European banking union

The ECB has assumed direct responsibility for the supervision of the euro area banking sector.significant banks (i.e. banks with a balance sheet total of at least EUR 30 billion) in the euro area since 4 November 2014. The EU now also has a single resolution mechanism and a related resolution fund, national deposit guarantee schemes have been harmonised, and there is the option of recapitalising banks directly from the European Stability Mechanism (ESM) as a last resort.

Single Supervisory Mechanism

The Single Supervisory Mechanism Regulation came into force in November 2013, and one year later the ECB effectively assumed its new supervisory responsibilities. Under the Single Supervisory Mechanism, responsibility for the prudential supervision of significant banks in the euro area has been transferred from the national competent authorities to the ECB. Non-euro countries have the option of joining the Single Supervisory Mechanism.

The ECB has also been made responsible for operational supervision, issuing and revoking banking licenses, assessing the acquisition (and disposal) of qualifying holdings, assessing compliance with European prudential rules and imposing higher capital buffers to address financial risks.

Evaluation of the Single Supervisory Mechanism (SSM)

The financial crisis and the sovereign debt crisis exposed undesirable links between national banking sectors and their governments. The banking union was established partly to break these links and to prevent national budgets being applied to rescue failing banks. The banking union consists of three pillars. The first relates to banking supervision and is known as the Single Supervisory Mechanism (SSM). The other two are the Single Resolution Mechanism (SRM) and the European Deposit Guarantee Scheme.

The SSM was established on 19 October 2012. It is implemented jointly by the European Central Bank (ECB) and the national supervisors/central banks of the euro zone member states. The ECB has been tasked with the prudential supervision of credit institutions, including banks. To this end, it has assumed specific tasks from the national supervisors/central banks in order to exercise prudential supervision of significant (i.e. large) banks in the euro zone. The national central banks supervise all other financial institutions, including the less significant (i.e. smaller) banks in their countries.

On 11 October 2017 the European Commission published an evaluation report on the functioning of the SSM. It concluded that the supervisory pillar of the banking union had been successfully established, was functioning well and had proven its efficiency. It also noted that:

  • with the assistance of national supervisors/central banks, the ECB had created the procedures and instruments necessary for a smooth transfer of the powers required to supervise significant banks and for the ECB to exercise its coordinating and supervisory functions;
  • although there was some uncertainty about the supervisory powers embedded in national legislation, no significant problems had been encountered regarding the allocation of tasks and responsibilities in the SSM. In practice, cooperation had grown steadily, with the various parties gradually coming to trust each other more and sharing more and more of their experiences with each other;
  • the regulatory framework for significant institutions (large banks) was now better harmonised and supervision was based on common methods that were applied consistently;
  • the ECB had also gone to great lengths to harmonise the supervision of less significant institutions but more time was needed to raise the harmonisation to a higher level;
  • the ECB was subject to extensive additional reviews by various EU institutions, such as the European Court of Auditors;
  • the ECB should conclude an interinstitutional agreement with the European Court of Auditors to clarify more precisely how information will be exchanged.

With regard to the last two points, the Netherlands Court of Audit observed in its 2017 report entitled Banking Supervision in the Netherlands that there were significant gaps regarding the ability of national and European audit institutions to carry out independent external audits of the SSM. They were due chiefly to the European Court of Auditors not having a mandate to audit the SSM.

Comprehensive assessment and stress tests

Before the Single Supervisory Mechanism became fully operational, the ECB, acting in close cooperation with the EBA, performed a comprehensive assessment of the European banking sector in 2014. This assessment consisted of a review (an ‘asset quality review’) of the balance sheets of the banks that will be subject to direct supervision by the ECB. This assessment of the carrying value of banks’ assets formed the starting point for the stress test, which involved testing the resilience of banks’ solvency in two hypothetical scenarios.

The Netherlands Court of Audit compared the results of the stress test with the state aid previously granted to banks. The findings of this analysis are set out in the attached document.

Further information on the Single Supervisory Mechanism for banks, the comprehensive assessment and its results are available on this ECB website.

2016 EU-wide stress test

The aim of the 2016 EU-wide stress test is to assess the resilience of EU banks to adverse economic developments, so as to understand remaining vulnerabilities. The results of the stress test is intended for supervisors, banks and other market participants.

The 2016 exercise covers a sample of 51 banks from 15 EU member states covering 70% of banking assets across the European Union. Each bank had to have a minimum of € 30 billion in assets in terms of total consolidated assets. Four banks in the Netherlands were part of the test:

  • ABN AMRO Group N.V.
  • Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A.
  • ING Groep N.V.
  • N.V. Bank Nederlandse Gemeenten

Starting point of the test was the ratio between a bank’s score equity capital and its total risk-weighted assets on 31 December 2015 (the Common Equity Tier-1 also mentioned as the Tier-1 capital ratio). The test simulates the effects of a baseline and a adverse scenario. The baseline scenario is based on the macroeconomic forecasts of the European Union in late 2015. The adverse scenario reflects the systemic risks that were considered to constitute the most material threats to the stability of the EU banking sector. The stress test had a three-year horizon.

