee of the European Systemic Risk Board.
Thus it is important to revitalise and strengthen alternative funding
channels which can further support sustainable growth in the real
economy.
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Competition with reputation rather than heavy regulation
My short answer to the question expressed in the topic of this panel (What
kind of regulation for the European shadow banking system) is that calls for
regulation are justified.
However, the shadow banking system should not be regulated in the same
way as the regular banking sector. Let me elaborate on this view.
First, we must ensure that regular banking activities and shadow banking
activities should not be mixed or confused with each other. It should be
crystal clear for investors in for example money market funds that they do
not enjoy any coverage comparable to a deposit insurance system.
Similarly, it should be clear to entities in the shadow banking system that
they will not be supported by the government (the same applies to banks as
failing banks will not be supported or bailed-out as the new recovery and
resolution framework has been fully implemented) nor that they have
access to the liquidity support of the central bank.
If shadow banking entities were under similar regulation and supervision
as regular banks, this might give a misleading signal to the market that they
implicitly also enjoy a similar safety net.
Formal surveillance by authorities can also reduce the incentives of
outsiders to monitor shadow banking entities.
Shadow banking entities have to earn the trust of investors and
counterparties on their own merits.
They have to be able to compete independently by prudently managing the
business and maintaining sufficient buffers.
Appropriate disclosure of information and sufficient transparency of
operations enable efficient monitoring and are instrumental in building
trust.
Secondly, in spite of our best efforts, supervisors tend to follow a step or
two behind the actions of those we supervise.
This is the case also with regular banks, which operate in and adjust to a
continuously changing environment.
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Still I would argue that the banking business is more stable.
Moreover, there are more similarities across regular banks than there are
across the heterogeneous group of shadow banking entities, making regular
banks easier to supervise.
Thus regulating and supervising the shadow banking system might be
particularly challenging, if not even impossible.
A better option might be to make sure they have the right incentives to do
their job well.
Regulating systemically important shadow banking entities and
the importance of separation between the regular banking and
shadow banking system
However, there are some exceptions to the ideal situation I have tried to
picture, making more comprehensive and stricter regulation warranted.
First of all if a shadow banking entity becomes systemically important its
failure may have devastating effects on the rest of the financial system and
eventually on the real economy.
As some risks are likely to shift to the shadow banking system due to the
tighter regulation in the regular banking sector, risk concentrations may
very well be built up in the shadow banking system.
There is an externality that calls for regulation.
Here the US has taken the lead and already allows the authorities to ensure
that the perimeter of prudential regulation can be extended as appropriate
to cover systemically important (and significant) shadow banking
institutions.
This avenue is one option to be considered in Europe.
Secondly, the systemic risk building up in the shadow banking system and
the failure of a shadow banking entity should not cause contagion to the
regular banking sector.
Thus there is a need to regulate and supervise the link between the regular
banking sector and the shadow banking system.
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Much has already been done to this end.
For example the Risk Retention Rule guarantees that an originator has a
skin-in-the-game as it must keep a certain part of the risks at its own
balance sheet and thus the bank will measure the risk of the link to the
shadow banking system appropriately.
Similarly the due diligence requirement reduces the information
asymmetry in securitisation structures and makes them more transparent.
This facilitates the understanding of risks taken by regular banks in the
shadow banking system.
The objective of the proposed Regulation of Money Market Funds is to
ensure that the risk of MMFs is properly accounted for by the investors
among which regular banks are frequently found.
The distinction between insured deposits and this important source of
funding for shadow banking entities is clarified.
To further strengthen the securitisation process the EU Credit Rating
Agency (CRA) regulations improves the transparency and accountability of
rating agencies.
Finally, the capital requirements related to securitisations have been
reformed to ensure that the parties involved in the process are sufficiently
protected against potential shortcomings and failures.
Also, there is an ongoing discussion on reforming the structure of banks in
the European Union based on the work of the High-level Expert Group
chaired by governor Liikanen, the member of which our panel chairman,
prof. Jan Pieter Krahnen also was.
Based on the final report of the Group, the Commission proposed
Regulation on structural measures to improve the resilience of EU credit
institutions.
One element of this proposal is to curb the link between banks and the
shadow banking system, by imposing a ban not only on proprietary trading,
but also on exposures to shadow banking entities engaging in proprietary
trading and exposures to hedge funds and entities sponsoring hedge funds.
Similar rules are already implemented in the US through the Volcker-rule.
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In January 2014, the Commission also published a proposal on Regulating
shadow banking system transparency.
The aim is to improve the reporting and increase the efficiency of
supervision on securities financing transactions so that the links to the
banking sector are properly understood.
Moreover, the proposed rules on how client assets can be reused as
collateral clarify the complex chains of rehypothecation.
The transparency of the collateral chains, in which both regular banks and
shadow banking entities are involved, is also improved.
During the financial crisis we learned that opacity and uncertainty about
the extent of rehypothecation and the risks involved can severely
undermine confidence in counterparties.
The ABS market in Europe
Continuing on the development of a particular shadow banking activity, I
would say that a step towards the right direction has been taken as the new
regulation supports the ABS market (or securitisation market in generally)
and endeavors to ensure growth, while for example the proposed regulation
on structural reform in EU aims to better separate shadow banking from
the traditional one.
Furthermore, it enhances the market discipline, which in turn, provides a
decent and solid ground for well-functioning shadow banking system.
As the ECB Governing Council decided in June 2014 to "intensify
preparatory work related to outright purchases in the ABS market (to
enhance the functioning of the monetary policy transmission mechanism)",
I would also like to say a few words about the ABS market in Europe and its
potential.
The current ABS market in Europe is small and impaired: public issuance
of asset backed securities is minimal and the market is shrinking.
It is unfortunate as the ABS-market has a good potential to contribute to
unlocking the Europe's credit market, by offering a viable complementary
funding source for the real economy, in particular for the SME sector.
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Considering the weakness of the securitisation market, it is obvious that
the market is still suffering from the stigma it received when the global
financial crisis erupted and the failures of the securitisation market were
uncovered.
The market suffers from a reputation as a capital arbitrage tool of banks
that turned out to be disastrous for financial stability.
The stigma is persistent and mutual, even though the European ABS
market performed relatively well during the crisis compared with the
respective American one.
Another reason behind the small and weak European securitisation market
may be the heterogeneity of the European securitisation market, namely
the differences in for example lending criteria, banking institutions, rating
standards and default laws among the European countries.
Diminishing these differences would enable a better-functioning European
securitisation market.
Harmonising some standards and enhancing relevant data availability
could dispel the risk that banks would off-load bad parts of their balance
sheets with securitisation activities.
Moreover, common rules and standards would support the development of
the currently very fragmented market to a pan-European one in a single
market spirit.
Finally, considering the potential role of the ABS market in the monetary
policy transmission mechanism, a central bank should avoid a situation in
which it could become the only buyer in the ABS market.
It is thus utterly important to enhance the development of the private
market in ABS.
So far the ABS market has probably played a minor role in private sector
debt financing; its main driver may have been the collateral needs of banks.
From the view point of regulation these facts should not be forgotten.
It is desirable to make regulation such that it restricts neither the supply
nor the demand side of the ABS market.
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Concluding remarks
To conclude, I would like to highlight the following points.
In principle, shadow banking system is beneficial, and one must be careful
with its regulation.
As professor Bengt Holmström has reminded: "Of special concern is the
tendency to demonize or ban innovations that backfired, not because they
were fundamentally wrong, but because the particular implementation was
flawed.
The originate-and-distribute model and MBSs [or securitisation in
generally] will certainly have an important place in the future."
Thus, we should learn from the fundamental analyses of what went wrong
last time, and keep restoring the confidence to the securitisation market.
Finally, one thing that should be kept in mind is a possible post-crisis
reinvention of the financial system that Andy Haldane, Chief Economist of
Bank of England, talks about in his recent publication.
As a consequence of the crisis, some part of financial activities will migrate
outside the banking system, inducing the shape and form of risk itself to
change.
