Contribution by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, for Eurofi Magazine
20 February 2024
European banking supervision was established to ensure that banks remain safe and sound and the financial system remains stable.[1] The decision to grant the ECB supervisory powers was taken in the aftermath of a severe financial crisis which revealed that it was untenable for monetary policy to be managed at European level while banking supervision and resolution remained the preserve of national authorities. The single European supervisor was billed as the first of three pillars in a banking union that was meant to overcome the fragmentation of the financial system along national lines.
It’s now been almost ten years since European banking supervision was established. So has the single supervisor delivered on its promise? And how can we adapt the financial stability agenda on the basis of what we have learned?
Resilient banks
Standard performance metrics for our supervised banks show that, in aggregate terms, they are now in much better shape than when they first came under ECB supervision in November 2014.[2] The fact that this improvement has been sustained in spite of the large negative shocks that have hit the banking sector in recent years, including a global pandemic and the fallout from Russia’s war in Ukraine, makes this development all the more remarkable.
In my view, the resilience of the banking sector can be attributed to two factors.
First, ECB Banking Supervision deserves credit for raising the common standard for the entire system.[3] Various initiatives were instrumental in restoring confidence in the banking sector, including progressively lifting the capital bar faced by banks, focusing on reducing legacy non-performing assets and reviewing banks’ internal models. These and other actions also mean that banks are generally in a better position to deal with external shocks when they materialise. It is also important to recognise that overhauling the Basel framework after the great financial crisis enabled these higher supervisory standards to be reached. This is why I believe that the revised framework has proven its worth – and also why it is crucial that the remaining Basel III standards are integrated into European law.
Second, when confronted with challenges on an unprecedented scale, both European and national policymakers have shown that they can act quickly and work together to respond appropriately to the severity of the situation at hand. Banks have also indirectly benefited from the support that was provided to the real economy, as this prevented the full impact of adverse shocks to growth from feeding through to their balance sheets.
Integration and crisis management
Over the last ten years, better regulation, more efficient supervision, well-capitalised banks and strong institutions have all helped make the banking sector more stable. While we should be pleased with this development, we also know from our experience during this time that no two crises are likely to be the same. Thinking that past success is a reliable bellwether for future performance could be tempting, but it is ultimately foolish. We know that banks will continue to face a number of headwinds, as they are still adjusting to the recent sharp interest rate increases even as the near-term economic outlook deteriorates.
In order to further cement the resilience of our banking system, we need to foster the creation of a truly integrated banking market, refine our crisis management framework and address the gaps in our macroprudential framework.
First, we need to complete the banking union as originally foreseen. Advances in supervision and resolution under the first two pillars have helped weaken the links between banks and their sovereigns. However, as long as the third pillar – a common deposit insurance scheme at European level – is missing, there remains the possibility that the “doom loop” between governments and banks will resurface. Making progress in setting up the third pillar should also foster bank mergers across national boundaries, which have so far failed to materialise to any meaningful extent.
Second, the process for unviable banks to exit the market could be improved. The scope of resolution can be expanded to ensure that the failure of small and medium-sized banks can be addressed in a harmonised manner, and deposit guarantee schemes can be empowered to provide a wider range of crisis management options to address potential or actual bank failures. The recent proposals by the European Commission are a welcome step in this direction.[4]
Finally, recent experience also suggests that policymakers will continue to be confronted with the question of how to ensure banks can use their buffers more effectively during a crisis, including by adjusting macroprudential frameworks to make these buffers “buildable” and “releasable” in a countercyclical manner.
