Single Supervisory Mechanism

The European Central Bank (ECB) has the leadership in European banking supervision. [17] A strict administrative separation is foreseen between the ECB's monetary and supervisory tasks. However, final decision-making on both matters takes place in the same body: the Governing Council.

The Governing Council is the main decision-making entity of the ECB. It comprises the members of the Executive Board of the European Central Bank and the governors of all national central banks of the Eurozone's member states. The Governing council is in charge, based on the opinion drafted by the Supervisory Board, of taking formal decisions with regards to its supervisory mandate.

Danièle Nouy was the first SSM head as chair of the ECB Supervisory Board

The Supervisory board is organised by article 26 of the SSM regulation (Council regulation (EU) No 1024/2013).[18] It is composed of all national supervisors participating in the SSM, a chair, vice-chair and four ECB representatives. These members meet every three weeks in order to draft supervisory decisions then submitted to the Governing Council.[19]

The composition of the Supervisory Board has been, over time, the following one:

• Chair:
  • Danièle Nouy (1 January 2014 - 31 December 2018)
  • Andrea Enria (1 January 2019 - 31 December 2023)
  • Claudia Buch (since 1 January 2024)
• Vice Chair:
  • Sabine Lautenschläger (11 February 2014 - 11 February 2019)
  • Yves Mersch (7 October 2019 - 14 December 2020)
  • Frank Elderson (since February 2021)
• ECB appointees:
  • Ignazio Angeloni (2014-2019)
  • Sirkka Hämäläinen (2014-2016)
  • Julie Dickson (2014-2017)
  • Luc Coene (2015-2017)
  • Pentti Hakkarainen (2017-present)
  • Edouard Fernandez-Bollo (2019-present)
  • Kerstin af Jochnick (2019-present)
  • Elizabeth McCaul (2019-present)

The other members are representatives of the respective national banking supervisors, known in SSM-speak as National Competent Authorities.

The Supervisory Board is assisted in the preparation of its meetings by a Steering Committee. This committee gathers the Chair and the Vice-Chair of the Supervisory Board, an ECB representative (Edouard Fernandez-Bollo since 2019) as well as five deputies of national supervisors.[19]

Joint Supervisory Teams (JST), composed of members of the ECB's staff, national competent supervisors and experts in the banking field, make the link between the national and supranational levels. There is a JST for each significant banking institution. They act as supporting bodies, responsible mainly for the coordination, control and evaluation of supervisory missions.[20]

A division of labour has been established between the ECB and national supervisors. Banks deemed significant will be supervised directly by the ECB. Even though the ECB has the authority to take over the direct supervision of any bank, smaller banks will usually continue to be monitored directly by their national authorities.[14] A total of 115 banks are currently being supervised by the ECB;[21] all other banks are supervised by their national supervisor.

A bank is considered significant when it meets any of the following criteria:[14]

• The value of its assets exceeds €30 billion;
• The value of its assets exceeds both €5 billion and 20% of the GDP of the member state in which it is located;
• The bank is among the three most significant banks of the country in which it is located;
• The bank has large cross-border activities;
• The bank receives, or has applied for, assistance from eurozone bailout funds (i.e., the European Stability Mechanism or European Financial Stability Facility).

This significance status is subject to change due to, for example, mergers and acquisitions. In 2020, two additional banks (LP Group B.V. in the Netherlands and Agri Europe Cyprus in Slovenia) have joined the list of banks supervised by the ECB.[22][21]

All 20 eurozone member states automatically participate in the SSM.[23] Croatia, being the latest country to join the Eurozone on 1 January 2023, was accordingly added to the scope of application of the SSM.

Under the European Treaties, non-Eurozone countries do not have the right to vote in the ECB's Governing Council and, in return, are not bound by its decisions. As a result, non-Eurozone countries cannot become full members of the SSM (i.e., they cannot have the same rights and obligations as Eurozone SSM members). However, non-Eurozone EU member states can enter into a "close cooperation agreement" with the ECB. This procedure is organised by article 7 of the SSM regulation (Council regulation (EU) No 1024/2013) and the ECB decision 2014/510.[24] In effect, these agreements imply the supervision of banks in these signatory countries by the ECB.[25] A close cooperation agreement can be ended either by the ECB or by the participating non-Eurozone member state.[14] Bulgaria, which is in the process of adopting the euro currency, signed a close cooperation agreement with the ECB in 2020.[26] Croatia likewise had a close cooperation agreement with the ECB prior to joining the eurozone.