This could have further implications for stability of the financial system and
the broader economy.
Haldane continues that as risk changes its composition, not its quantum,
the financial system may exhibit a new strain of systemic risk that is even
more related to shadow banking entities.
Therefore, regulators must follow intensively the development of the post
crisis financial system that might result in new type of systemic risks, and
be ready to adjust regulation accordingly in a proactive manner.
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Big Bang banking union - what can we expect?
Speech by Dr Andreas Dombret, Member of the
Executive Board of the Deutsche Bundesbank, at the
Euro Finance Week, Frankfurt am Main
1. Introduction
Ladies and gentlemen
Thank you for the invitation and the opportunity to speak again at the Euro
Finance Week. It is a pleasure to be here today.
Let us briefly discuss physics before we turn to a topic that is more related
to the Euro Finance Week.
The British astronomer Martin Rees once said: "We can trace things back
to the earlier stages of the Big Bang, but we still don't know what banged
and why it banged.
That's a challenge for 21st century science."
Well, the euro area had its own "Big Bang" two weeks ago, and in this case
we know pretty well what banged - and why.
On 4 November, the ECB became the direct supervisor for the 120 largest
banks in the euro area which, in terms of assets, represent more than 80%
of the euro area's banking system.
Thus, with a big bang, the ECB became one of the largest banking
supervisors in the world.
Taking banking supervision from the national to the European level has
been the biggest step of financial integration in Europe since the
introduction of the euro in 1999.
This big bang created a new universe for the banks and the financial
markets.
But what exactly can we expect from the new European banking
supervision?
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And probably even more importantly: what is it that we cannot expect from
it?
In the following I would like to discuss both questions.
2. The Single Supervisory Mechanism - just the first step
Taking banking supervision from the national level to the European level
addresses three problems that became apparent during the recent crisis.
First, European banking supervision will allow banks in the entire euro
area to be supervised according to the same high standards.
These standards will emerge from sharing experience across borders and
taking the best parts from every national approach towards banking
supervision.
Germany, for instance, could benefit from a more quantitative-oriented
approach towards banking supervision which other countries already
follow.
Second, European banking supervision will make it possible to effectively
identify and manage cross-border problems.
This is essential because today, large banks are usually active in more than
one country.
The failure of the Franco-Belgian bank Dexia in 2011 is a classic example in
which banking supervision with a cross-border focus could have improved
crisis management.
Another example is the case of German Hypo Real Estate, which failed in
2009.
Third, taking banking supervision from the national to the European level
will add a degree of separation between supervisors and the banks they
supervise.
This will prevent supervisors from treating their banks with kid-gloves out
of national interest.
Nevertheless, we can expect European banking supervision to draw upon
the experience and resources of national supervisors.
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Supervision itself will take place in so-called joint supervisory teams.
These teams are headed by ECB staff but are composed of national
supervisors.
To sum up: there is a lot we can expect from European banking
supervision, and now it has to deliver.
In this regard, we should remember one thing: European banking
supervision is an immensely complex operation that has been put together
in a very short time.
Thus, it would probably be unrealistic to expect everything to run smoothly
from day one. It will certainly take some time before every detail is sorted
out deep down in the engine room of actual banking supervision.
Nevertheless, I am confident that we will get there and that our
expectations will be fulfilled.
3. The Single Resolution Mechanism - the necessary second step
But we should not let unrealistic expectations become the roots of
complacency and, consequently, disappointment.
European banking supervision is not the holy grail of financial stability.
It certainly contributes to making banks more stable, but it is no panacea.
Thus, we have to supplement it with other measures.
Let me elaborate on one point in that regard.
Banking supervision cannot prevent individual banks from failing - not at
the national level and not at the European level.
Is this a problem?
Not at all: the possibility of failure is an essential element of a market
economy.
Nevertheless, banks are special in that respect.
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Just remember the 15th of September 2008, when the failure of a single
investment bank pushed the financial system to the brink of collapse.
The lesson is that the failure of very large or interconnected banks can lead
to a systemic crisis.
Thus, these banks are perceived as being "too big to fail": when push comes
to shove, the government might be compelled to step in to prevent disaster.
Consequently, "too big to fail" banks operate with an implicit and cost-free
insurance.
Apart from the costs this insurance imposes on taxpayers, it most definitely
sets the wrong incentives for the risk-conscious behaviour of banks.
Thus, solving the "too big to fail" problem is paramount for making the
financial system more stable and saving taxpayers' money.
Can European banking supervision solve that problem?
Well, it can certainly contribute by putting "too big to fail" banks under
close observation.
And yet it has to be supplemented with other measures.
And here, we recently made some progress - at the global level and at the
European level.
At the global level, the G20 Heads of Governments and States have just this
Sunday decided on international criteria that global systemically important
banks will have to fulfil in future regarding their capital structure.
In particular, these banks will need a minimum amount of Total Loss
Absorbing Capacity - in short TLAC.
This approach combines the existing minimum capital requirements with
new requirements to ensure that large banks have sufficient capacity to
absorb losses, both before and during resolution.
TLAC therefore, in my view, represents a watershed in ending "too big to
fail".
It will allow for the orderly resolution of those banks without disrupting the
financial system and while protecting taxpayers from having to foot the bill.
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For the TLAC-concept, I wish to signal my strong support.
To achieve these worthy goals, I suggest agreeing upon a figure at the
upper end of the range of 16% - 20% proposed by the FSB.
However, reaching an agreement on TLAC is not the finish line of the
regulatory agenda.
The next months need to be used for in-depth public consultation as well as
an impact study of the new rules.
I hope that this study will lend support to a figure at the upper end of the
proposed range.
Finally, after both the impact study and the public consultation,
implementation is the next step, and this should not be underestimated.
Another major step towards solving the "too big to fail" problem has been
taken with regard to cross-border resolution.
In October, 18 global banks and the International Swaps and Derivatives
Association agreed to implement new rules on derivatives trading.
Whenever a large bank fails, these rules will allow authorities to
temporarily suspend the right of other banks to terminate derivatives
contracts.
This will buy precious time to organise an orderly resolution of the failed
bank.
However, it is paramount that we not only have the necessary procedures in
place to wind down a failed bank, but the political will to go through with it.
This political will exists in Germany and is a universal pre-condition for
ending "too big to fail".
We have also made progress at the European level.
The Bank Recovery and Resolution Directive spells out clear rules on who
has to bear the costs when a bank fails.
In a nutshell: bail-out is out and bail-in is in.
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In future, shareholders and creditors will be first in line when it comes to
bearing losses; taxpayers will be last in line.
This directive will be implemented in Germany in early 2015; the latest
possible date for implementation in other countries is 2016.
Also from 2016 onwards, European banking supervision will be
supplemented with a European resolution mechanism for banks.
From then on, the banking union will rest on two pillars and provide a
stable framework for European financial markets.
4. What about the banks?
What does all that mean for the banks?
In essence, regulators and supervisors are working towards strengthening
the principles of a market economy.
Naturally, this puts more weight on the shoulders of market participants,
that is, the banks.
In future, there will be no public lifeguard standing by to bail banks out
when things go wrong.
Failure has become a real possibility and banks have to acknowledge that.
They should have an interest in safeguarding their stability and
strengthening their profitability.
Regarding the stability of banks, the comprehensive assessment provided a
deep insight into the state of the European system.
So let us take a closer look at the German banks that were subjected to that
assessment.
All in all, German banks did rather well.
Of the 25 German banks that were examined, there was only one "technical"
failure, since the bank in question has already remedied its capital shortfall.
Over all, it could be concluded that German banks are stable enough from a
capital point of view to cope with severe economic stress.
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But again, no bank should give in to complacency.
And neither should supervisors. We should, for instance, be aware that the
comprehensive assessment focused on risk-weighted capital ratios.
Markets and supervisors, however, also cast an eye on unweighted capital
ratios.
