Before the financial crisis

Single rule book, EBA and SSM
– implications for supervisory convergence
Director General Ulrik Nødgaard
February 27 2014
Financial integration after the crisis
The regulations on the European Financial Supervisory System (setting
up the ESAs and the ESRB).
The 2nd, 3rd and 4th capital requirements directive and a regulation.
Bank Recovery and Resolution Directive (BRRD)
2. Convergence in 4 different areas
4 core areas where sustantial convergence is to be expected:
• Solvency and own funds:
Treatment of risk weights
Quality of capital
Asset quality reporting
• Liquidity
• Recovery and resolution
• Supervisory Colleges
Solvency: Risk weights (I)
Before the financial crisis:
• More risk-sensitive risk weights introduced with the CRD.
Banks’ internal estimates, subject to supervisory approval.
• Potential for very considerable differences across banks.
Different data history, modelling approaches, treatment of
In some cases also differences in supervisory practices and range
of options in the CRD.
Solvency: Risk weights (II)
• Increased importance of benchmarking (CRD 78).
At least annually.
Identify outliers and reasons for deviation.
Corrective action in case of underestimated capital requirement.
Important role for the EBA in ensuring convergence via guidelines
Increased supervisory convergence via numerous technical standards
and guidelines produced by the EBA, for example:
Material changes and extensions (CRR 143).
Methodology for assessing compliance with minimum requirements (CRR
Permanent partial use and roll-out plan (CRR 148 and 150).
LGD floor (CRR 164).
Waivers to use shorter data histories (CRR 180, 181, and 182).
Downturn conditions for LGD estimation (CRR 181).
Solvency: Quality of capital (I)
Before the financial crisis:
• Multiple national discretions in the CRD including for important
deductions and prudential filters.
• Lack of regulation of standards for innovative hybrid AT1-capital
instruments led to a proliferation of hybrid issuances which were not
loss absorbent in a crisis.
• Lack of harmonisation of T2-instruments
Solvency: Quality of capital (II)
• Implementation of the 14 Basel-criteria for Common Equity Tier 1
(CET1) making it very difficult to financial engineer new
instruments that are not loss-absorbing.
• Enhancements and harmonisation of the definition of hybrid capital
and T2-capital.
• Harmonised prudential adjustments to all classes of own funds and
more deductions taking in CET1.
• EBA shall monitor the CET1-issuances ex post and report to the
Solvency: Asset quality reporting
Before the financial crisis:
Very diverging supervisory standards and practices regarding
supervisory reporting on asset quality
Common European definitions of reporting of forbearance and nonperforming loans.
More uniform reporting
Enhanced transparency at the EU-level in relation to stress-test
Before the financial crisis:
• 28 different liquidity regulations set by national authorities where
quantitative regulation was non-existing in some Member States.
• No alignment of liquidity-buffer requirements as to for example
volume and composition of assets.
• Very few Member States had requirements regarding stable funding.
Alignment of liquidity regulation based on the Basel-standards taking
into account European specificities on a harmonised basis.
Liquidity Coverage Requirement (LCR):
Stable Funding Requirement:
Promote the short-term resilience of the liquidity risk profile of institutions.
Hard limit requirement for LCR from 2015 with a phasing in until 2019.
Harmonised standard which can be compared across European banks.
Institutions shall ensure that long term obligations are adequately met with a
diversity of stable funding instruments from 2016.
Possible introduction of a stable funding metric (NSFR) and hard limit
requirement later EU-Commission to present legislation by end 2016 at the
Additional liquidity monitoring metrics (for example concentration of
funding, maturity mismatch etc.)
Recovery and resolution
Before the financial crisis:
No harmonisation of recovery and resolution tools and insufficient
national legal frameworks relying on regular insolvency procedures for
No bail-in mechanism to ensure alignment of incentives and that also
junior and senior debt holders have proper ”skin in the game” thereby
securing better pricing and rationing of credit in the system.
No cooperation between authorities in different Member States in place
to handle complex large banks operating in many countries.
Part of the explanation why a very large number of banks in Europe of
banks were bailed out in Europe using tax payers money (state aid
approved of around 40 per cent of GDP for Europe from 2008-2011).
Resolution: Bank Recovery and Resolution Directive (BRRD)
After CRR/CRD IV and BRRD:
The BRRD contains a number of standards for supervisory early
intervention actions and recovery plans.
EBA will play a substantial role here also through binding technical
standards and guidelines.
Harmonised resolution tool-box with bail-in as an important tool with
clear water-fall of burden sharing.
Standards for minimum eligible liabilities will contribute to gone concern
loss absorbency in crisis situations.
Harmonised level of resolution funds set in legislation.
Trigger for when resolution funds can be drawn upon set at 8 per cent
bail-in/write down of liabilities.
Supervisory Colleges
Before the financial crisis:
Colleges of supervisors established via memorandum of understandings
(MoU), i.e. bilateral/multilateral agreements and initiatives.