The Supervisory Review and Evaluation Process, also known as ‘SREP’, is a periodic assessment of the risks taken by European banks. This process, undertaken annually by supervisors from the ECB and Joint Supervisory Teams, is an essential element of the implementation of the Single Supervisory Mechanism. The aim of the SREP is to make sure that banks remain safe and reliable; that any factors that could affect their capital and liquidity are under control.[27] Today, the capital and liquidity levels of banks are then directly subject to an ECB monitoring system while beforehand it was heterogeneously done at a national level.[28]

This evaluation is based on the monitoring of four different areas:[27]

• Business Model - assessment of the bank’s strategy and its main activities;
• Internal Governance - examination of the organizational structure and the management;
• Risks to capital - close analysis of risks linked to credits, markets, interest rates, and operations;
• Risks to liquidity - zoom on whether the banks have sufficient cash to cover their short-term needs.

In addition, each year, the European Central Bank is, under European Union law,[29] obliged to perform at least one stress test on all supervised banks. This test will be part of the annual SREP cycle.[30] Stress tests are computer-simulated techniques which evaluate the capacity of banks to cope with potential financial and economic shocks.[31] Annual SREP cycles are based on data from the previous year and  after each cycle, there is an individual evaluation.[27]

The overall SREP process [32]

Based on these assessments and simulations, supervisors write a report on the vulnerability of European banks, with a score ranging from 1 (low risk) to 4 (high risks), and list concrete measures for these banks to take. These measures can be quantitative - related to capital or liquidity, or qualitative (e.g., a change in the management structure or the need of holding more capital especially in times of financial crisis).[27] These actions shall normally be fulfilled by the following year. In case of non-compliance with these requirements, the ECB can charge a fine up to the double of the profits (or losses) which have been generated (or caused) by the breach and that can amount up to 10% of these banks’ annual turnover.[18] The ECB can also request national authorities to open proceedings against these banks.[18] In the worst case scenario, when a bank is likely to fail, the second pillar of the European Banking Union, the Single Resolution Mechanism, enters into play. Eventually, even though the methodology and the timeframe are identical for banks, the actions to take can significantly differ among them[33] as well as the sanctions.[34]

As banks can take considerable risks, holding capital is essential to absorb potential losses, avoid bankruptcies and secure people’s deposits. The amount of capital banks should hold is proportional to the risks they take.[35] This is closely monitored by the supervisory authorities.

Since 2016, if the results of the SREP for a bank do not reflect a proper coverage of the risks, the ECB may impose additional capital requirements to those required by the Basel agreement. This agreement provides a minimum capital requirement (called Pillar 1 requirement) of 8% of banks’ risk-weighted assets. Since Basel II, extra requirements (called Pillar 2 requirements) can be set in order to cover additional risks.[36] This second category of requirements is divided in two:

• Pillar 2 Requirement (P2R): requirements in terms of risk sensitivity and flexibility that must be fulfilled at all times;
• Pillar 2 Guidance (P2G): identification of the levels of capital to be maintained by banks in the longer run.

Finally, Basel III provides additional capital buffers covering more specific risks.

The SSM has been actively involved in the making of Non-Performing Loans action plans. In the ECB guidance recommendations, the SSM, along with the European Banking Authority (EBA), have introduced a new definition of Non-Performing Loans (NPLs) that relates to the optimisation of the disposal of the NPLs by the banks. The main purpose is to integrate the multidimensional framework that the banks use in their evaluation process in the comprehensive assessment by the Supervisory Authority.[37]

A bank loan is non-performing when the 90-day period is exceeded without the borrower paying the due amount or the agreed interest.[37] If customers do not follow the agreed upon repayment terms for 90 days or more, the bank must further protect itself by increasing its equity reserve in the event the loan is not paid. The purpose of this procedure is to increase the bank's resilience to shocks by sharing the risk with the private sector. In other words, addressing the problems associated with PNPs in the future is paramount to consolidating the banking union, while developing lending activity.