And with regard to these leverage ratios, German banks are below average
compared to other euro-area countries.
Thus, there is ample room to catch-up and improve stability even further.
Nevertheless, while stability is necessary for a bank, it is not sufficient.
Banks have to be profitable as well.
And in this regard, too, German banks need to catch up.
Their return on assets and their return on equity are also relatively low
compared to other euro-area countries.
A recent study even comes to the conclusion that only 6% of German banks
earned their cost of capital last year.
What can explain these weak earnings?
Well, the main culprit in Germany seems to be a business model that is
relatively dependent on interest income.
Such a business model poses a major challenge in the current environment
of low interest rates.
Consequently, in the first six months of this year, the operative results of
the large German banks were about 8% below their 2013 levels - a result
which was largely driven by a contracting interest margin.
Nonetheless, banks are also faced with a structural problem in this context:
the interest margin has been declining constantly since the mid980s.
The banks should therefore reconsider their business models and gear
them towards sustainable profitability.
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To be sure, the need to adapt business models is not only relevant for
German banks.
However, in its recent Financial Stability Report, the IMF finds that
German banks are again below average in terms of reforming their business
models.
Again, there is room to catch up with international peers.
An obvious strategy for the German banks would be to diversify their
sources of income away from interest income.
Looking at the cost-side, German banks fare rather well compared to other
countries.
That is the good news. But there are still options to reduce costs.
In this regard, mergers may well be a potential strategy.
The German banking market still offers scope for further consolidation the focus here should, of course, always remain on arriving at a sustainable
business model.
As a side note: in future, European banking supervision will also keep a
close watch on the business models of banks.
However, we should not expect supervisors to be the better bankers.
At the end of the day, management decisions have to be taken by those who
bear the risks and reap the rewards.
What the supervisors could do is impose additional capital or liquidity
requirements whenever they have doubts about the sustainability of a
bank's business model.
5. Conclusion
Ladies and gentlemen
There is no doubt: European banking supervision is an important step
forward in ensuring financial stability in the euro area.
Nevertheless, as I said earlier, unrealistic expectations are the roots of
complacency and, consequently, of disappointment.
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European banking supervision is just the first pillar of the envisaged
banking union.
It has to be supplemented with the European resolution mechanism for
banks.
This second pillar of the banking union will be erected in 2016.
Eventually, the banking union will provide a stable framework for the
banking system and strengthen market forces.
This, in turn, puts more responsibility into the hands of banks.
It is up to each individual bank to ensure its own stability and profitability.
This requires the banks to rethink their business models and to rethink
their culture. Regulatory measures like TLAC that will abolish implicit
guarantees for banks will also necessitate changes in banks' behaviour for
the better.
The original role of banks is to service the real economy.
Putting this idea back into the heads of bankers would contribute greatly to
making the financial system more stable.
We have to do away with a culture in which everything is allowed that is not
explicitly forbidden.
We need a culture which encourages bankers to look beyond the horizon of
short-term returns.
If banks succeed in creating such a culture, they will eventually regain the
trust of the people that got lost in the crisis. Regulation and supervision can
play a supporting role, but the burden ultimately lies with the banks.
Thank you.
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Taking stock of the global role of the Renminbi
Speech by Benoît Cœuré, Member of the Executive
Board of the ECB, at the European-Chinese Banking
Day, Frankfurt.
Dear Ladies and Gentlemen,
It is an honour to be invited here to the European-Chinese Banking Day,
part of the Frankfurt Euro Finance Week, and I would like to thank my
hosts for giving me the opportunity to share some thoughts on the issue of
yuan (or RMB) clearing.
Clearly, the increasing importance of the Chinese economy and its currency
over the last decades brings many new challenges, some of which also
encompass international payment activities.
As a major economy, the euro area is naturally affected by this process.
The rise of China has been astonishing.
Since 1990, its weight in global GDP has increased from just below 2% to
over 13% this year, and is projected to surpass 15% before 2020.
In PPP terms, China’s share in the global GDP is, as of this year, even larger
than that of the US.
This rapid economic development would not have been possible without
China also becoming one of the world’s main trading nations, together with
the euro area and the US.
This economic prowess is also gradually translating itself into a greater
presence in the financial sphere.
China has liberalised cross-border financial transactions, first those related
to trade and direct investment, but increasingly also those related to
portfolio investment.
Approved investments under the different schemes that allow domestic and
foreign institutional investors to make cross-border investments in and out
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of China have been rising steadily, although, so far, they amount only to
about 2% of China’s GDP.
However, we should not forget that financial liberalisation is an ongoing
process, which is still not complete.
Additionally, in the last few years, central banks across the world have
started to hold onshore Chinese renminbi (CNY) in their reserves
portfolios, usually with the expectation that CNY may become a reserve
currency in the coming years.
Many others indicate interest in reserve asset diversification into CNY once
China’s onshore market opens up further.
This is an issue that the Eurosystem will also have to further reflect on in
the future.
Also, the Shanghai – Hong Kong Stock Connect programme, which allows
institutional and private investors from mainland China to invest up to a
certain quota in Hong Kong and vice versa, is operating as of today and
represents a further important step in opening the capital account and
liberalising financial flows.
The growth in cross-border transactions has also led to an increasing
volume of RMB circulating outside China, giving rise to local RMB markets,
in Asia and in the euro area.
In response to these developments, many central banks have established a
bilateral currency swap arrangement with the People’s Bank of China
(PBC).
In October 2013, the ECB signed a bilateral currency swap arrangement
with the PBC with maximum sizes of 45 billion euros when euro are
provides euros to the PBC and 350 billion yuan when yuans are provided to
the ECB.
From the ECB’s perspective, the swap line serves as a backstop facility to
address sudden and temporary disruptions in the RMB market owing to
liquidity shortages, so as to reassure market participants that a safety net is
in place to address possible future market malfunctioning and reassure
euro area banks regarding the continuous provision of RMB.
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After having launched direct trading between the renminbi and a number
foreign currencies in China’s onshore forex market over the last few years,
direct trading between the euro and the onshore renminbi was launched in
September 2014.
This has the potential to reduce transaction costs, enhance the price
discovery of the EUR/CNY exchange rate and ultimately improve the
functioning of the global financial system.
Considering the rise of China in the global economy, the extent of its
external trade and the continuing development of its domestic financial
markets, it is no surprise that also the number of payments and financial
transactions being conducted between parties in China and elsewhere has
been growing rapidly.
Five years ago, the use of RMB in trade settlement was marginal, but
according to SWIFT statistics, it is now already the seventh most popular
payment currency, accounting for 1.72% of global payments in September
2014.
This might not sound like a lot, but the growth rates are impressive; and it
is worth noting that even the fourth most popular currency, the Japanese
Yen, only accounts for 2.74% of global payments.
The RMB as an invoicing currency for international trade has also been
growing sharply: nowadays, about 25% of Chinese trade is invoiced in
RMB, up from less than 2% in 2011.
Looking forward, the RMB clearly has the potential to become a major
international currency and to be included, when the International
Monetary Fund will deem it appropriate, in the basket of currencies that
determines the value of the Special Drawing Rights (SDRs).
That said, any currency of a truly global reach needs, amongst others, safe
and efficient arrangements and seamless processes to clear and settle
transactions in that currency.
In the euro area, we have undertaken great efforts to introduce safe and
efficient financial market infrastructures for payments and the clearing and
settlement of financial instruments.
Also within China, extensive work has been, and is, underway in this
regard.
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However, while these infrastructures facilitate the safe and efficient
handling of transactions within the respective economies, they do not yet
provide for effective automated linkages between the two currency areas.
Therefore, the institutions participating in domestic infrastructures are
acting as intermediaries and service providers to corporates and financial
actors wishing to transact within and between the two currency areas.
Various challenges exist in the processing of cross-border transactions.
One is the need to have common or interoperable technical standards, a
lack of which hamper a fully automated and fast processing of transactions,
leading to higher failure rates and costs.
