Inside the EU's New Banking Watchdog

09 Sep 2011

Shane Fitzgerald

Introduction

The European Banking Authority (EBA) is one of three newly established European Supervisory Authorities (the others are the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority). Alongside the European Systemic Risk Board, these institutions form the core of the EU's new system of financial supervision.

The EBA was established in February 2011 and is based in London. Adam Farkas, its Executive Director, was in Dublin on Monday to meet with Irish regulators and supervisors to discuss the EU's new banking regime.

He also gave a breakfast briefing to members of the IIEA, outlining the responsibilities and priorities of his organisation. The main points of his presentation are presented below in the following order:
 

·      Background

·      The EBA's Major Objectives

·      Achieving the Objectives

·      Establishing a Single Rulebook

·      Oversight

·      Supervising Cross-Border Banks

·      The Stress Tests

·      The EBA's Role in Consumer Protection

·      Conclusion

NB: This briefing is not a verbatim transcript but a summary of Mr Farkas' presentation with background material and links added where appropriate.

To listen to an audio podcast of his presentation or to download his slides, please visit the IIEA event page here.

To view an infographic representation of the new European System of Financial Supervision, please click here.

Background

The advantages of financial integration in the EU, and in particular in the monetary union, have been well documented. Cross-border activity increases the international diversification of both credit risk and bank funding. A welcome pooling of knowledge and expertise across borders has also been evident. Nevertheless, it is clear that a true single market in financial services does not yet exist, and that the increase in cross-border activity in the EU generated huge risks, many of which were not clearly understood until the financial crisis.

These included problems in the supervisory landscape whereby cross-border or global institutions were regulated very differently in different markets, leading to regulatory arbitrage. International diversification also led to unprecedented interconnectivity between banks, so that problems emerging in one area quickly spread throughout the system.

The global financial crisis triggered the recognition that something had to be done at European level in order to preserve the benefits of financial integration while minimising the risks. The IIEA has previously covered the process by which the EU moved towards a new regulatory regime. The outlines of that regime can be seen in the infographic linked to above.

The new EU institutional arrangements are based on two major pillars and four new organisations. The European Systemic Risk Board is the first pillar and the institution responsible for macro-prudential supervision. It tries to identify risks that are threatening the broad functioning of the financial system. Its seat is at the ECB in Frankfurt and its chairman is the President of the ECB. It is largely composed of central bankers.

The other pillar is micro-prudential and comprises three European Supervisory Authorities (ESAs) – the EBA, the ESMA and the EIOPA. A joint committee of the ESAs meets on a quarterly basis. The ESAs are relatively small operations for the moment. The EBA for example has only about 50 staff.

The EBA's Major Objectives

The European Banking Authority has a number of key priorities:

1.    Establish a single EU rulebook for banking supervision. At the moment EU directives in this area are transposed by national legislators and subject to interpretation, variation and discretion that has resulted in major differences between jurisdictions and hence major regulatory arbitrage and under-regulation.  In future there will be a clear and level playing field for the roughly 8000 financial institutions that operate in Europe.

2.    Harmonise supervision. It became clear during the crisis that not only were the rules different but the enforcement of the rules varied greatly among jurisdictions. The EBA aims to upgrade the quality and consistency of national supervision and enforcement.

3.    Reinforce the oversight of cross-border groups. Cross-border banks present particular problems and need to be supervised better than before.

4.    Provide early warning of upcoming vulnerabilities. The ESRB will pursue a top-down, macro-prudential approach. The EBA will seek and share micro-level information by monitoring major European financial players.

5.    Intervene promptly and effectively in times of crisis and ensure that resolution procedures are in place. The European Commission has undertaken extensive consultations and is preparing a proposal in the area of cross-border financial crisis management and resolution. The precise role of the EBA in this new regime is not yet clear but is expected to be significant.

6.    Protect consumers and promote financial innovation. The EBA's role here will be relatively modest, owing to limitations on its resources.

Achieving the Objectives

The EBA aims to achieve these objectives by:

1.    Developing binding technical standards based on the higher-level legislation issued by the EU. The EBA's legislation will be applicable directly in all EU member states with no scope for interpretation. The EBA will issue an estimated 150 pieces of legislation over the next 2^1/2 years. National supervisors will be closely involved at all stages.

2.    Promoting a common European supervisory culture. The EBA will take part in and monitor the colleges of national supervisors (pdf) which monitor the activities of international banks.  

3.    Performing EU-wide risk assessments and stress tests. The 2011 EU-wide stress tests were conducted by the EBA. As well as regular stress-testing exercises, the Authority will also conduct other types of risk assessments on an ongoing basis.