The new provisions put in place a "prudential backstop," or minimum common loss guarantee for the reserve funds that banks set up to deal with losses from future non-performing loans. If a bank fails to meet this agreed minimum level, deductions are made directly from its capital.[38]

Before the financial crisis of 2008, an increasing number of banks were merging across Europe.[39] This trend stopped as a result of the crisis: between 2008 and 2017, while we saw a decline in the number of cross-border M&As,[40][39] domestic consolidations (i.e., between two national institutions) rose.[41] In 2016, there were about 6 000 banks in the Eurozone, most of which with a clear focus on their domestic market.[42] Today, the European banking landscape is composed of banks with a smaller market share at the EU level than what can be observed in the United States.[42] As a result, the European market is said to be more fragmented and therefore less competitive than in the US or Asia.[39][43]

Cross-border mergers in banking would help banks to diversify their portfolio and, therefore, better recover from localized shocks in the economy.[42][44] On the other hand, spreading risks across different geographies could also be a threat to the stability of financial markets: one might, indeed, worry of a potential effect of contagion between regions.[41][45] Such transactions could also lead to the creation of groups regarded as “Too big to fail”, which, in case of systemic crises, would require significant support from the public purse.[44] Following the terrible consequences of the Lehman Brothers’ fall in 2008, public authorities seem committed to avoid the collapse of other systemic banks.[46] One of the side effects of these public guarantees is to encourage moral hazard: protected by a public net, these financial institutions are incentivized to adopt riskier behaviors.[47] As this opposition of opinions illustrates, if cross-border mergers might have the potential of reducing the exposure of individual firms to localized shocks, studies[47] show that they also increase systemic risks on financial markets.

In the attempt to mitigate those risks, the ECB is, since 2013, responsible (as part of the Single Monitoring Mechanism), with the European Commission, for assessing the soundness of banking mergers (Council Regulation No 1024/2013, Art. 4).[18] While the European Commission is in charge of checking the impacts such transactions will have on competition and, therefore, on consumers, the ECB is tasked to monitor the risks entailed by the suggested consolidations. If a transaction includes the acquisition of more than 10% of a bank’s shares or voting rights (i.e., a qualifying holding – Regulation 575/2013, Art. 4(1)36),[48] it must be reported to the national competent authority of the Member State in which the bank is established. This national authority must then conduct an assessment of the deal and forward its conclusions to the ECB, which is the final decision-maker, validating (with or without conditions) or refusing the transaction (Council Regulation No 1024/2013, Art. 15).[18]

In 2020, the ECB published a document aiming to clarify the way they were assessing such transactions, with the objective of being more transparent and predictable.[36] Even though transactions are assessed on a case-to-case basis, the supervision process of these deals follow the same three stages:

1. The preliminary stage: the ECB advises companies to contact them early in order to get feedback on their transaction project;
2. The formal application stage: the project is officially sent for approval to the ECB;
3. The implementation phase: if approved, the project and its developments are closely monitored by the ECB.

In phase two, the ECB pays particular attention to the sustainability of the suggested business model (e.g., under which assumptions it has been built, what has been planned in terms of IT integration, etc.) and to the governance mechanism at stake (e.g. what the skills and experiences of the leadership are). With this communication, the ECB also took the initiative to clarify how it was computing the capital requirements of the new entity and how it would assess the quality of this new body's assets.

According to two PwC analysts, the publication of this document by the ECB seems to indicate that it wishes to encourage banking consolidation.[43] This position from the ECB is not new. In November 2016, the ECB wrote in its Financial Stability Review the following sentence with regards to the banking sector:

“Consolidation could bring some profitability benefits at the sector level by increasing cost and revenue synergies without worsening the so-called “too-big-to-fail” problem” (ECB Financial Stability Review, Nov. 2016, p. 75)[49]

This positioning of the ECB, in favor of bigger and more competitive banks in Europe, translates a certain bias of this institution towards the financial industry.[50] This bias can be explained by different power mechanisms at stake:

• Instrumental power: central bankers have, through their interactions with expert groups and their past professional experiences, close relationships with professionals from the financial industry, framing their preferences in support of these firms.[46]
• Structural power: banks have today such a large influence on the European economy, employing many people and financing many organizations, that the ECB actually have incentives to protect this industry.[46][50]
• Infrastructural power: central bankers rely on the banking industry to transmit their policy’s objectives to the real economy. When setting its short-term interest rate, the central bank hopes to get an indirect influence, through private banks’ lending operations, on different macroeconomic variables (e.g., inflation).[51][50]