In this regard, we appreciate the efforts undertaken in China to introduce
state-of-the-art standards such as ISO20022, as well as those by SWIFT to
increase fully-automated processing, for example by developing a
standardised dictionary for the Chinese Commercial Code (CCC).
The setting up of RMB clearing arrangements like the one introduced here
in Frankfurt –which I understand is starting operations today- and those
existing or planned for other centres in Europe and other parts of the world,
will play an important role in facilitating cross-border payments, as well as
closer integration and relations between economies.
I am convinced that the continuous development of more efficient payment
and clearing arrangements will benefit corporates and financial actors, both
in the euro area and in China.
To conclude, we should not forget that, together with many opportunities,
the integration of a new major currency in the global economy also brings
risks, as it allows shocks to propagate more easily across borders.
To minimise risks, such a process therefore must be monitored carefully
and complemented by close cooperation between authorities in China and
abroad.
Even more important however, is to strengthen the Chinese financial
sector, in particular banks, so that it is sufficiently resilient to cope with the
new pressures that financial liberalisation inevitably brings.
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I fully trust Chinese authorities to continue upgrading financial sector
supervision and cooperate closely in order to safeguard overall financial
stability.
Thank you for your attention.
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Economic outlook, monetary policy, and
credit ratings
Speech by Mr Már Guðmundsson, Governor of the
Central Bank of Iceland, at the Chamber of
Commerce Monetary Policy Meeting, Reykjavik
Madame Chairman, honoured guests,
The Iceland Chamber of Commerce has a
long-standing tradition of holding a meeting like this one on economic
developments and prospects and monetary policy.
The meeting is held following the publication of the Central Bank's autumn
forecast and, in latter years, the Monetary Policy Committee's interest rate
decision.
It often has an additional specific topic, and on this occasion, our hosts have
expressed an interest in the outlook for credit ratings.
I will touch on that towards the end of my talk today, but as I usually do, I
will focus mainly on monetary policy and the current and future economic
situation.
The big picture regarding the economy is this: the recovery that began in
Q2/2010 is now well enough advanced that the slack in the economy is
almost fully absorbed.
The domestic economy has seldom been as well balanced as it is now.
There is internal equilibrium, in that inflation has been at or below target
for nine months and output is close to capacity.
And there is external equilibrium, in that we have had a sizeable current
account surplus that covers net capital outflows with room to spare, as the
Central Bank has bought foreign currency for a total of 95 b.kr., or 5% of
GDP, so far this year.
According to the Bank's forecast, the near-term outlook is positive. GDP
growth is projected to measure just under 3% this year and then rise to
about 3½% in 2015 before tapering off again to 3% in 2016.
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This level of growth is expected to exceed that of potential output with the
effect that a positive output gap might emerge, particularly in 2015.
Other things being equal, this will contribute to higher inflation.
GDP growth in 2014-2016 will be driven by domestic demand, both private
consumption and investment, and the contribution from net trade will be
negative for the entire period.
As a consequence, the sizeable current account surplus we have seen in the
recent term will shrink rapidly next year and give way to a small deficit in
2016.
This is cause for concern in and of itself, and we hope that the forecast will
not materialise, as Iceland needs to maintain a current account surplus in
the next several years as it focuses on putting its external debt onto a
stronger footing and building up domestically financed foreign reserves.
Economic policy and economic incentives would then have to take into
account the task of of improving the outlook for the current account
balance.
Inflation has been below the inflation target for nine consecutive months.
This is the second-longest such period since the inflation target was
adopted in March 2001, the longest being a twelve-month period from
November 2002 through October 2003.
But it is not inconceivable that we might break that record, as the Bank's
forecast, published yesterday, entails that inflation will remain below target
through the early months of 2015.
Inflation below target is not more desirable than inflation above target,
though.
In this context, we mustn't fall into the trap of expecting monetary policy
instruments to be so strong and quick-acting that inflation will always
measure 2.5%, no matter what shocks hit the economy.
The main objective is to keep average inflation close enough to the target
over a long period of time that the target itself provides an anchor for
inflation expectations and the many decisions that require an estimate of
future inflation.
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But how close is close enough? In this context, our so-called tolerance
limits for the inflation target - namely, 1% and 4% - are too wide, and it is
worth noting that those limits are merely the trigger for the submittal of a
report to the Government explaining how inflation will be brought back to
target.
In short, then, the inflation target is not 1-4%.
In order to underline the control problem, I sometimes say that the
inflation target is not 2.5% but 2½%.
What this means is that, if we think in whole and half percentage points, a
deviation of half a percentage point or less from target would be considered
within the boundaries of target-level inflation.
By that criterion, inflation as projected in the Bank's forecast will be at
target for the entire forecast horizon through end-2017, apart for the last
quarter of 2015 and the first quarter of 2016.
According to the forecast, inflation will average 2.6% during the period
2014-17 and will therefore be at the 2½% target.
If this materialises, it is hard to call it anything other than an acceptable
performance.
It is naturally less of a concern if inflation deviates temporarily from target
if inflation expectations do not deviate in the same direction.
Early this year, inflation expectations were above target even though
measured inflation was below it.
But fortunately, inflation expectations have subsided towards the target in
the recent term and, by some measures, are close to it, particularly
short-term expectations.
This is important for monetary policy, as I will explain shortly.
I have briefly discussed the current situation and the economic outlook.
But what about uncertainties and known risks?
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There are risks attached to the global economy, which seems to be on the
downside, at least in the near term, as regards both output growth and
inflation.
And there is the risk that our economic policy and contractual wage
negotiations will not be successful, as has so often been the case during
upswings.
GDP growth will then be somewhat stronger in the short run, but the
current account balance will deteriorate and inflation will rise, and
ultimately GDP growth will fall below what it would have been otherwise.
There is uncertainty about the exchange rate, in connection with the
settlement of the failed banks' estates and the liberalisation of the capital
controls.
There is little I can say about that at this point, but the aim of the work the
authorities are doing at present is to minimise that risk.
It can be done, but it is a risky process, and one that could be derailed at
many points along the way if great care is not taken - and perhaps even if
great care is taken.
And now I will turn to monetary policy.
Yesterday the Monetary Policy Committee decided to lower Central Bank
interest rates by 0.25 percentage points, in view of recent developments
and the near-term outlook for inflation and the decline in inflation
expectations, which I mentioned a moment ago.
If the Bank's interest rates had remained unchanged, its real rate would
have been higher than is warranted by where we are in the economic cycle
and by the near-term outlook, particularly in view of the fact that it could
rise still further in coming months.
Estimating the Central Bank's real rate is not always a simple matter, as
different measures of inflation and inflation expectations give differing
results.
According to an estimate based on the average of various measures of
inflation and inflation expectations, the Bank's real rate was about 2½%
before the recent reduction, and it had risen by approximately a percentage
point in the previous year, which is a large change in terms of real rates.
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It could be argued, too, that this is more likely an underestimation than an
overestimation, as there is systemic positive bias in household inflation
expectations and the breakeven inflation rate in the market entails risk
premiums.
The effect that the real rate has on domestic demand and inflation depends
on what the equilibrium real rate is considered to be at any given time; that
is, the real rate that neither stimulates nor dampens the economy.
The equilibrium real rate has probably fallen in Iceland, as it has in most
economies in the wake of the financial crisis, but exactly where it lies is
highly uncertain.
One of the Monetary Policy Committee's tasks is to attempt to assess it.
It is normal that Central Bank interest rate should rise above equilibrium
when a positive output gap develops and inflation is above target, but
neither is the case at present.
That being so, it was appropriate to contain the rise in the real rate by
lowering the Bank's nominal interest rates.
Some will surely ask: Shouldn't the Bank have lowered interest rates
earlier?
Hasn't the monetary stance simply been too tight in the recent past?
I don't think this is the right time to dissect these questions, not least
because many things look different in the rear-view mirror.
As is said in Njáls saga, "Everything is ambiguous in retrospect."
That said, I think there are solid arguments in favour of a negative response
to both questions.