4.    Reacting to risk warnings from the ESRB where they have implications for micro-prudential supervision.

5.    Handling emergency situations. The EBA will have special powers in the event that the European Council of Heads of State and Government declare an emergency situation. 

6.    Monitoring financial innovation and consumer issues. The EBA will identify trends that are potentially detrimental to consumers. In extreme circumstances it can even constrain the distribution of certain financial products throughout the European market.

Establishing a Single Rulebook

The establishment of a single rulebook is perhaps the most important task assigned to the EBA. The goal is to ensure that exactly the same rules apply across the Single Market, eliminating opportunities for regulatory competition and arbitrage. The rulebook will incorporate proportionality so as to capture differences across financial institutions and will be directly visible and applicable to individual companies. A clear distinction will be made with national rules.

The EBA will develop more than forty binding technical standards relating to the Basel III regime alone. Working groups will be formed under the umbrella of the EBA to draft each standard. They will involve EBA representatives as well as representatives of national supervisors. Once drafted, the standards must be approved by the 27-member board of supervisors of the EBA. The texts will then be subject to public consultation and impact assessment. The final versions must be endorsed by the European Commission, at which stage they will become directly applicable throughout the European market. The EBA aims to produce legal texts of high quality and clarity. Detailed Q&A documents should ensure consistent application.

Oversight

The EBA has broad oversight responsibilities which include continuous risk assessment, occasional stress-testing, the development of risk dashboards, and ongoing communication with national authorities and colleges. It will also be responsible for investigating breaches of EU regulations. It has a very broad scope in this regard – Basel III, bank resolution issues, financial innovation, consumer protection, deposit guarantee schemes, anti-money laundering and payment services will all be covered by its remit.

Its top priorities will include capital requirements, liquidity risk capture, compensation practices and reporting issues.

Supervising Cross-Border Banks

In total there are about 110 cross-border banks operating in the EU. Their day-to-day supervision is conducted by national supervisory authorities while broader supervision is organised via colleges of national supervisors. There are more than one hundred of these in Europe. The EBA has found that while these colleges operated smoothly when business was good, their efficacy deteriorated rapidly during the crisis because supervisors became reluctant to share information and risks with each other.

 

The EBA aims to build capacity to effectively oversee these colleges and ensure consistency in their operations. As the 'consolidating supervisor' it will take on a coordinating role and make sure that decision-making and information-sharing procedures are standardised. Decisions will be made by the most involved supervisors but effective communication with the extended college will be ensured.

Though the EBA has a mandate to ensure that the way that institutions are supervised is standardised and effective, it is important to stress that under the current legislation, the responsibility for supervision of individual financial institutions remains with national authorities (see Farkas' slide set for more information about the EBA's risk assessments and risk dashboards for EU cross-border banks).

The Stress Tests

The Authority shall, in cooperation with the ESRB, initiate and coordinate EU-wide assessments of the resilience of financial institutions to adverse market developments. The EBA will develop common methodologies for assessing the effect of economic scenarios on an institution's financial positions. Where appropriate, the EBA will address recommendations to the competent authority to correct issues identified in the stress test.

Mr Farkas claimed that the 2011 stress tests were much improved on the 2010 exercise. Market perceptions were much more positive. The EBA will continue to improve and refine the methodology of these stress tests.

The EBA's Role in Consumer Protection

The EBA has a mandate to monitor developments in the retail financial market. For example, a recent controversy related to the mis-selling of payment protection insurance for mortgages in a number of European countries. The scandal has resulted in litigation and massive compensation claims. If something like that occurred in more than one EU country in the future, the EBA would be expected to get involved by issuing warnings to consumers.

In addition to monitoring financial innovation and consumer trends (in cooperation with the two other ESAs), the EBA will coordinate financial literacy and education initiatives by the competent national authorities, develop training standards, and contribute to the development of common disclosure rules.

However, the EBA's activities in the consumer protection sphere are likely to be limited owing to a shortage of resources. The handling of individual complaints will remain with national authorities, unless there is a suspicion that EU law is being breached, in which case the EBA is mandated to intervene.

Conclusion

Rulemaking, oversight and consumer protection are the three pillars of EBA activity. The rulemaking role is very clear and central to its activities. Oversight is much more dependent on national authorities and so will be less centralised in the European context. Unfortunately, and owing to limited resources, the EBA is likely to be able to do relatively little in the area of consumer protection in the coming months and years.

The EBA is at a very early stage of its existence. As further reforms in European financial regulation, economic surveillance and corporate governance unfold, its role is likely to continue to evolve and expand.

 

This content forms part of the E View project, which is part-funded by DG Communication of the European Parliament. 

 

As an independent forum, the Institute does not express any opinions of its own. The views expressed in the article are the sole responsibility of the author.