The stress test of 2016 cannot be compared to the tests of 2011 and 2014. This time there is no minimum capital demand. So there will be no banks ‘failing’. But the results give some indication. All 51 banks - except Banca Monte dei Paschi di Siena - have an capital ratio of 5.5% or more. This percentage was used in 2014 as the minimum of the adverse scenario. In a scenario of a minimum capital ratio of 8% - according the Basel Committee on Banking Supervision rules – nine banks scores below this ratio. The capital ratio of the four Dutch banks was higher than 8%..

The EU-wide stress test is coordinated by the European Banking Authority (EBA) and carried out in coorperation with the competent authorities from all relevant countries, the European Central Bank (ECB) and the European Systematic Risk Board (ESRB).

Single resolution mechanism

The Single Resolution Mechanism was established in July 2014 to ensure that banks facing serious financial difficulties are resolved effectively. This includes selling off viable parts of the bank in question and establishing a ‘bad bank’. The Single Resolution Mechanism is due to come into force on 1 January 2016 and will apply to all banks in the euro area as well as to banks in member states that join the Single Supervisory Mechanism.

The Single Resolution Board became operational as an independent European agency on 1 January 2015. In its first year, the Resolution Board will be preparing a resolution timetable and resolution plans for individual banks, among other things. Since the Single Resolution Mechanism came into effect on 1 January 2016, the Resolution Board is a fully operational resolution authority responsible for the orderly resolution of failing banks as and when necessary.

The Single Resolution Fund is a key component of the Single Resolution Mechanism. The Resolution Board can use this bank-financed fund for resolving failing banks. The total target size of the resolution fund is 1% of the covered deposits of the participating banks, equivalent to some €55 billion in total.

Challenges to the banking union

A vital element of the European banking union is the bail-in mechanism to resolve failing banks. Not taxpayers (i.e. governments), but shareholders, creditors and large savers will foot the bill if a bank collapses. Should a bank be in difficulty, it will be resolved by means of the Single Resolution Mechanism (SRM). The objective of resolution is to wind up an insolvent bank as smoothly as possible. The Single Resolution Board (SRB) is the most important decision-making body within the SRM. This new mechanism was applied in four cases in 2017. They are summarised below.

Spain (Banco Popular Espanol S.A.)

On 7 June 2017 the Single Resolution Board (SRB) announced that:

  • the European Central Bank had informed it on 6 June 2017 about the financial situation at Banco Popular Espanol S.A. The bank was in danger of becoming insolvent;
  • the SRB – together with the FROB (the Spanish Executive Resolution Authority) – had decided that Banco Popular Espanol S.A. should be sold in the interests of all the bank’s account holders and to ensure financial stability in Spain and Portugal;
  • Banco Popular Espanol S.A. would be acquired by Banco Santander S.A. for the sum of €1;
  • the acquisition would not involve any public funds.

On 8 August 2017, the European Commission gave the green light for Banco Santander S.A. to acquire Banco Popular Espanol S.A.

Italy (Banca Monte dei Paschi di Siena S.p.A.)

On 1 June 2017 the European Commission announced that an agreement in principle had been reached with the Italian Minister of Economy and Finance regarding the restructuring of Banca Monte dei Paschi di Siena S.p.A. by means of a ‘preventive recapitalisation’.

Under Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and Regulation (EU) No. 806/2014 of the European Parliament and of the Council of 15 June 2015 establishing uniform rules and uniform procedures for the resolution of credit institutions and certain investment firms, preventive recapitalisation is permitted under certain conditions. The European Commission set additional conditions in that the bank had to be resolvable, had to satisfy applicable capital requirements and its non-performing loans had to be assumed by private parties.

On 4 July 2017, after the conditions had been satisfied and the shareholders and some bond holders had contributed €4.3 billion to the resolution plan, the European Commission gave its permission for the Italian government to invest €5.4 billion (state aid) to restructure Banca Monte dei Paschi di Siena S.p.A.

Italy (Banca Popolare di Vicenza S.p.A. and Veneto Banca S.p.A)

On 23 June 2017 the European Central Bank (ECB) concluded that Banca Popolare di Vicenza S.p.A. and Veneto Banca S.p.A. were in danger of collapsing owing to a lack of capital. The ECB informed the Single Resolution Board (SRB) of its opinion on the same day.

On 23 June 2017 the SRB decided that no alternative private solutions were available for either bank, that they did not perform any critical functions and that their collapse would have no detrimental effects on the financial stability of Italy (= public interest). As resolution was not in the public interest, both banks would be wound up in accordance with national (Italian) insolvency law.