As regards timing, it is worth mentioning that it was not until very recently
that inflation expectations have moved as close to target as they are now.
As regards the latter question, most measures of the monetary stance have
been well within normal range for quite a while, and there are few other
signs that it has been too tight, expect perhaps in the past few months.
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For example, nominal growth in broad money measures about 6% after
adjusting for factors that are largely unconnected to domestic economic
activity, such as deposits of failed financial institutions in active ones.
This growth is consistent with the situation that should exist when the
economy is at equilibrium - when inflation is at target and output is at
capacity.
An examination of nominal GDP growth gives a similar result.
Based on forecasts for 2014, it will average 5% in Iceland over the period
2011-2014, as compared with just under 4% in the US and the UK, about
2½% in Sweden - which is just above the inflation target alone- and about
1½% in the euro area, which is even below the inflation target for the
region.
This has been used to support the argument that monetary policy has been
too tight in the euro area and Sweden, but as the figures show, this rationale
does not apply to Iceland.
And last but not least, GDP growth has been relatively robust and the
margin of spare capacity in the economy has been disappearing at the same
time as inflation has been trending towards target.
Many observers would consider this to be evidence that monetary policy
has hardly been on the wrong track.
Yesterday's announcement that future interest rate movements would
depend on wage developments in the labour market seems to have drawn
some attention.
But there seems to be some misunderstanding about what this means.
Over time - but not necessarily at every moment in time - wages in the
labour market as a whole - but not necessarily for each group - should rise
by an amount equal to the inflation target plus productivity growth.
How much this is depends, then, on productivity growth.
At present, productivity growth appears to be low - about 1%.
This means that the scope for wage increases consistent with the inflation
target is 3.5%.
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What that means for wage settlements depends on the degree to which
wage drift can be contained.
Some groups could receive larger pay rises than this, but then others would
have to have smaller increases. Sometimes there are grounds for this.
Then it is important to bear in mind that this is a long-term relationship.
For a period of time - even perhaps a few years - wages can rise somewhat
more without jeopardising the inflation target - for example, if the ratio of
wages to national income is unusually low following a crisis and businesses
are able to absorb some of the increase.
This has been the case to an extent in the past few years.
Other factors could counteract larger wage increases as well - for instance,
declining foreign-currency prices of imports and a stronger króna have
contributed to declining inflation even though wages have risen
considerably more than the sum of the inflation target and the increase in
productivity.
But there are a number of indications that we will not be able to rely on
these countervailing factors next year.
By then, the slack will have disappeared from the economy, the ratio of
wages to national income is at or above its historical average, and there are
no premises for further appreciation of the króna, as the current account
surplus is narrowing and the real exchange rate is no longer below its
estimated equilibrium value.
Nevertheless, different wage increases could be negotiated for different
groups if there are grounds and will to do so.
As I draw near the conclusion of my talk today, I would like to shift gears a
bit and say a few words about credit ratings.
When all is said and done, the primary objective of a credit rating is to
estimate the probability that a borrower will service its debt in full and on
time.
This probability depends on two factors - the ability to pay and the
willingness to pay - which, as history has shown us, are not necessarily one
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and the same, as could maybe be seen in the examples of Finland and
Argentina.
Sometimes it seems as though rating agencies exceed their mandate and
act as though they are purveyors of some sort of Good Housekeeping seal of
approval for economies and governments.
For example, one could ask what the Republic of Iceland's probability of
default is, since the country didn't default during the financial crisis.
While it is pointless to debate this fact with them, it actually, seems to me
that a number of improvements have taken place in the wake of the crisis.
Upon closer examination, much of what rating agencies take into account is
clearly related to developments in both ability and willingness to service
debt.
Among the factors they consider are debt levels and guarantees, GDP
growth potential, the size and structure of the economy, and other factors
that affect vulnerability to shocks, institutional quality, governance and
policy continuity, and political risk.
This gives some indication, of course, of which factors are a drag on
Iceland's credit rating at present, and how they could be addressed.
Iceland's sovereign credit rating soared during the years before the crisis,
and Icelandic banks' credit ratings followed in its wake.
In fact, perhaps they rose higher than was warranted and was good for us.
In spite of the ensuing nosedive, we managed to keep the sovereign rating
on the bottom rung of investment grade, apart from two years in Fitch
Ratings' speculative category after the first Icesave referendum.
Keeping Iceland's ratings in the investment-grade category cost an
incredible amount of effort, and other countries that have gone on an IMF
programme in recent years have seen their ratings from Moody's and S&P
fall to speculative grade. Some of them have managed to rise up faster than
Iceland has, however.
Studying the rating agencies' reports shows which factors will be most
important in order to improve Iceland's sovereign rating and thereby pave
the way for the banks to follow suit.
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Among them are continued reduction of public debt levels and sound,
focused economic policy that provides stability throughout the ongoing
upswing.
The liberalisation of the capital controls is an extremely important factor,
but it could work both ways.
Successful moves towards liberalisation without jeopardising stability will
have a positive effect, but disturbance of economic and financial stability
will do the opposite.
My assessment of this, and of conversations with the rating agencies, is
that it is probably not realistic to expect an improvement in our sovereign
rating in the very near term.
But if we can preserve stability and GDP growth next year while
demonstrating that we can at least begin lifting the capital controls without
compromising stability and confidence, our chances for a higher credit
rating should improve markedly.
Thank you.
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Introductory remarks at the EP’s Economic
and Monetary Affairs Committee
Speech by Mario Draghi, President of the ECB
Mr Chairman,
Honourable Members of the Economic and Monetary
Affairs Committee,
Ladies and Gentlemen,
It is a pleasure for me to be back again in this committee for the last hearing
of 2014.
This year has once again been a year of profound change for the euro area
and for the Union as a whole.
It was a year of legislative and institutional progress on many fronts, as
2014 saw the birth of banking union with the agreement of the Single
Resolution Mechanism, the start of the Single Supervisory Mechanism and
the successful conclusion of the comprehensive assessment of banks’
balance sheets.
And it was indeed a challenging year for monetary policy, which saw the
ECB take a wide range of measures to respond to the risks emanating from
an increasingly sobering economic outlook.
You have chosen two topics for today’s hearing, the relationship of financial
fragmentation and monetary policy as well as the Eurosystem’s collateral
framework.
I will touch on both these issues, but let me first run you through our
current assessment of the economic outlook.
Economic and monetary developments
The euro area growth momentum has weakened over the summer months
and most recent forecasts have been revised downwards.
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At the same time, our expectation for a moderate recovery in 2015 and 2016
remains in place.
Demand should be supported by a number of factors.
Among them are our monetary policy measures and progress made in fiscal
consolidation and structural reforms in some countries.
At the same time, high unemployment, sizeable unutilised capacity, and the
still ongoing and necessary balance sheet adjustments are likely to dampen
the recovery.
Risks to the economic outlook continue to be on the downside. In
particular, the weakening in the euro area’s growth momentum, alongside
heightened geopolitical risks, could dampen confidence and, in particular,
private investment.
In addition, insufficient progress in structural reforms in euro area
countries constitutes a key downward risk to the economic outlook.
Inflation in the euro area remains very low.
In October, it stood at 0.4%.
We expect it to remain at around current low levels over the coming
months, before increasing gradually during 2015 and 2016.
Looking forward, we closely monitor risks to price developments.
The latest monetary data point to subdued underlying growth in broad
money.
Its annual growth rate has increased moderately over recent months.
It appears that the turning point in credit growth is now behind us, and
credit growth rates, while remaining negative, are gradually improving.
Monetary policy and financial fragmentation
Let me turn to financial fragmentation, the first topic you suggested for
today’s hearing.
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Fragmentation in various segments of the financial market has been a
major obstacle to the smooth conduct and transmission of monetary policy,
and ultimately to our ability to deliver on our mandate.
Also owing to determined actions the ECB has taken, fragmentation has
receded significantly since the height of the financial crisis.
