The Banking Union in Europe Professor Concetta Brescia Morra

OUTLINE The evolution of EU supervision structure Mutual recognition and the single license in the EU in 1993 The Lamfalussy report in 2000 and the de Larosière report in 2008 The EU Financial Regulatory Package in 2010 The European Systemic Risk Board European Supervisory Authorities The Banking Union and the Single Supervisory Mechanism The macroeconomic and structural rational for a Banking Union The Single Supervisory mechanism (SSM) Legal basis of the SSM Scope of the SSM Prudential supervision Operational details

The evolution of EU supervision structure The EU single market for banks (1993) is based on: The principles of “minimum harmonization”, “mutual recognition” and the “single passport”, a system which allows a “credit institution” legally established in one Member State to establish/provide their services in the other Members States without any further authorization requirements The principle of “home country control”: the home country authorities are responsible for the prudential supervision of foreign established branches Subsidiary, on the contrary, fall under the competence of their State of incorporation

The evolution of EU supervision structure The integration of financial markets in Europe has increased in the last decades The rise of multinational banking groups (scale and scope economies encouraged the creation of financial banks along the universal banking model or in the form of integrated groups) Notwithstanding minimum harmonization of prudential regulation, there are substantial divergences in national implementation and supervisory practices among EU countries

The evolution of EU supervision structure The Lamfalussy Report (endorsed by the Stockholm Council of Economics and Finance on March 2001 and then agreed upon by the European Parliament on February 2002) in order to reduce market fragmentation in Europe: Adopted a four-level regulatory approach: 1. framework directives; 2. implementing measures (directives or regulation); 3. convergence in supervisory practices; 4. enforcement of Level 1 and Level 2 measures by the European Commission Created 3 Committees of Supervisors (CESR, CEBS and CEIOPS) in order to assist the Commission in proposing Level 2 framework and trying to coordinate the behavior of national competent authorities in regulation and supervision trough Level 3 “guidelines”

The evolution of EU supervision structure Problems that emerged in the system created after Lamfalussy Report: The mechanism of the “guidelines” didn’t work in order to manage an higher level of harmonization among EU countries Many conflicts raised between home and host countries in charge of supervision of EU cross-border intermediaries

The evolution of EU supervision structure The CRD directive (first package; 2006/48/UE and 2006/49): Enforced the cooperation between consolidated supervisor and national authorities of banks included in the cross border-group The CEBS guidelines (2007) established the colleges of supervisors for banking groups that operate in multiples EU countries to address potential conflicts and supervisory overlaps between “consolidated supervisor” and host authority

The evolution of EU supervision structure The financial crisis of 2007-2009 revealed that: Financial supervision failed to prevent the accumulation of excessive risk in the financial sector Lack of coordination in supervising cross border group and the “light touch approach” adopted by some important national authorities (the UK example) helped the propagation of the crisis

The evolution of EU supervision structure The de Larosière report 2008: In November 2008, the European Commission mandated a High level Group chaired by J. de Larosière to make recommendations on how to strengthen European supervisory system and to restore the confidence in the financial system In September 2009 the Commission proposed to create a European Systemic risk board to deal with macrostability issues, and to replace the EU's existing supervisory architecture based on the Level 3 Committees with a European system of financial supervisors (ESFS), (micro-prudential) consisting of three European Supervisory Authorities (ESAs): a European Banking Authority (EBA), a European Securities and Markets Authority (ESMA), and a European Insurance and Occupational Pensions Authority (EIOPA).

The EU supervisory structure The European Systemic Risk Board: The ESRB tasks should be to monitor and assess systemic risk in normal times for the purpose of mitigating the exposure of the system to the risk of failure of systemic components and enhancing the financial system’s resilience to shocks. the ESRB should contribute to ensuring financial stability and mitigating the negative impacts on the internal market and the real economy

The EU supervisory structure The European Supervisory Authorities: the European System of Financial Supervisors (ESFS) as a network of national financial supervisors within three newly created European Supervisory Authorities (ESAs) with 2 tasks: Regulation Supervision

The EU supervisory structure ESAs exercise the “regulatory” functions of the old Level 3 committees: advising the EU Commission in drafting Level 2 measures promoting convergence by national competent authorities in the implementing measures through non binding guidelines and recommendation to establish harmonised regulatory technical standards in financial services in order to ensure, possibly through a single rulebook, a level playing field and adequate protection of investors and consumers across the Union

The EU supervisory structure ESAs technical standards: Regulatory technical standards The Authority may develop draft regulatory technical standards to submit for endorsement to the Commission, in cases when the European Parliament and the Council delegate power to the Commission to adopt regulatory technical standards by means of delegated acts under Article 290 TFEU The Commission may endorse the draft standard in full, but it may happen that in extraordinary circumstances the Commission may endorse it in part, with amendments Implementing technical standards: submit draft implementing technical standards for endorsement to the Commission in cases when the Commission has to issue implementing acts under Article 291 TFEU

The EU supervisory structure ESAs supervision powers: direct exclusive supervisory powers: only ESMA was assigned a direct power related to “credit rating agencies” the power to take individual decisions addressed to financial market participants, in three specific cases: In case of breach on Union law by a national competent authority which do not comply with the formal opinion of ESA. in emergency situation when a national competent authority does not comply with the decision of the ESA to settle disagreements between competent authorities in cross border situation

