Contribution by Edouard Fernandez-Bollo, Member of the Supervisory Board of the European Central Bank, for Eurofi Magazine
20 February 2024
ECB Banking Supervision welcomes the diversity of banking business models in Europe. This diversity is a key strength that enables various financing needs to be met and facilitates the inclusion of different groups of economic operators in the financial system. As prudential supervisor, our primary role is to foster the resilience and sustainability of all healthy business models. To that end, we must strike a balance between making meaningful horizontal comparisons and paying adequate attention to the specific characteristics of each bank or group of banks. Horizontal comparisons are a crucial part of supervision as they help us to ensure a level playing field for banks and to identify peer institutions and the best practices for similar customers or markets.
Our supervisory activities are particularly useful in the current environment of heightened uncertainty and elevated geopolitical risks. One of our key aims at present is to gauge the impact of macroeconomic trends on different business models. We are analysing and challenging banks’ financial projections in baseline and adverse scenarios to understand how banks are factoring the impact of the changing macroeconomic environment into their key financial and business decisions. We are also paying attention to structural changes, such as digitalisation and the green transition, and looking at how banks are seizing related business opportunities and managing the associated risks.
In parallel, we are focusing on the specific characteristics of individual business lines, banks or clusters of banks so that we can better address certain patterns or issues which require tailored supervisory actions. For example, we are currently examining the investment banking business line to better understand the risk-adjusted profitability measures applied and, in turn, adapt our supervisory approach. We are gathering information on the root causes and early warning signals of structural weaknesses in banks’ business models with a view to devising an appropriate supervisory strategy to address them as early as possible. Such a strategy may envisage escalation and full use of our supervisory toolkit.
More generally, following up on last year’s reviews of our supervisory practices by external experts, we are revising our approach, including how we carry out our supervisory review and evaluation process (SREP) and how the results feed into supervisory measures. We want to focus more on the most important issues while still maintaining sufficient checks to ensure that we do not overlook any areas of risk and that we deliver on our priorities. With this goal in mind, we are finetuning the processes established under the multi-year SREP approach so that our supervisors can better adjust the intensity and frequency of their analyses to individual banks’ vulnerabilities and the broader supervisory priorities. This will go hand in hand with a focused increase in the use of our supervisory tools to ensure that priority issues are addressed. The exact changes to be made to the SREP methodology have not yet been decided, but the capacity to tackle major identified weaknesses will likely play an increased role, which should ensure that the specific characteristics of different business models are duly taken into account.
Our supervisory priorities for 2024-26 illustrate this new approach. In them, we emphasise the need for banks to enhance their internal governance and risk management practices. This includes traditional areas like credit risk and asset and liability management frameworks as well as emerging challenges such as climate-related and environmental risks and risks associated with the digital transformation. Banks should also have the capacity to assess the risk/reward balance across business lines and benchmark their performance against their peers. To do so, they need effective, well-functioning management bodies with strong steering and enhanced risk data aggregation and reporting capabilities. Certain banks, with very different business models, have not adequately addressed major shortcomings in these areas. This is despite ten years of supervisory engagement – the Basel Committee on Banking Supervision’s Principles for effective data aggregation and risk reporting were published back in 2013. Some delays are understandable, as banks may need to make major changes to existing IT infrastructure to resolve the issues, but it is crucial that they have a clear action plan in place with verifiable milestones. In all cases, measures to address the underlying weaknesses need to be carefully tailored to the specific situation of each bank, taking into account its legal form, ownership and organisational structure. This is why the ECB is seeking to establish best practices that are tailored to these characteristics. But the banks themselves also need to prove that the nature of their business organisation allows for effective remediation. This requires the right data to be able to take the right decisions.
We are therefore convinced that focusing on the effectiveness of internal governance for remediation will benefit all banks. It will provide more flexibility to tackle new and emerging risks in a rapidly changing macroeconomic environment, where swiftly identifying emerging issues is critical for the sustainability of all business models.