Unsecured money market rates are trading again at reasonable spreads
over their secured counterparts.
Sovereign bond spreads in the euro area decreased significantly from their
peaks in 2012.
Together, these developments reflect the gradual return of confidence
among investors in the euro area.
Yet, we still face a situation where our very accommodative monetary policy
stance does not sufficiently reach some final borrowers in the euro area.
This is because credit markets in some parts of the euro area are still
impaired and show only timid signs of recovery.
As a result, credit growth continues to contract and credit conditions - while
having eased recently - remain overall tight from a historical perspective.
Importantly, costs of bank funding have improved, but are still relatively
high in some Member States.
Where they are lower, they are not passed on in full to the real economy.
The monetary policy measures decided in June and September this year,
the Targeted Longer-term Refinancing Operations and the purchase
programmes for asset-backed securities and covered bonds, are designed to
overcome these obstacles.
They will enhance the transmission of monetary policy, support the
provision of credit to the euro area economy and, as a result, provide
further monetary policy accommodation.
We see early indications that our credit easing package is delivering
tangible benefits.
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Since the beginning of June, forward money market rates have shown steep
declines across the maturity spectrum.
Now, the forward curve consistently lies below zero over a two-year
horizon.
EONIA is not expected to exceed 25bps before well into 2018.
The 3-month EURIBOR rate, which is an important conduit of monetary
policy impulses to lending rates, dropped to all-time lows and now stands
close to zero.
And the policy decisions, in particular those announced in September,
triggered a compression of spreads across other asset classes, including
ABS, covered bonds and sovereign bonds.
But more time is needed for the full materialisation of the positive effects of
the most recent set of measures.
In this context, let me emphasise that we are committed to scale the total
magnitude of our measures – lending operations as well as outright
purchases – up to a size that can deliver the intended support to inflation
and the recovery of the euro area economy.
All these measures will have a sizeable impact on our balance sheet, which
we expect to move towards its early 2012 dimension.
This will ensure that our accommodative monetary policy stance will
contribute to a gradual recovery and a return of inflation rates in the
medium term to levels closer to our aim of below but close to 2%.
Nonetheless, we need to remain alert to possible downside risks to our
outlook for inflation, in particular against the background of a weakening
growth momentum and continued subdued monetary and credit dynamics.
We therefore need to closely monitor and continuously assess the
appropriateness of our monetary policy stance.
If necessary to further address risks of too prolonged a period of low
inflation, the Governing Council is unanimous in its commitment to using
additional unconventional instruments within its mandate.
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In this context, we have also tasked relevant ECB staff and Eurosystem
committees with the timely preparation of further measures to be
implemented, if needed.
Such measures could include further changes to the size and composition of
the Eurosystem balance sheet, if warranted to achieve price stability over
the medium term.
Monetary policy alone – however – cannot overcome financial
fragmentation in the euro area.
Fragmentation across national borders also reflects underlying national
imbalances and institutional deficiencies.
Overcoming these require determined structural reforms on the side of
national governments to improve the business environment and setting
incentives to invest, with the aim to boost productivity, create new jobs and
raise the growth potential of the economy.
Reducing financial fragmentation also requires tackling remaining
shortcomings in economic and financial integration.
As already mentioned, substantial progress has been made this year.
Banking union should now be completed following the finalisation of the
Comprehensive Assessment and the SSM taking on supervisory
responsibility.
This means in particular completing the SRM, enhancing the borrowing
capacity of the Single Resolution Fund and thereby delivering on the
commitment to establish a credible backstop.
Moreover, looking forward, a greater integration of financial markets – also
referred to as a Capital Markets Union (CMU) – would be warranted to
further reduce fragmentation of financial markets, improve funding to
SMEs, enhance the transmission of the ECB’s monetary policy, and overall
benefit economic growth.
We look forward to the detailed elements that the Commission will
announce in the course of 2015 and I have no doubt that the European
Parliament as co-legislator will again play a decisive role in this regard.
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The collateral framework of the Eurosystem
Let me now say a few words on the second topic you have chosen, our
collateral framework.
Since the very beginning, the Eurosystem collateral framework had been
designed to achieve two goals at the same time: First to protect the
Eurosystem from incurring losses, as it is explicitly required by the Statute
of the ECB/ESCB; second to ensure that Eurosystem credit operations can
be carried out smoothly by making sufficient collateral available.
The past and recent experience has shown that such a dual set-up of the
Eurosystem collateral framework has been indeed very effective.
So far, the Eurosystem has never had to recognise a loss stemming from the
Eurosystem credit operations.
In the few cases where counterparties have defaulted, for instance in the
case of a subsidiary of Lehman Brothers, the Eurosystem was able to fully
cover its exposure by seizing the posted collateral.
At the same time, the collateral framework ensured that banks were able to
obtain sufficient amounts of central bank liquidity throughout the crisis.
This became most visible in the context of the two Very Long Term
Refinancing Operations that the ECB conducted in 2011 and 2012.
In these operations banks obtained collateralised central bank liquidity in
the order of EUR 524 billion within only 10 weeks.
This basic set-up of the collateral framework has remained the same since
the beginning of monetary union; the three constituent parts of the
Eurosystem collateral framework, i.e.
(i) the counterparty framework,
(ii) the basic eligibility criteria for underlying assets and
(iii) the risk control measures, have remained largely unchanged.
The Eurosystem maintains a broad counterparty framework and its
eligibility criteria are still based on the same principles as at the beginning.
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This shows that the design of the Eurosystem collateral framework is in
general very robust.
However, some changes were necessary to guarantee a smooth
implementation of monetary policy at times of financial market stress that
led to a general reduction in access to market funding.
A collateral framework must never act in a pro-cyclical manner: Restricting
banks’ access to liquidity in a crisis – for instance, by introducing more
restrictive criteria for collateral – might pose a risk not to only to the most
vulnerable banks, but to the whole financial system.
Ultimately, this would increase the risk for the central bank’s balance sheet
rather than protecting it.
Hence, in order to enable that a wide range of the counterparties could
continue participating in the refinancing operations, the Eurosystem
temporarily relaxed some of the eligibility criteria for underlying assets.
This was done on several occasions.
For instance, from 2008 to 2011 and again as of 2012, we accepted foreign
denominated marketable assets.
In 2012 we created the Additional Credit Claims framework.
Credit standards have been changed by accepting lower rated assets
compared to those accepted at the beginning, notably for ABS that fulfill
certain criteria.
However, these accommodative measures were coupled with a
stronger-scrutinised counterparty framework and with more stringent risk
control measures.
As a result, the total amount of eligible collateral increased.
Thus, an enhanced participation of counterparties in the refinancing
operations was enabled, while at the same time the risks for the Eurosystem
expanded only moderately.
The Eurosystem collateral framework has been quite complex from the very
beginning, not the least because of the variety of national frameworks
preceding it.
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With the onset of the monetary union, the goal was to provide access to
Eurosystem credit operations to a broad range of counterparties, in
contrast to some other central banks which rely on a few counterparties.
Therefore, the collateral framework had to take into account the various
national banking systems and financial markets.
Some national central banks, for example, accepted credit claims as
collateral, while others did not.
Some countries had developed covered bond markets, while others only
started to set up a respective covered bonds law later, and the same could
be said for ABS.
For a collateral framework, a common standard had to be found which
embraces these national characteristics, while at the same time ensuring
that sufficient collateral is available.
Several of the measures taken in the crisis have added to this complexity.
Therefore a challenge going forward is to make the collateral framework
simpler and more transparent, without impacting the ability of
counterparties to access our refinancing operations.
I am confident that we will achieve this.
Conclusion
Ladies and gentlemen,
2014 has been a year of profound change.
But what has been achieved so far is not enough.
2015 needs to be the year when all actors in the euro area, governments and
European institutions alike, will deploy a consistent common strategy to
bring our economies back on track.
Monetary policy alone will not be able to achieve this.
