Mazars: What will the banking union mean for Irish banks?
Mark Kennedy, Head of Financial Services, Mazars, outlines what the European banking union will mean for the Irish banking system.
“We need to move towards an integrated financial framework, open to the extent possible to all Member States wishing to participate. In this context, the European Council invites the legislators to proceed with work on the legislative proposals on the Single Supervisory Mechanism (SSM) as a matter of priority, with the objective of agreeing on the legislative framework by 1 January 2013.”
Conclusions from the European Council Summit, 18-19 October 2012
The European Council summit of 18-19 October has, by providing the necessary framework for development of legislation for the Single Supervisory Mechanism (SSM), continued to progress towards the goal of a banking union which was outlined by the European Commission in September 2012. It seems likely now that European banks will participate in some form of supra-national regulatory regime, and in relatively short order if the European Council’s wishes are met.
The package of measures announced under the heading ‘Integrated Financial Framework’ goes further than outlining a single supervisory regime; it makes explicit the desire for a harmonised resolution mechanism and deposit insurance, as well as clarification of capital requirements. All of these items will be dealt with in a single rule book. The announcement also transparently links this agenda to the capacity of the European Stability Mechanism (ESM) to directly re-capitalise banks of participating member states.
Of course, politics will have the last word on the implementation of any initiative of this sort and we have already seen how the political debate has begun to develop. Nonetheless, it seems clear that the Irish Government is likely to bring Ireland’s banks into the arrangement, with such an explicit link to the ESM role. It is also clear that whatever the ultimate form of a banking union, the impacts on our banking system in Ireland and other countries will begin to be felt in the short to medium term.
Short-term impacts
The proposals are still in summary form, but the timelines mentioned in the European Council are all short. The European Council is aiming for a legislative framework for SSM by 1 January 2013, progress on resolution and deposit guarantee “rapidly” and clarity on the Capital Requirements Directive IV by the end of the year. Accordingly, we can expect to see some practical effects sooner rather than later. The first of these is an almost inevitable increase in the demand for micro-prudential data by regulatory authorities. This will place significant pressure on finance and risk teams, particularly if existing reporting (FINREP/COREP) is amended or replaced. There will also likely be additional requests from a macro-prudential perspective.
In addition to the specific demands on those functions dealing with regulators and with financial reporting, we also anticipate that senior executives will find that more of their time is consumed by supervisors and supervisory activities. The ECB is likely to consult on the development of the regime, supervisory teams will have to be built and all of this activity will likely see senior executives heavily involved in understanding, analysing and responding to the developing situation. As national central banks continue to hold responsibility for conduct of business and anti-money laundering supervision, this increases the challenge for banks, which will have to hold and manage two sets of supervisory relationships.
The changing landscape
The SSM and related proposals will, if given full effect, change the banking environment in a number of significant ways. Obviously, the creation of an effective resolution regime will change the relationship between banks, the supervisory authority and the ECB, quite dramatically. Certainly this aspect and the deposit guarantee element will serve to re-order the allocation of business risk between banks in this country and the State. This, together with a functioning ESM will, it is hoped, stabilise the banking sector across Europe.
There are also a number of very practical considerations relevant when considering the SSM. The first of these is an important shift in emphasis by supervisors. The European Council communication describes a single rule book for supervision, and it is likely that the philosophy and practice of prudential oversight will turn to a more supervisory model under the tutelage of the ECB. There has been much talk in the recent past of simplification of regulatory regimes. This may be both positive and negative for senior bank executives as simplification may yield efficiencies, but the style of intervention may be more challenging, including a greater willingness on the part of supervisors to interact on day-to-day business decisions, including the selection and appointment of staff. This may prove particularly challenging in Ireland, where the business direction of banks is subject of some controversy already.
Consolidation of the industry seems increasingly likely throughout Europe, particularly as some policy-makers at a European level appear to believe that the system is excessively fragmented. The single market project has taken a blow in the recent past, as banks have retreated in many cases substantially back to their home markets.
In the Council communication, we have seen a re-affirmation of commitment to the single market and accordingly it is likely that the SSM regime will afford an opportunity to address this issue, in theory at least. This will remain a challenging zone, with national interests, bank stakeholder interests and ECB interests interacting and potentially colliding. The resolution mechanism will provide a somewhat blunt tool for dealing pre-emptively with those banks in a weakened position. For the Irish sector, this remains an area of some focus, with clear government commitment to the pillar bank concept conceivably at odds with broader EU strategy should banking in this country remain distressed for a prolonged period.
The communication has also underlined one other crucial issue for the sector: the question of Capital Requirements Directive IV and capital and funding more generally. The economic outlook for Europe suggests an environment where bank profitability will remain under pressure. Equally, measures to strengthen balance sheets will continue to depress returns. The key concern is whether prudential requirements are constraining lending in Europe. The ECB will address this issue through monetary policy, financial stabilisation measures and through bank supervision.
The Council does not seem to have reduced the timeline on this item, proposing clarification of the position by year end. What this clarification may lead to remains to be seen, but we consider that it may see some elements of the proposals reconsidered.
Some sensible steps
While there is good sense in holding back and watching to see how the proposals will evolve, timelines are relatively short and some steps might be taken to ensure that Irish banks are prepared for the likely changes. There is an opportunity to build resource to deal with the likely changes in nature and focus of regulation, including the significant increase in data requirements. It may also be timely to ask whether the compliance and risk management frameworks internally applied remain fit for purpose, as the regulatory and business environment has evolved.
The consolidation of supervisory authority in the ECB, including resolution capacity, potentially provides the ECB with a similar framework as that of the Bank of England: holding both supervisory and resolution powers. The UK experience suggests that euro zone banks will be pushed to develop recovery and resolution plans and the availability of skills to execute this planning may be unavailable in many banks at present.
The proposals made by the European Commission, now supported by the European Council, will mean significant change for many banks, both in Ireland and throughout Europe. The challenge, added to the many challenges already facing the sector, will be to adjust to the developing environment and to put the required resource and structures in place to deal effectively with the SSM.
For more information please contact:
Mark Kennedy, Head of Financial Services, Mazars
Tel: +353 1 449 4442
Email: mkennedy@mazars.ie
