OREANDA-NEWS. A Keynote Address by Deputy Governor Pentti Hakkarainen at the High-Level Seminar on the Banking Union, Danmarks Nationalbank, Copenhagen on 15 December 2014.

It is a great pleasure for me to participate in this seminar here at the Danmarks Nationalbank. And I’m very pleased to speak to you today about the establishment of the Banking Union.

The recent crises have made it very clear at least that international, highly interconnected financial markets (like we have here in the Nordic region) require a stronger institutional framework than what we have had in recent years. The authorities need proper tools to deal with ailing banks operating in integrated cross-border markets. The creation of these tools has taken major steps forward since, but there is still a lot of work ahead. For the Banking Union, i.e. the Eurozone countries and potential opt-in countries, the work is almost completed. With outside countries cross-border problems may exist even though power and tools of authorities are harmonised through the Bank recovery and resolution directive (BRRD).

The key lesson we have learnt is that economic dislocations without proper arrangements to tackle troubled banks have devastating effects on the real economy, taxpayers and the whole society. And regaining growth proves to be painfully slow and long-lasting.

In order to avoid collateral damages it is imperative that institutional arrangements for supervision and resolution match the integrated structures of banking business in the real world.

Banking Union

As part of the economic and monetary union and as a remedy for the crisis, the EU leaders agreed in June 2012 on creating a true Banking Union.

The Single Rulebook provides a foundation for the Banking Union. It is based on the idea of harmonised regulatory requirements, such as capital adequacy rules for banks. These are achieved through European legislation and lower-level technical standards.

The second main pillar of the Banking Union is the Single Supervisory Mechanism which started its practical operations just over a month ago in the beginning of November.

The third important pillar is the Single Resolution Mechanism. The SRM will gradually start its practical operation in the beginning of 2015.

The Banking Union will help us prevent banking problems. I would argue that there will be fundamental cultural change not only in the supervisory, crisis management and regulatory frameworks for banks but also in the banking industry. In the future, we will avoid the use of taxpayers’ money as a rule and bail-out would be only a rare exception. This, in turn, means also better incentives in banking and hence a more stable financial system.

The Single Supervisory Mechanism

The SSM was established to ensure that strong supervisory standards are applied in a consistent manner across the euro area. We also need the SSM to strengthen the confidence and resilience in the banking sector which has been shaken quite severely over the past few years. To achieve these goals, the SSM, with the ECB at its centre, has been entrusted with an extensive set of micro- and macro-prudential powers, covering all key tasks relating to the prudential supervision of credit institutions.

The SSM operates as a system, gathering all of the expertise of national supervisors and at the same time possessing a strong decision-making centre. The justification for the two-tier system is that the local supervisors will have an information advantage with respect to local banks. The centralized decision making is required to address cross-border issues and to minimize the risk of excessive forbearance on the part of local supervisors. The shared competence is important also because credit cycles differ nationally and the associated potential problems need to be mitigated through nationally differentiated ways.

The SSM uses a risk-based approach to supervision. A common SSM Risk Assessment System has been developed, relying on an integrated and harmonised information base, to direct supervisory resources on the basis of the risk and impact assessment. Common methods and processes have also been developed for assessing the adequacy of banks’ capital and liquidity levels. The SSM goes considerably deeper than the work of the EBA in developing the Single Rule book and harmonising supervisory practices at the EU-level as a whole.

The SSM possesses early intervention powers in accordance with the Bank Recovery and Resolution Directive. The early intervention powers are significant and make it possible to take action with respect to institutions which are approaching the point of non-viability.

The ECB’s overall responsibility for supervision is matched by controlling powers over the system as a whole. First, all the components of the system have to act in accordance with a system of guidelines, ECB-specific regulations and manuals of supervisory practices. The supervisory function has the power to overtake direct supervision of any bank or group of banks, if this is deemed necessary in order to preserve financial stability and confidence in the institutional framework. The centre monitors also that adequate supervisory quality prevails in national competent authorities.

Governance of the SSM

The governance structure of the SSM has been designed to separate the ECB’s monetary policy and supervisory roles, and to make the position of different participating countries as fair as possible.

The Supervisory Board is responsible for the supervisory functions of the SSM. While the decisions are formally and finally adopted by the Governing Council of the ECB, the Supervisory Board is, de facto, the main decision-making body in supervisory matters.

In prudential supervisory matters, the Governing Council cannot alter the decisions of the Supervisory Board, but only prevent their entry into force. Such a veto power could be exercised when the decision is seen to be in conflict with monetary policy.

The special status of the non-Euro Area countries is taken into account in the decision-making mechanism. Non-euro area member states can participate through establishing a close cooperation agreement with the ECB. By giving non-euro area Member States full membership and voting rights in the Supervisory Board they are placed on an equal footing with the euro-area members. A non-euro area country may even announce non-satisfaction at the Governing Council’s decision and can choose not to adopt the decision. For its part, the ECB could then consider breaking up the agreement of close cooperation.

Day-to-day work

For carrying out the day-to-day supervision of significant banks, Joint Supervisory Teams have been established. They integrate the ECB and national competent authority staff into single supervisory units responsible for the conduct of the on-going supervisory activities, planning of on-site inspections and other supervisory work and for preparing supervisory decisions. The Teams are led by the ECB. There is one Team for each significant banking group, tailored to the needs of each banking group (proportionality). The Joint Supervisory Teams provide a single interface for the supervised banks and a single entry point for applications e.g. concerning internal models to be approved by the supervisor.

The SSM adopts best supervisory practices to conduct high-quality supervision with no biases. The participating national authorities get all the information and can take part in supervisory decisions. Moreover, there is a European approach to SSM decision-making without any national bias.

SSM vs. national interests

Banking, and financial services more generally, is a high value added industry which typically is deemed necessary to have a strong national ownership. One can even say that national banking supervisors have traditionally had a dual role to play: first, to carry out effective supervision and thus promote financial stability but, second, to also promote the interests and competitiveness of the national financial industry.

However, when banking is getting more and more globally regulated and less and less restricted within any country’s borders, one can ask whether there are national interests left. In today's economies and also for banks themselves it may be better to aim for a level playing field internationally and enhance competition in the national market than look after the interests of domestic banks only. Over time, the banking union is envisaged to lessen the role that national interests play.

The ECB, as an established and strong European institution, is well placed to tackle the emergence of national interests in supervision. It is therefore imperative that the structures and the processes of the SSM support a European perspective and interests. So far, the developments seem to point to this direction. The fact that the ECB can, if deemed necessary, take over the direct supervision of any bank operating in the Banking Union area underlines that the ECB is fully in charge of the SSM.

New macroprudential role

The crisis has shown that micro-prudential supervision at individual bank level is not sufficient, and that macro and micro risks can actually be mutually reinforcing.  This calls for very close cooperation between the macro- and micro-prudential functions. The ECB has powers also in the macro-prudential area, which is a shared competence with national macro-prudential authorities.

The ECB will be consulted on national measures and it has the possibility to tighten national measures if they are deemed inadequate. Macro-prudential instruments could also be applied to the euro-area financial system as a whole. The role of the EU macro-prudential supervisor, the European Systemic Risk Board (ESRB), is broader both sector-wise and geographically than the SSM. The ESRB covers all EU member states and the whole financial system rather than only the banking sector.