The recovery is fragile so what is the state of European banks? How healthy or unhealthy is the sector right now?
I think the European banks are in a better situation than the market now assesses them to be. They have been doing a lot to put their house in order during the post-crisis period. Since the collapse of Lehman Brothers, the increase of capital held by European banks has been about €450 billion. The median Core Tier 1 ratio of the largest banks has increased by four percentage points. It was 11.5% as of the end of 2013, and during the last months, because of the comprehensive assessment, we have seen many banks moving to increase capital.
The exercise is very big: 128 banking groups, that’s a very significant percentage of the banking system and banking assets of the euro area. So we tell them not to wait until the last minute, until after the end of the comprehensive assessment, so that all viable banks with some shortfalls, are able to find the equity they need.
What kind of guarantees can the comprehensive assessment give us?
First of all, the comprehensive assessment is a transparency exercise. Again, I believe the European banks are in better shape than the market believes, but they have to demonstrate that there are no hidden losses, that the required provisions have been made. We are assessing the value of the assets and collateral to make sure collateral is valued properly and to make sure appropriate provisions, both collective and specific provisions, have been made. This is also true for banks’ trading books. We are looking at the level 3 assets, meaning the assets for which there is no easily observable market price. Because there is no easily observable price, banks use models: using mark-to-market prices is one thing, using mark-to-model prices is something else. We need to make sure that these models are used for valuations only when actually needed, and that here too there is enough conservatism in the valuation of collateral.
What does the stress test need to do to be credible? Are some bank failures necessary and unavoidable?
The asset quality review (AQR) is an important part of the comprehensive assessment and means that the stress test can be conducted on a firm footing. The quality control of the whole process has to be excellent. This means having national teams of supervisors working in cooperation with the ECB’s “country teams”, to make sure that what is done, is done properly. The country teams are comprised of national supervisors, who are however working in countries other than their own; so this is a kind of peer review. And of course there is the quality control operated by the ECB at the centre. So there are three levels of quality assurance on both the AQR and the stress test.
Concerning failures, some shortfalls may indeed mean failures; that is why banks that have sufficiently good quality assets should not wait until October before taking remedial action. I would definitely prefer them to start addressing any problems they may have before then.
Are the stress tests strict enough to unmask latent risk? Does it depend very much on the assumptions in the scenarios?
I think they are very strict. The baseline scenario comes from the European Commission’s forecasts, and the stressed scenario was developed by the European Systemic Risk Board (ESRB) with input from the European Banking Authority (EBA) and the ECB.
The scenarios are more severe than those of the previous stress tests. As in the AQR, we also want to have conservatism, additional buffers, to be on the safe side. Altogether, there has been a lot of conservatism injected, to the extent that some people ask: “Are we sure we know what we are doing?! After piling up all the conservative buffers, maybe we are going one step too far?” I don’t believe so. I think it’s just correct and it’s good to be tough.
The comprehensive assessment covers just the 130 big banks. How big a risk is it that the other banks left to the national authorities will surface problems that have to be cured jointly?
That is a good question, but it sounds as if you think that performing the comprehensive assessment with roughly 130 banks is a small undertaking. Frankly, I would like to say that this is very big. It is a very large part of the Single Supervisory Mechanism (SSM) banking systems. To take the example of France, of the 128 groups being examined under the comprehensive assessment, there are 13 banking groups from France, which represent 97% of the French banking system. So it’s a lot. And for the others, the indirectly supervised banks, regular AQR assessments will be part of the normal work of the supervisors.
Indeed, one small bank defaulting is not a systemic problem; but if several small banks that present the same risk profile fail together, that’s a systemic issue for a country – and maybe for more than one country. That’s why we have to be tough with the indirectly supervised banks as well. It’s a single system. There will be a single supervisory model, a single manual and the ECB can take direct responsibility for the supervision of a small bank at its own initiative. So it’s not a two-tier system in any fashion.
So the asset quality review will also take care of the small banks?
Yes, in a proportionate fashion, but more so in 2015 than this year. All the supervisory capacities are busy with the directly supervised banks at the moment. The outcome of the comprehensive assessment will be helpful for the indirectly supervised banks as well. For example: if we discover that big banks, that are competing with a number of small banks for mortgages in the same country, have not set aside enough provisions, it would be a good idea to check what the indirectly supervised banks of that country are doing, because it probably means that the whole banking system should have more provisions for those exposures.
The IMF’s Christine Lagarde said last week that progress on building a safer financial system has been too slow because of industry actions to halt new rules. She said this risks the stabilisation of the global economy. Do you share her opinion?
Well, yes and no. On the one hand, we probably should have conducted tougher AQRs and stress test exercises sooner. That would have been better for banks and probably for the European economy.
