Dr Andreas Dombret Member of the Executive Board of the Deutsche Bundesbank Stress Relief: Europe s banks, the Comprehensive Assessment and the Way Forward Speech at the European School of Management and Technology in Berlin Monday, 17 November 2014 Page 1 of 11
Table of contents 1 INTRODUCTION... 2 2 THE PAST: THE PATH TO THE SINGLE SUPERVISORY MECHANISM... 3 3 THE PRESENT: THE INTRODUCTION OF EUROPEAN SUPERVISION... 5 4 THE FUTURE AND THE WAY FORWARD: CHALLENGES FOR SUPERVISORS AND BANKS... 7 5 CONCLUSION... 10 1 Introduction Dear Prof. Rocholl, ladies and gentlemen Thank you very much for being invited to speak at the European School of Management and Technology. It is a pleasure to be here, at this very fine university. I would like to speak about a new era of European banking supervision that started only two weeks ago with the Single Supervisory Mechanism. I therefore do not have much experience to draw on, and my speech will address many facets that lie in the future. In this context, the Danish philosopher Sören Kierkegaard once said: Life can only be understood backwards, but it must be lived forwards and these Page 2 of 11
are exactly the two time dimensions I would like to focus on today. First, on the past, because we cannot understand and explain the path to common European banking supervision without looking backwards. Second, I will focus on the future and discuss many of the remaining challenges for banking supervisors and banks. 2 The past: The path to the Single Supervisory Mechanism Thirteen days ago, on 4 November, the ECB assumed responsibility for supervising the 120 largest banking groups in the euro area which, in terms of aggregated assets, represent more than 80% of the euro area s banking system. Thus, the ECB has become one of the largest banking supervisors in the world. I am certainly not overstating the case when I describe Europe-level supervision as the most important European initiative aimed at financial market integration since the launch of our European monetary union in 1999. To put it in the words of the IMF, the European banking union, consisting of the Single Supervisory Mechanism and the Single Resolution Mechanism, is the logical conclusion of the idea that integrated banking systems require integrated prudential oversight. The Single Supervisory Mechanism is the first pillar of the European banking union. The whole banking union project aims to tackle many problems that became apparent during the financial crisis: First, different national supervi- Page 3 of 11
sory practices the national bias of national supervisors towards their banks and insufficient cross-border cooperation, especially when supervising international banks. Second, the lack of instruments for the resolution of big banks, which led to bank bail-outs funded by the taxpayer and, again, increased public debt. The banking union will address these weaknesses. Only one year ago, in November 2013, the European legislator agreed upon the SSM Regulation, the legal basis for common European supervision. Since then, all those involved have achieved a real tour de force which has ultimately seen the SSM assuming supervisory responsibility for the largest European banks. In the run-up to assuming supervisory responsibility, the SSM performed a so-called Comprehensive Assessment an asset quality review and a stress test in collaboration with the national competent authorities. The aim of this exercise was to shed greater light on banks balance sheets so as to ensure that the SSM gets off to a credible start in early November. As a German supervisor, I see two gratifying developments: First, German banks have shown that they can cope with significant stress. The stress test revealed that German banks are well capitalized even in an adverse scenario. They have also improved their leverage ratios in recent months: 20 of the 25 assessed banks already fulfil the requirement of 3%, which will, according to the Basel III framework, be mandatory from 2018. I will come back to the Comprehensive Assessment later. Page 4 of 11
Second, and this is of equal importance: The Comprehensive Assessment has led to an unprecedented level of transparency for supervisors and for the market. The comprehensive assessment delivered a unique and broad assessment of the European banking market, which was analysed for the first time according to a harmonised set of pan-european standards. This ensured a level playing field across national jurisdictions. I am hopeful that this transparency will also bring back trust into the banking system. 3 The present: The introduction of European supervision By assuming responsibility for the supervision of Europe s most important banks, the Single Supervisory Mechanism addresses three problems that became apparent during the recent crisis. First, it introduces more harmonised supervision standards: Under the SSM, European banks will be supervised according to the same high standards. These standards will be developed by sharing experiences across borders and cherry-picking the best practices from national approaches to banking supervision. The second point is that the SSM will effectively supervise banks in a genuinely cross-border manner. Although home-host collaborations and supervisory colleges for international banks existed quite prior to the introduction of the Single Supervisory Mechanism, this was no substitute for genuine crossborder supervision. European supervision will provide precisely this because Page 5 of 11
only one supervisor is in charge and really receives a full picture. This is essential today because large banks are usually internationally active. Third, transferring banking supervision from the national to the European level will lead to greater distance between supervisors and the banks they supervise and therefore minimize any home bias. Ladies and gentlemen, I have just named all advantages of the SSM. However, you may be under the impression that Europe has entered into uncharted territory by transferring responsibility for banking supervision to the ECB, an institution with no previous experience of supervising banks. Be sure, that is not the case. National supervisors will continue to play an important role in supervision within the Single Supervisory Mechanism. Within the SSM, responsibility for supervision will lie with so-called joint supervisory teams. These teams are headed by ECB staff, but mainly include national supervisors. For us, as national supervisors, the introduction of European supervision is an extremely exciting challenge. Since our national supervisors began taking part in the joint supervisory teams, our tasks and perspectives have been broadened substantially. In addition to our work in the joint supervisory teams, we, as national supervisors, are still responsible for the supervision of the remaining 1,800 German credit institutions that are not supervised by the SSM. I am sure that our national supervision will also benefit from the experiences we gain by working in the joint European teams. Page 6 of 11