This is why there is an urgent need to agree on concrete short-term
commitments for structural reforms in the Member States, on a consequent
application of the Stability and Growth Pact, on the aggregate fiscal stance
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for the euro area, on a strategy for investment, and to launch work on a
long-term vision to further share sovereignty ensuring the sustainable and
smooth functioning of EMU.
On that note, I am looking forward to our discussion.
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What legacy for the future of Mauritius?
Address by Mr Rundheersing Bheenick,
Governor of the Bank of Mauritius, at the
Annual Dinner in honour of Economic
Operators, Pailles
"At this stage of the development of our
country, the best contribution that the Central Bank can make is to keep
inflation low, stable, and predictable as the foundation for a fairer and more
equal society."
In the heat of the election
1. The Annual Dinner in honour of Economic Operators has become a
linchpin in the Bank's calendar of events as it gives me the occasion to share
with you my current thoughts and concerns as well as my vision for a better
Mauritius from my vantage point as Governor.
In the heat of election fever now gripping the country, I thought it timely to
reflect on times ahead and the legacy of the economic operators for the
future of this small island state of Mauritius.
They say that a country gets the leaders it deserves.
Happily for us, we have had some of the best in both business and politics.
Although not all now running for office may prove to be so. Time will tell.
2. I am here reminded of that quip in Bernard Shaw's Major Barbara,
assessing a young man's employment prospects:
He knows nothing and thinks he knows everything. That points clearly to a
political career.
3. But in this small island developing state of ours, as we all know, we are
economically and environmentally vulnerable, and that demands continual
decisive leadership.
Perhaps, not so decisive as that of the Duke of Wellington.
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He was famed for his brilliant military record against Napoleon. Less
well-known is that he actually was Prime Minister of Britain, twice.
Thirteen years after defeating Napoleon, the bold Iron Duke conducted his
first cabinet meeting.
The experience must have jolted him as he confided to a friend afterwards:
An extraordinary affair. I gave them their orders, (and damn it) they
wanted to stay and discuss them.
4. I know the feeling after meetings of the Monetary Policy Committee
here.
And, I dare say, so do many of you heroes and veterans of boardroom
battles where unwary captains of industry and corporate honchos meet
their Waterloos.
The future
5. Tonight, I want us to look into the future and ask how we are facing up to
the prospects ahead. Do we have the resilience to survive as a nation, or
indeed as a civilisation?
Resilience is the capacity for bouncing back after shocks.
Despite our small size and our isolation, resilience or anti-fragility has
become our badge of honour.
But is that enough?
6. We survived the 1960's prediction of inevitable catastrophe of a future
Economics Nobel prize-winner.
We exorcised the ghost of Malthus, just as we have seen off the plague of
malaria, that used to kill 2,000 of us a year up to the late 1940's.
We have developed remarkable defences against cyclones that are a regular
occurrence in this part of the world.
We have fought off dengue fever and chikungunya.
And, now we are busy preparing our defences against the dreaded Ebola.
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We escaped the geopolitical risks of war.
But more than this, we have come through in pretty good shape from the
global financial and economic crises of recent years.
Hardly a month goes by without the country garnering some new accolades
from the likes of the World Economic Forum, the Heritage Foundation, the
Mo Ibrahim Foundation and so on.
Well done Mauritius! Well done our policy-makers! Well done you
economic operators!
To say nothing of you bankers: well done bankers, indeed!
We are sitting pretty, aren't we?
7. But, as we give ourselves a collective pat on the back, can we spare a
thought to the risks to the future fortunes of this land?
What steps are we taking to move towards a more inclusive society that
leaves no-one behind?
How far will our current plans and policies mitigate the worst economic and
environmental ravages to come?
How will they promote the job-rich and inclusive growth that the head of
the IMF, Christine Lagarde, has recently been calling for?
8. So let me try my hand at prophesy.
Did I hear a sharp intake of breath?
I know that, sometimes, it is said, I have a slight streak of arrogance, though
I trust not as much as the notorious Alfonso the Wise, King of Castile.
Surveying the state of the world in 1252, he observed:
Had I been present at the Creation, I would have given some useful hints for
the better ordering of the universe.
9. Let me polish off my crystal ball and look forward to 2035, as I once did
to 2020, in the sadly defunct Ministry of Economic Planning and
Development, our long-term think tank of times past.
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What do I see, twenty or so years ahead?
I see three major interrelated strands ahead:
First, there will be an inescapable and massive transformation of all aspects
of society, underpinned by inexorable globalisation.
Second, this will be driven by transformational technologies, policy changes
and international agreements.
These will lead to greater availability and rapidly declining cost of
communication, transport, health care, education and food.
Third, I see a complete make-over of banking, business, industry and social
life.
In short, in the next two decades to 2035, I see a substantial
transformation of the world as we know it.
10. Think on it.
How many of you here tonight, how many businesses here will continue
exactly as they are, or indeed survive twenty years?
Not all: not many, I guess.
So we must give a thought to our legacy. What will we leave behind?
Prosperity?
Or the decline and fall of the wannabe tiger of the Indian Ocean?
11. Global warming and sea level rise - that's firmly on the cards: but that's
nothing compared to what else may be out there.
For I see the driving forces of cheaper, faster and more reliable transport
and communication running rough-shod over our present amiable
tranquillity, unless we act now.
Banking will be transformed:
Mobile may become the main delivery channel for banking and payment
services.
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We shall have bankless banking, no counters, no backrooms, no paper, no
sky- high buildings.
There will be more common currencies and digital currencies, with
corresponding declines in fewer exchange transactions.
In short banking will be cash-lite, with fewer staff, and still fewer bankers.
12. This is not a scenario of a distant future.
Some of it is present reality.
It is already happening.
Just a couple of weeks ago, Lloyds Banking Group, a British bank
announced plans to axe 9,000 jobs and close 200 branches as it "digitises"
its business.
Technology is already reaping barren harvest on jobs.
Beyond banking, business will be transformed:
Not capital- or labour-intensive but knowledge-intensive
Big offices going: big companies gone
Weightless companies with minimal capital and staff
Malls will re-invent themselves, becoming more a gathering place for
socialising than shopping
Shops going, internet sales with drop-off delivery
Private on-line matching of buyers and sellers of goods and services
More niche markets: applications markets, e-entrepreneurs
Computer-controlled, driverless, electric transport: the internal
combustion engine is history
Pilotless drone airplanes, railways, shipping
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New businesses small, agile, short life-span, not the butterfly but the impala
with many predators.
Our life will be transformed:
Towns and Cities turn into integrated regions.
Beau Bassin runs into Rose Hill and runs into Quatre Bornes.
The Port Louis/Curepipe corridor, energised by the Light Rail Transit
Systems, spills over neighbouring agglomerations.
The likes of Flacq in the east, Rose Belle in the south and Goodlands and
Triolet in the north will blur the rural/urban divide.
The country will be well on its way to become a city-state.
Nation-states fading away with free movement of labour and capital
Laws harmonised, lawyers going
Education transformed:
Massive Open Online Courses: teachers redundant
Life-long learning becomes the norm
But, despite this rosy scenario, there are also some ominous clouds on the
horizon.
Without concerted action, the worse-case scenario is bleak:
Massive unemployment and underemployment
Rising inequality: super-rich amidst a sea of poverty, and the collapse of
the middle- and lower-middle class
Gated luxury estates: sprawling slums
Social unrest, strikes, crime increasing
Decline and fall of urban civilised life: extremist terrorist barbarians at the
gates
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13. In case your worry levels are rising, let me hasten to add that this
dystopian nightmare is not a fatality.
It is certainly not beyond human ingenuity to envisage pre-emptive
measures to temper the worst excesses that can push us in that direction.
Tonight, I shall focus my remarks on inequality, not because I have a
ready-made solution - nobody has - but to stimulate debate on what is often
seen as a taboo subject in polite society.
Rising inequality is a time bomb ticking away across the world
and indeed here in Mauritius
14. Growing inequality is rapidly developing into a fault line that we ignore
at our peril.