But on the other hand, I consider that we have moved incredibly fast in Europe during the last two years. We had the establishment of the SSM, we had the implementation of Basel 3 in the Capital Requirements Directive (CRD IV) and Capital Requirements Regulation (CRR). We have the directive on recovery and resolution. We have the Single Resolution Mechanism (SRM). We worked on the deposit guarantee schemes at the European level. So I think we have done a lot with quite an impressive speed in Europe. And those who are blaming Europe sometimes for being too slow are proven wrong. I think European decision makers should be congratulated for having been able to make so many reforms happen in such a short period of time.
Banks are very worried about how much regulation costs. What are the costs?
Well, there is a cost to good supervision. Like the premium for insurance. It is always too expensive before there is a problem, but after problems, people regret sometimes that they had not paid more for their insurance. I think it is still very reasonable. There will be a European supervisory fee – the ECB published its draft Regulation on supervisory fees just two weeks ago. The amount of the supervisory fee will be based on both the size and the risk profile of the banks. All the banks will pay. In my view, it is just a matter of balance between the different groups of banks: between the big and the small, between the most risky and the least risky. Banks are very fortunate in my view that the SSM has been created. Big, directly supervised banks know that this is a positive element. I’m sure that strong supervision, managed, hosted and led by the ECB will be a plus for banks and will reduce their costs of borrowing on the markets, as this will reassure markets. The banks include sometimes in the costs, the funds they will have to put aside for the resolution fund. Part of the difficulty is that everything is happening at the same moment. But, it is not surprising after a crisis. And altogether it may well cost more than it was costing before the crisis, but we don’t want to be back to where we were then.
We have to make sure that we are better protected. We need this resolution fund, just like we need the resolution tools that have come in with the directive. We need to make sure that the costs of resolution are not paid by the taxpayer. It cannot happen again. It’s just not a possibility.
We heard today that the bankers think that the supervisory fees are like taxation, or close to taxation. What do you think?
I think there is nothing wrong with taxes. That’s the way democracies finance themselves. And what comes with taxes is accountability and oversight by public authorities. In Europe we will have such oversight. We will have to make appropriate use of the money that we receive to do our work. We need adequate resources – there is no other option. We need to get good people, the best possible people. I am not saying that supervisors should have the same kind of compensation as bankers. This is public service, and people have to decide what they want to do with their career.
What is an average salary at the SSM?
I believe that the average salary is not the same in the 18 countries. The salary bands of the ECB are published in the Annual Report and also in the vacancy notices. My own salary, just like the salaries of the members of the Executive Board, will be published in the Annual Report.
Some people have raised a question on the effectiveness of supervision at the supranational level. Are you worried about the effectiveness of the system?
I want to be effective for sure. The first challenge will be in delivering consistency across the 18 countries in the SSM. We will need to use “constrained judgment”. If everybody and anybody could make use of his or her judgment without constraints, it would be a miracle if we would deliver such consistency.
We need to find the right balance, because supervision for me is about using judgment: good judgment, educated and experienced judgment that you develop from listening to fellow supervisors, other stakeholders and also the banks, who have the right to be heard as set out in the Framework Regulation.
I believe the Joint Supervisory Team (JST) structure that we are putting in place will work in this regard. The head of the JST (known as the “coordinator” but the role goes beyond the usual understanding of the term) is really the head of the supervisory team for each directly supervised group. And he or she will cooperate with national supervisors in charge of the same banking group. And I think that this is a very powerful tool.
Each national supervisory authority has a representative on the SSM Supervisory Board and each representative has equal voting rights. Each vote carries the same weight. So on any given issue, the vote of Anneli Tuominen, Director General of the Finnish Financial Supervisory Authority, for example, has the same weight as that of the representative of BaFin, the German Federal Financial Supervisory Authority, for a German bank. Moreover, we will make sure that of, for example, the ten people in the JST of a large directly supervised bank, at least one or two of them will have been in charge of that bank before (so they will know the bank from the national supervisor perspective) but the coordinator of the JST will be of a different nationality.
So they won’t make decisions about their own country?
There will be no national bias. And also in the centre, we have recruited very European-minded people. They are in my view joining the ECB for the unique opportunity to build something powerful at a historic moment, and to help the integration of Europe by providing a good example of what can be delivered.
Do you see any problem that many decisions have to be made at the very high levels of the Supervisory Board because of the legal structures?
No. I don’t see problems. It’s true that in most supervisory authorities that have boards, there are delegations of powers to the staff of the supervisory authority. That was the case in France for example. But it doesn’t make a big difference, because the delegations are not on the important issues. Anything that is important and sensitive will reach board level in any case, with or without delegation. And of course we meet often – every other week. I think it’s adequate.
Is it a problem that there are countries – the UK, Sweden and Denmark – that are in the European Union but not in the SSM?
For the time being I think that’s ok. Because of the crisis, the pressure was really on the euro area countries. So it’s good to get started with a smaller number of countries, although 18 is not exactly small. All of those countries are committed to improving the situation in the euro area. I am sure that if we complete good work with the SSM, other countries will want to join. I will be extremely honoured and proud if this is the case. We are totally committed to doing a good job. With already 24 people around the table (the Chair, the Vice-Chair, four Supervisory Board members and 18 heads of banking supervision), that’s a good basis on which to begin.