4 The future and the way forward: Challenges for supervisors and banks Ladies and gentlemen, to hark back to Kierkegaard s words: the building of the Single Supervisory Mechanism as the first pillar of the European banking union can only be understood by looking to the past. Specifically, this means drawing the lessons from the financial crisis and reforming our supervisory structures. But, as in life, European supervision must also look to the future. And that is exactly what I would like to do now. We have come to expect a lot from European banking supervision. But even though I am extremely optimistic about the successful work of the European supervisors, we have to supplement European banking supervision with other measures. This is where the second pillar of the European banking union the Single Resolution Mechanism, or SRM in short comes in. Banking supervision cannot and should not prevent individual banks from failing neither at the national level nor at the European level. The possibility of failure is an essential element of a well-functioning market economy. Nonetheless, in the financial crisis, we learned the lesson that the failure of very large or interconnected banks could lead to a systemic crisis. Such banks are perceived by the market as being too big to fail and consequently operate under the assumption of implicit and free state protection. This assumed protection sets the wrong incentives for risk-conscious behaviour on Page 7 of 11
the part of banks. Thus, solving the too big to fail problem is utmost in order to make the financial system more stable and save taxpayers money. And this is where banking supervision has to be supplemented by other measures. At the global level, the G20 have just agreed to a proposal that global systemically important banks will have to fulfil in future regarding their capital structure at the Brisbane summit this weekend. In particular, these banks will need to ensure a minimum amount of total loss-absorbing capacity, and this may be up to 20% including the minimum capital requirements. This will allow for the orderly resolution of banks. Furthermore, the G20 are working intensively to develop principles for cross-border resolution and continue to implement the measures agreed. In Europe, from 2016 onwards, European banking supervision will also be supplemented by a European Single Resolution Mechanism for banks. From that point, the banking union will rest on two pillars and provide a stable framework for European financial markets. With the institutionalisation of the Single Supervisory Mechanism and the resolution framework, regulatory policy has achieved a lot of what it set out to do. But this is only one side of the coin. The other side are banks tasks to fulfil, and here they can learn a great deal from the results of the comprehensive assessment. It provided an in-depth insight into the state of the European system. Let us take a closer look at the main lessons learned for German banks that were part of this process. Page 8 of 11
Let s begin with the main findings. German banks fared rather well. Of the 25 German banks that were examined, there was only one technical failure, and the bank in question has already closed its capital shortfall. From this we can conclude that German banks are sufficiently stable to cope with severe economic stress. Having said that, some German banks only barely made the grade in the Comprehensive Assessment. They are far from being best pupils. The proven stability is not sufficient on its own. Banks also have to be profitable. And in this regard, German banks have a lot of catching-up to do. According to the recent financial stability report of the IMF, the return on equity in the euro area is relatively low compared with the United States or Asia. And, with a return on equity of 1.26% and a return of total capital of 0.06% in 2013, German banks in particular are performing below average compared with other European countries. The interest results of German banks are also weak in an international context. How can these weak earnings be explained? The first reason is a business model that is relatively dependent on interest income. Such a business model certainly poses a challenge in the current environment of low interest rates. Thus, banks have to reconsider their business models and adjust them to sustainable profitability. A recommendable strategy for German banks would be to diversify their sources of income besides interest income. In terms of costs, German banks are faring relatively well compared with other countries. Nonetheless, options remain to reduce costs. Mergers could be one Page 9 of 11
strategy. In my view, the German banking market still offers scope for further consolidation. 5 Conclusion Ladies and gentlemen As I have shown, the establishment of the European banking supervision as the first pillar of the envisaged banking union is one of the central lessons learned from the recent crisis. Here, we have learned from the past in order to shape the future. The African-American human rights activist Malcom X once said: The future belongs to those who prepare for it today. And this is exactly what we as regulators have done and are still doing: Reforming supervisory structures and also capital and liquidity rules a topic I didn t speak about today in order to achieve a future with more resilient banks and greater financial stability. As I also mentioned, preparations for the future do not end with the introduction of the new European banking supervision system: This has to be supplemented by the European Resolution Mechanism for banks. This second pillar of the banking union will be established in 2016, enabling the banking union to ultimately provide a stable framework for the banking system and strengthen market forces. Page 10 of 11
Last but not least, banks also have to do their part by ensuring they remain stable and profitable. First and foremost, banks have to rethink their business models and align them to sustainable profitability. I am convinced that supervisors and banks alike have grasped the importance of looking to the past and drawing lessons from the financial crisis. Thereby, they will be able to successfully prepare for the future and all the challenges that lie ahead. Thank you. * * * Page 11 of 11