Last month, addressing a conference on The Challenges of Job-Rich and
Inclusive Growth on the eve of the IMF-World Bank Annual Meetings,
Christine Lagarde, the IMF Managing Director, echoed recent OXFAM
research findings:
...the world's richest 85 individuals control as much wealth as the world's
poorest 3.5 billion people.
15. Thomas Piketty, in his massive tome, Capital in the Twenty-First
Century, the 21st century sequel to Karl Marx's great work, adds to the large
body of evidence on rising concentration of income and wealth.
Piketty argues that generally wealth grows faster than economic output.
Slower economic growth has increased the weight of wealth in society,
leading to higher inequality, which could pose risks to economic and
political stability.
We are living in an increasingly divided world where many Africans risk
their lives on shaky boats to escape poverty and conflict while the
super-rich chase their next billion to improve their ranking in the Fortune
list.
Even here in Mauritius, some of our top income-earners are being paid over
two hundred times the wage of their office cleaners, and ten times more
than the surgeons in our hospitals.
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Is that the society we want to perpetuate? Is that a society that is just and
sustainable?
The time bomb of growing inequality is ticking away.
16. We are a country trying hard to escape from the middle income trap.
But we have no chance of doing that if we do not focus on the risks inherent
in jobless growth, persistent high unemployment, and the widening divide
between the haves and the have-nots.
17. Over the last decade, the Gini coefficient points to growing inequality,
worsening from 0.371 in 2001/02 to 0.413 in 2012.
Just over the last five years, households in relative poverty, defined as half
the median household income per adult equivalent, increased from just
below 8% of the total in 2006/07 to 9.4% in 2012.
The distribution of income by quintile paints an even starker picture: the
bottom 20% of households witnessed a fall in their share of total income of
a full percentage point, from 6.4% in 2001/2 to 5.4% in 2012; this went
hand-in-hand with a rise of more than three percentage points (3.4%) in the
share of the topmost 20%, bringing it to 47.4%, not far from half the total
income.
Put differently, in still starker terms, between 2001/2 and 2012, the richest
20% of Mauritian households enjoyed an eight per cent increase in their
incomes while the poorest 20% suffered a steep decline of twice as much.
And, again, the same question arises: is this our idea of a just society?
18. There is much talk of faster economic growth paving the way to a
higher-income status for the country.
There has been learned, if often uninformed, debate about giving a
monetary stimulus to push growth from its current 3.5% to the 5% of
pre-crisis years.
There has been much less concern over the quality of growth.
In a small country, with a heritage of skewed asset ownership, such myopia
can turn out to be very costly.
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A headlong rush for growth can be the royal road to social instability and
economic breakdown.
What we need above all is growth that provides for all, a decent house,
quality education, health, transport, food, leisure and respite from debt.
19. Growth is good; sustainable growth is better; sustainable and inclusive
growth is best of all - absolute nirvana.
Is it attainable?
Here in Mauritius, with our population of only 1.3 million, and a policy
environment never trailing too far behind best practice, we could have a
stab at it.
This is not a goal too far - not for us who have made a habit of punching
above our weight.
But we must work for it and encourage our policy-makers to press ahead
with the reform agenda.
And, while they are fixing the policy environment, we must accelerate our
corporate social responsibility (CSR) drive.
Since January 2012, profitable companies have been required to pay 2% of
their book profit into a CSR Fund to finance social and environmental
activities.
This is no doubt a good basis to build on.
But isn't there a better way for corporates to carry and demonstrate their
social responsibility?
20. Let us draw some inspiration from James Wolfensohn, former World
Bank President.
Ten years ago, at a function of the World Savings Bank Institute, he
remarked:
... I want to salute these banks [WSBI's members] and encourage them to
continue in their theme of a double bottom line: to think not just of profit,
but to think also of social responsibility which savings banks carry so well.
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21. Double bottom line reporting seeks to extend the conventional bottom
line, measuring financial profit or loss, with which we are all familiar, by
adding a second bottom line to measure their performance in terms of
positive social impact.
Indeed, to address our sustainability concerns, so well encapsulated in the
overarching Maurice Ile Durable concept, we can go one better and
embrace triple bottom line reporting.
This will include the valuation and protection of the rich resources of our
beautiful natural environment.
22. Rising inequality worldwide, and here in Mauritius, raises key issues on
the role of monetary policy and its redistributive role. We need bold policies
to reverse inequality.
Planning ahead
23. So what are we to do?
We certainly can't ignore these threats which are already upon us.
How best to wage war against poverty and inequality?
As I cast about for possible answers, I am reminded of US President
Eisenhower, who was a much-decorated US General and who knew a thing
or two about wars.
He declared:
In preparing for battle I have always found that plans are useless, but
planning indispensable.
24. I agree with Ike that we must have a battle plan.
We must put our minds to the task of planning for both resilience and
inclusive and sustainable growth, and audit the results on the triple bottom
line.
I can only reiterate my forlorn call for a strong and well-resourced strategic
planning capacity at the heart of the policy-making establishment. For me
there are seven essentials.
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First, become a learning country, not just adapting to change, but
anticipating it, and thriving on it;
Second, harness knowledge transfer, learning, and investment whether
foreign or domestic, to increase our productive potential;
Third, ensure life cycle education for all, as we adapt and re-adapt to a
rapidly-changing environment;
Fourth, transform our universities into centres for R&D and innovation,
and put undergraduate teaching online;
Fifth, attract and retain our best talents offering international rates for the
job, for them and for our migrant diaspora;
Sixth, build a strong targeted social safety net, with business incubators,
incentives for start-ups and skills development;
Seventh, shift the employer of last resort from the public to the private
sector, and harness technology for your business and for national welfare.
25. Christine Lagarde at the IMF has called for more targeted subsidies and
welfare schemes, with the savings put into education, training and
improved infrastructure.
There is one thing that we definitely must not do: and that is to increase the
fiscal burden.
We must obviously redouble efforts to extract greater efficiency from all
public expenditure, whether recurrent or capital.
26. At this stage of the development of our country, the best contribution
that the Central Bank can make is to keep inflation low, stable, and
predictable as the foundation for a fairer and more equal society. Inflation
is the worst form of taxation.
It is regressive and enemy of the poor. Price stability promotes inclusive as
well as sustainable growth.
Exchange rate stability operates through the import channel to support
price stability.
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Regular calls for what is euphemistically called "a competitive rupee" are an
invitation to depreciate the currency.
It is difficult to see how an unequal society, with an import-dependent
economy, can depreciate its way to development.
27. The Central Bank is rightly concerned with the distributional effects of
monetary policy.
Borrowers have been subsidized for too long by savers.
Savers have responded to persistent low interest rates by halving the
savings effort over the last two decades.
In parallel, low interest rates have boosted the wealth of asset holders and
increased inequality.
As the US ends Quantitative Easing and normalises interest rates, we must
prepare for greater currency volatility and changing market sentiment.
The Central Bank will have its hands full in combating these pressures to
ensure continued stability.
We must always bear in mind that price stability and exchange rate stability
engender social stability - and that is the public good we should all be
working for.
The end
28. Without foresight, and concerted action now, we will leave a poor
legacy for our children to live in a socially and environmentally degraded
and divided society. Change we must.
For as the political philosopher Edmond Burke once declared:
A state without the means of change is without the means of its
conservation.
We should all be in the business of change. Change for the better is the
order of the day.
29. After these weighty ponderings, let us turn to lighter things for a
change.
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As we prepare to tuck into the delightful fare awaiting us, may I invite your
attention to the First Law of Dietetics, as proclaimed by best-selling science
fiction writer and noted biochemist, Isaac Asimov.
When I tell you what this law says, you will understand why it must be
taken with a pinch of salt, preferably a large one:
If it tastes good, it's bad for you
Salt or no salt, this First Law of Dietetics is suspended tonight. Dinner will
be served and I prophesy it will be good, and taste good too.
Thank you!
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