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Banking Union: update on supervisory issues - Resilience of the EU financial sector in the global context

The Single Supervisory Mechanism (SSM): Towards a true Banking Union

By Walter Stefan - Director General, DG Microprudential Supervision I, European Central Bank (ECB)

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The SSM was born of the 2012 financial crisis in Europe as the first pillar of Banking Union – the most significant decision towards deeper European financial integration since the introduction of the euro in 1999. The SSM is a major step towards a level playing-field in banking supervision in the Eurozone, substantially scaling back the fragmentation in supervisory practices and thus promoting an integrated banking market. It benchmarks itself towards international best practices, acts in an independent manner and is subject to highest standards of democratic accountability.

The SSM is a globally leading supervisor: It directly supervises 129 banking groups, covering € 22.5 trillion assets. In addition, the SSM indirectly supervises around 3500 institutions through its 19 member National Competent Authorities (NCAs). The Joint Supervisory Teams (JSTs), comprising ECB and NCA staff, are the cornerstone of SSM supervision. The SSM approach is intrusive, risk and judgement based, forward-looking, and action-oriented. It is applied in a consistent but proportionate manner. It combines a deep understanding of the business models, governance, and risk profiles of entities within the context of a system-wide perspective on financial sector risks. The increased opportunities for benchmarking and peer comparison at the Eurozone level promote multiple perspectives on risks, leading to more effective, forward looking supervision.

Since its inception, the SSM can already point to a number of important supervisory achievements. The Comprehensive Assessment (CA) acted as a basis to assess the capital adequacy and asset quality of the Eurozone banking sector. It also focused on the identification of and provisioning for non-performing loans, using for the first time a common definition across the Eurozone. As a step towards a more harmonised regulatory and supervisory framework, the SSM has agreed on a consistent interpretation of some 120 national options and discretions within certain European provisions, covering the treatment of capital adequacy, large exposures, and liquidity, among others. In 2015 the SSM introduced a common approach to the so called Supervisory Review and Evaluation Process (SREP), which is now performed for every institution in the Eurozone based on a common methodology, resulting in consistency in how supervisors assess capital and liquidity across the 19 Eurozone member countries. As a result, the sector is much more resilient, with higher and better quality capital and more robust liquidity profiles.

Looking to the future, the SSM is particularly focused on the soundness of the banking sector’s business models and profitability in an environment where banks face economic, financial, competitive, and regulatory headwinds. Weak profitability and pressure on business models might push some banks into a hazardous search for yield, especially in the context of cheap and ample funding. Supervisors and banks therefore need to be vigilant that business models evolve in a manner that is sustainable over the long run. This drives the focus on sound governance and risk management practices within a clearly articulated risk appetite framework. In this regard, the SSM also assessing the degree to which banks have the tools to manage their business risks in an appropriate manner, including through internal stress tests and reliable Internal Capital and Liquidity Adequacy Assessment Processes (ICAAP and ILAAP). Finally, banks need to have in place sound risk data aggregation and reporting frameworks to ensure that Boards and senior managements can judge whether business decisions entail risk levels in line with the institution’s stated risk appetite.

The SSM’s annual Supervisory Evaluation Plans (SEPs) flow from these system-wide priorities. Tailored to the risk-profile of every institution, the SEP articulates an array of supervisory activities ranging from thematic reviews, institution specific deep-dives, on-site inspections, and off-site monitoring. Through all these tools and in the context of a more harmonised banking market, SSM supervision endeavours to promote the soundness of credit institutions and therefore the resilience of the financial system as a whole.