The EU supervisory structure EBA supervision powers: Prudential competences related to colleges of supervisors: EBA should contribute to promote and monitor the efficient, effective and consistent functioning of colleges; EBA will lead in ensuring a consistent and coherent functioning of colleges of supervisors for cross-border institutions across the Union, taking account of the systemic risk posed by financial market participants staff from the authority shall be able only to participate in the activities of the colleges, including on-site examinations, carried out jointly by two or more competent authorities

The EU supervisory structure EBA supervision powers: Europe wide stress test: EBA has powers to initiate and coordinate the EU-wide stress tests, in cooperation with ESRB. The aim of such tests is to assess the resilience of financial institutions to adverse market developments, as well as to contribute to the overall assessment of systemic risk in the EU financial system EBA Recommendations: on 15 July 2011 EBA published a formal Recommendation related to banks’ recapitalisation needs (this measures form part of a broader European package, agreed by European Council on 26 October and confirmed during the ECOFIN Council on 30 November, to address the current situation in the EU by restoring stability and confidence in the market)

The macroeconomic and the structural for a Banking Union There is a fundamental inconsistency of banking supervision being carried out at national level in a currency area with a single monetary policy Fragmentation and tension in bank funding conditions at the national level have impaired the transmission mechanism of monetary policy

The macroeconomic and the structural for a Banking Union The fragmentation contributed to negative loops between banking problems and tension sovereign funding Fragility in national banking systems can be quickly transmitted to the national fiscal side and vice versa, triggering an adverse feedback loop between fiscal and banking problems

Legal basis of the SSM Under Article 127 (6) of the TFEU, the ECB is able to take on “specific tasks concerning prudential supervision” without Treaty change, upon a unanimous decision of the European Council and after consultation with European Parliament and the ECB Regulation No. 1024/2013 of 15 October 2013 conferred specific tasks on the ECB concerning policies relating to the prudential supervision of credit institutions The SSM started to operate on November 4, 2014

The ECB mandate The ECB would directly supervise banks that “shall not be considered less significant” because of the size, importance for the economy of the EU or any participating member State, significance of cross-border activities : With over euro 30 billion in assets 20 percent of national GDP Upon initiative of the ECB where the bank has established banking subsidiaries in more than one participating member States and its cross-border assets or liabilities represent a significant part of its total assets or liabilities subject to the conditions laid down in the methodology

The ECB mandate Notwithstanding the previous rules, the ECB shall carry out the tasks confers upon the regulation in respect of : the 3 largest banks in each member state, unless justified by particulars circumstances

Tasks conferred on the ECB for prudential supervisory purpose To authorise credit institutions and to withdraw authorisations of credit institution To assess applications for the acquisition and disposal of qualifying holdings in credit institutions (except in the case of a bank resolution) To ensure compliance with acts which impose prudential requirements on credit institutions in the areas of own funds requirements, securitization, large exposure limits, liquidity, leverage, and reporting and public disclosure on those matters

Tasks conferred on the ECB for prudential supervisory purpose To ensure compliance with acts which impose requirements on credit institutions to have in place robust governance arrangements, including fit and proper requirements for the persons responsible for the management, internal control mechanism, remuneration policies and internal capital adequacy assessment process, including Internal Rating Based models To carry out supervisory reviews, including stress tests To carry out supervision on a consolidated basis To participate in supplementary supervision of a financial conglomerates

Tasks conferred on the ECB for prudential supervisory purpose To carry out supervisory task in relation to recovery plans and early intervention where a credit institution does not meet or is likely to breach the applicable prudential requirements and structural changes from credit institutions to prevent financial stress or failure, excluding any resolution powers

Cooperation within the SSM The ECB shall carry out its task within a single supervisory mechanism composed of the ECB and national authorities The ECB shall be responsible for the effective and consistent functioning of the single supervisory mechanism Both the ECB and national competent authorities shall be subject to a duty of cooperation in good faith and an obligation to exchange information

Cooperation within the SSM With respect to “less significant banks” supervisory decisions are adopted by national competent authorities. The ECB shall issue regulations, guidelines or general instructions to national competent authorities With respect to “banks of significant relevance” national competent authorities shall be responsible for assisting the ECB with the preparation and implementation of any acts relating to the ECB tasks, including assistance in verification activities.

The regulatory powers The EBA remain the main authority in the regulatory field: the objective is the “single rule book” The regulatory powers of the ECB is limited to operational aspects: The ECB shall apply all relevant Union Law and where this Union law is composed of Directives, the national legislation transposing those directives The ECB shall adopt guidelines and recommendation subjects to and in compliance with the relevant Union law The ECB may also adopt regulations only to the extent necessary to organise or specify the modalities for the carrying out of those tasks

SSM governance

Independence and accountability The ECB accountability to the European Parliament and to the Council: annual reporting to the Parliament, Council, Commission and the Eurogroup the ability for the European Parliament Committees to require the Chair of the Supervisory Board to appear before them an obligation on the ECB to reply to questions put to it by the European Parliament or by the Eurogroup Accountability of the ECB in front of national Parliaments annual reports to national parliaments of participating Member States

The “pre-ins”: the non Euro Member States that may wish to join the SSM Non-euro member States may opt into the SSM The “Pre-ins” are “participating member States” The Council agreement grants the “Pre-ins” participation in the Supervisory Board, though the representative of their national authorities, but we have to remember that they cannot be represented on the Governing Council