• Colleges of supervisors – driver for supervisory culture:
• Formalized cooperation regarding cross-border banking groups
• Joint risk assessments and decisions (capital and liquidity)
• Common view on essential supervisory measures
• RTS and ITS from EBA:
 RTS and ITS on the functioning of Supervisory Colleges (CRD 51
and 116)
 ITS on joint decisions on institution-specific prudential requirements
(CRD 114)
3. The effect of the EBA on the convergence in EU28
• It follows from the revised EBA-regulation that EBA - also after
setting up the SSM - shall continue to enhance convergence of
supervisory practices across the Union as a whole.
• Supervisory convergence in the future will occur partly through the
the numerous binding technical standards written into the
CRD/CRR and the BRRD and the guidelines which EBA is
• However EBA is also mandated through the revised EBA-regulation
to develop a Supervisory Handbook which should identify best
practices across the Union as regards supervisory methodologies
and processes.
Further effects of the EBA on convergence in the EU28
• Work is in the pipeline on a number of ”chapters” in this Supervisory
Handbook for example:
Business model analysis
Common scoring methodology for the Supervisory Review and
Evaluation Proces
Supervisory review of institutions stress-testing
Methodology and process for the assessment of recovery plans
• The Supervisory Handbook will not be legally binding and will give
sufficient room for supervisory judgement.
• Nonetheless the work being done will to a large degree probably
contribute to ensure further harmonisation of supervisory practises
across EU28 at a high supervisory level.
4. Limits to convergence : Macroprudential concerns
Adressing macro-prudential concerns calls for flexibility
CRR/CRDIV tries to strike a balance between single rule book and
Several macro-prudential tools in the CRD/CRR including temporary
stricter measures in art. 458 on:
Own funds
Large exposures
Liquidity requirements
Risk weights in the residential and commercial property sector
Intra financial sector exposures
Constrained discretion: complex coordination proces in place involving
Commission, Council, Parliament, the ESRB and EBA.
Limits to convergence: National Specificities
The ”Supervisory Diamond”:
Specific supervisory tool called the ”Supervisory Diamond” has been
introduced for banks setting limits to counteract excessive risk-taking,
but at the same time enable banks to offer credit.
Calibration specifically based on specific risks seen for Danish banks.
Increased transparency on pillar 2-add on and inspections reports:
• Publication of internal capital assessments since the annual reports
2009. If the Danish FSA has stipulated an additional pillar 2 capital
requirement, this also has to be stated.
• Publication of inspection reports (on-site and off-site).
Specialised mortgage banks
5. The effect of the SSM on convergence in EU28 (I)
Single Supervisory
Mechanism (SSM)
Single Resolution
Mechanism (SRM)
Single deposit
guarantee (delayed)
Single rule book(CRD/CRR/BRRD)
The effects of the SSM on convergence in the EU28 (II)
• Starting point: High degree of convergence
• The ECB through the SSM will assume responsibility for
supervision in the SSM on 4 November 2014 in the 18 euro
Member States:
for initially 128 significant institutions and
for several 1000’s lesser significant institutions
• Two channels of interactions:
The work of colleges
Negotiating BTS, guidelines and handbook in EBA
• Coordination of SSM positions in the EBA
• Revised voting rules in the EBA
The effects of the SSM on convergence in the EU28
• The ECB is working on an internal SSM Supervisory Manual:
Will cover the general principles, processes, procedures and
methodologies for supervising significant and less significant
Focus will amongst other things be on the Supervisory Review and
Evaluations Proces covering the risk assessment system, the
methodology for quantification of capital and liquidity buffers and
how to integrate with stress test outcomes.
Will be based on EBA Guidelines on SREP and Pillar 2.
Will be published as a comprehensive public version.
• But what will be the practice?
An average of German and French practice, with an italian twist?
A new and different approach to supervision?
6. The will to act
IMF staff position note:
• Supervisors must be willing and empowered to take timely and
effective action, to intrude on decision-making, to question common
wisdom, and to take unpopular decisions.
• Developing this “will to act” is a more difficult task and requires that
supervisors have a clear and unambiguous mandate, operational
independence coupled with accountability, skilled staff, and a
relationship with industry that avoids “regulatory capture.”
• These essential elements of good supervision need to be given as
much attention as the regulatory reforms that are being contemplated
at both national and international levels.
Handbooks, Manuals and guidelines cannot replace the will to act
The will to act – The Danish track record
• Hands-on approach, Credit review file-by-file
• No supervisory forebearance
a number of banks closed due to inspections of loan books by FSA
In 2/3 of the inspections, the Danish FSA concludes that there should
be higher impairment charges
• Accounting rules prevent “bad” forebearance by banks
• Also intrusive approach in other areas:
Risk weights
Funding and liquidity
Summing up regarding supervision
• Significant convergence for all 28 EU-countries in the coming years
• Very difficult at the current stage to make firm predictions on future
supervisory approach to supervision in the SSM and possible spillover effects
• A credible supervisory regime in Denmark

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