How is the SSM going to cooperate with Swedish and Danish supervisors? (For example, in one case the treasury of a large bank is here in Finland while its headquarters is in Sweden).
As supervisors, we know each other very well. We have been cooperating for quite a long time. And the process of cooperation built up by the EBA, through colleges of supervisors and Memorandums of Understanding, is working very well. So, starting in November, we will do what is expected from either home or host supervisor perspectives; and where we are the host supervisor for the SSM (as for the subsidiaries of the Swedish or Danish banks), we are very committed to making sure that it works well.
Subsidiaries have to be properly supervised. That’s for sure. But if a group in its entirety is not supervised properly, even the best supervised subsidiaries will be at risk if there is a problem. So we want to be tough host supervisors and we are ready and committed to cooperate under the leadership of the home supervisor.
How independent can the SSM be in the face of a political environment in a national country if you close a big bank in a big Member State?
More independent than ever really. The fact that we are in Frankfurt, based in the ECB, is a very strong signal. And the SSM Regulation gives us a lot of tools to do a good job. Also, the fact that we are under the leadership of the ECB, which is a very independent authority with a very good reputation, is extremely helpful. It protects the new supervisory authority and, in my view, the fact that we have double accountability to the European Parliament and to the Council is also helpful. So I think we are in a very good position.
How do you think the division of labour between the EBA in London and the SSM in Frankfurt will work?
I have known the Chair of the EBA, Andrea Enria, for decades. We have always worked very well together. He and I worked together at the EBA predecessor, the Committee of European Banking Supervisors (CEBS).
We will conduct the stress test with the EBA and they will help us to carry out the quality control by producing benchmarks for the process. However, the national supervisors and the SSM remain responsible for quality control. So if we don’t do a good job, it will be our responsibility, and I think that’s right. So that’s the right balance for the two institutions. The EBA is an asset for the SSM, and we want to be an asset for the EBA as well. We bring the voice of 18 countries that will not be able to have 18 different views anymore. So this will bring discipline in the cooperation and that’s good.
You have said there are up to 6,000 supervisors, auditors and consultants doing the AQR. How can you guarantee quality?
First, we need excellent governance. If you want to really lead and manage the project from the centre, you need to be able and willing to react as soon as someone is two or three days late in providing information. You need very strong and good governance at the centre. This central governance has been duplicated at the level of each of the 18 national authorities. The national supervisors are the first level of quality control for the on-site consultants and auditors. We also have the ECB country teams that monitor what is taking place. To alleviate the burden for the national supervisors, they also have a responsibility to respond to the many questions coming from the auditors or the banks. So part of their mission is to provide support locally, but the overall raison d’être of their mission is to monitor what is taking place at the national level. We have all the tools we need to ensure the quality of the exercise, we do not need more.
How do you view suggestions that we should embrace ring-fencing of risky businesses?
Well this is only my own view, not the ECB’s view, which is not fully finalised, but I have mixed feelings about the separation of banks’ activities. I see the pros, but I also see the cons. For example, when you separate a bank into two parts, you run significant operational risks. Is taking on that operational risk compensated by more security, for example regarding market risks? I’m not sure. In any case, we need to have the risky operations within the perimeter of supervision. Pushing the problems outside of the regulated perimeter is not a solution. The hedge-fund Long-Term Capital Management (LTCM), which brought the financial world into trouble in the 1990s, was not a regulated bank but we still came close to having some banks very seriously hit by LTCM. It is better to regulate and supervise what is dangerous than push it outside the area that is scrutinised by supervisors.
If the UK would leave the European Union, which is now a real risk – what would you think?
Personally, I think it would not be good for the UK. I think it benefits from being in Europe. But then I am very European-minded. I think all of our countries are too small to have a big say in the new world that is arising out of the crisis. If UK citizens want to leave the European Union, that would be a pity for Europe too.
Will it affect supervision?
No, not at all.
What do you think the SSM will look like after five years? Will we have a single supervisor in the European Union or at least in the euro area?
I hope we have a very well-established, very strong, very European SSM. What will be the scope, how many countries will have joined? I don’t know. We will see. My first milestone is in November. Then for 2015, we will have a fully-fledged supervisory programme. Five years away, that’s quite some time – we’ll see what happens.
How do see your role, a “super-supervisor”?
I don’t see myself in that way – that would mean there is another layer of supervision and that’s not the case. I work with my people in Frankfurt and the people in the supervisory authorities. I met with the supervisors in Luxembourg two weeks ago; I met with the Finnish supervisors this week. The contribution of national supervisors is absolutely crucial – I cannot do my job without them. Even with the biggest directly supervised banks, 90% of the joint supervisory team will, on average, be made up of national supervisors. So I very much need their very best contributions and that’s my message to them.