On 24 June 2017 the Italian government informed the European Commission of its plan to wind up the two banks.

On 25 June 2017 the European Commission announced that it approved the plan. The plan would be paid for in full by shareholders and certain bond holders. The two banks’ good activities would be transferred to Banca Intesa Sanpaolo S.p.A. (Intesa) for €1 and its bad activities would be assumed by a ‘bad bank’. The Italian government would then inject approximately €4.8 billion (state aid) into Intesa and guarantee up to €12 billion of loans from Intesa to finance the winding up.

According to the European Commission, the Italian government’s decision to provide financial support in order to prevent economic disruption in the Veneto region was compatible with European state aid rules.

Single Deposit Guarantee Scheme

The European Commission published a proposal for a European Deposit Insurance Scheme (EDIS) in November 2015. It is now under negotiation between EU Member States and within the European Parliament.

The excisting Deposit Guarantee Scheme Directive came into force in 2014. The Deposit Guarantee Scheme guarantees depositors that they will receive to a maximum of €100,000 of their savings (per bank) if their bank finds itself in financial difficulties. This guarantee is intended to prevent depositors from making panic withdrawals if their bank is in danger of failing.

The current system is organised on a national basis. This means that the deposit guarantee scheme of a country experiencing a serious banking crisis at some point may not be able to bear the costs any longer. If that happens the scheme loses its effectiveness, exacerbating the crisis even further. The European Commission’s plan therefore is to create a backstop by setting up a European fund. This fund would not create extra costs for taxpayers or banks, because it will be built up gradually from the contribution’s of banks to their national deposit guarantee scheme’s. Banks with a higher risk profile will pay a higher contribution. The scheme would become mandatory for countries in the Eurozone, and voluntary for countries outside it. Only Member States that fulfil strict European rules would be able to participate.

More information on this proposal can be found on the European Commission’s website.

Direct recapitalisation of banks by the ESM

Since 2012, the option has existed of using the ESM for the indirect recapitalisation of banks. In an indirect recapitalisation, a government applies for aid, which it then transfers to the banks in financial trouble. Spanish and Cypriot banks were recapitalised in this way in the past.

On 8 December 2014, the ESM’s Board of Governors gave its consent to the use of the ESM for the direct recapitalisation of banks. The amount of ESM funds available for the direct recapitalisation of banks is limited to €60 billion. The ESM may be used only if a bank is unable to comply with the ECB’s capital requirements (or is unlikely to be able to comply in the future), and if this situation poses a severe threat to the financial stability of the euro area. A further requirement is that all other private and (national) public avenues must have been exhausted. The use of the ESM for the purpose of direct recapitalisation requires the approval of the ESM’s Board of Governors.

Further information on this subject is available on the ESM’s website.

Access of supreme audit institutions to financial supervisors

The financial crisis has given rise to questions in many European countries about the quality of banking supervision exercised by the country’s main financial supervisory authority (FSA). In October 2011, the presidents of the supreme audit institutions (SAIs) in the EU decided to conduct a joint audit to test their mandates and their access to FSA files in their countries. This is important in order to measure the effectiveness of supervision of the financial sector. Thirteen national SAIs and the European Court of Auditors took part in the joint audit; the final report and a resolution were presented in October 2012.

The audit showed that seven of the 13 national SAIs have no mandate to audit their FSA, and do not therefore have access to banking supervision files. One SAI, i.e. the Netherlands Court of Audit, did have a mandate to audit the FSA at the time, but was not given access to FSA files in practice. Five of the 13 SAIs have both mandates and access to FSA files.

The situation in the Netherlands changed in 2014. Following the amendment of the Financial Supervision Act on 14 May 2014, the Netherlands Court of Audit now has access to confidential data held by the Dutch central bank and the Netherlands Authority for the Financial Markets (AFM) (Bulletin of Acts, Orders and Decrees 2014 179).

The Contact Committee of the Supreme Audit Institutions of the European Union however stated in September 2015 that the transfer of banking supervision to the ECB created another audit gap. After all the new powers of the Netherlands Court of Audit for audits of the Dutch supervisors does not apply to the ECB, and the same is true for other national SAIs or the European Court of Auditors. The Contact Committee therefore calls on SAIs to raise awareness of this issue among their respective governments and parliaments. The Netherlands Court of Audit did so earlier in a letter of 2 July 2014 to the Dutch House of Representatives  (i.e. the lower house of the Dutch Parliament).

The new audit gap was also a reason for the Contact Committee to call for a common collaborative audit of the supervision of individual non-significant banks in selected EU countries to be started in 2015. As part of this collaborative audit, the Netherlands Court of Audit will audit the prudential supervision of less significant banks in the Netherlands. Other national SAIs will do the same in their own country. The idea is to combine the results of these audits and draw conclusions on the supervision of less significant banks in Europe under the SSM.

The European Court of Auditors has started an audit of significant banks in the EU.