Because of these mechanisms, it is argued that the interests of central bankers can often be found aligned with the ones of the banking industry.[46] With regards to banking consolidation, the position of the ECB, in support of large competitive banks operating across Europe, tends to favor a situation of financial stability at short-term, at the expense of longer term consequences resulting from an increase in the European systemic risk.[50]

The centralization of banking supervision at the EU level and the harmonization of banking regulations in the EU has already been a way to foster consolidation in the financial industry.[40] Nevertheless, many obstacles to consolidation – economic (e.g., poor economic conditions in Europe), regulatory (e.g., national discrepancies in corporate law) and cultural (e.g., linguistic barriers) – remain.[42][44] Zooming on obstacles linked to regulatory and monitoring practices, despite efforts of harmonization, the fact that there remain some national inconsistencies in those practices has been identified as a barrier to consolidation (e.g., some countries assess subsidiaries as separate entities, others as part of a single group).[44] Another issue is the tendency of some EU member states, since the EU sovereign debt crisis, to impose minimum capital requirements to their national banks, hindering the free movement of capital across EU’s subsidiaries.[44] This reaction could be explained by the current incompleteness of the Banking Union: lacking a third – risk-sharing – pillar, national authorities would not be ready to drop their prerogatives.[41] To sum up, despite a willingness from the sector and authorities to boost the competitiveness of the European banking industry, obstacles remain in the way of a further integration of the European banking market.

Stress tests are an integral part of the supervisory activities of the ECB.[58] Methodological flaws related to these stress tests have been identified and corrected throughout the years in order for these assessments to properly reflect the actual risk status of the banks.[59] In the 2014 stress tests, the capital strength of banks was assessed according to the Basel III approach that uses Common Equity Tier 1 as the only capital buffer. This methodology has been the subject of criticism by many scholars and organisations for its failure to provide good estimates of the actual solvency of banks. This method was deemed to favour investment banks that were less exposed to credit risk as opposed to commercial banks.[60] Today, stress tests remain flawed: e.g., they do not take into account potential externalities and spillovers while these risks have been shown to have significant impacts in a time of crisis. Andrea Enria, the head of the European Banking Authority (EBA), also pointed out the fact that these tests do not take into account possible adjustments that a bank could make in reaction to an economic shock (i.e., stress tests assume that the bank will not react to the shock). Finally, he also emphasised that, while the methodology of stress tests is transparent, decisions taken by the supervisor as a result of these tests (e.g., increase its capital or decrease its dividend payments) are the result of a mutual agreement closed with the bank in a rather non-transparent manner.[61]

In their 2018 report, the European Court of Auditors (ECA) pointed out flaws in the Comprehensive Assessment process of the SSM. The main identified flaws by the ECA were the limited resources of the ECB to gather the necessary information to assess the assets' quality of banks and a lack of effective guidance on risk assessment.[62]

A first limit to the SSM's scope of application is geographical: it does not cover all EU member states. This system hence contributes to what is known as the multi-speed Europe. Another limitation to the scope of application of the SSM is the fact that it only deals with the supervision of banks. Supervision of the rest of the financial sector (e.g., insurance firms) remains a national competence. The supervisory role of the ECB is restricted to individual banking institutions as they are defined in the Capital Requirements Directive IV.[63] This means that the ECB cannot conduct supervision on over-the-counter derivatives markets, wholesale debt securities markets and on the shadow banking industry. In addition, some aspects of bank supervision (e.g., consumer protection or money laundering monitoring[64]) continue to be dealt with at the national level.[65] Furthermore, while the ECB directly supervises the most significant banks of the Eurozone, the supervision of smaller banks remains under national realm. National authorities are also in charge of defining their own macro prudential policy, limiting the ability of the ECB to take a proactive stance on systemic and liquidity risks.[66] Finally, when the SSM was first launched, some economists were sceptical with regards to the composition of its Supervisory Board: they criticized the fact that a large majority of this board would be composed of national supervisors who "do not appreciate ECB interference in their daily national supervisory activities".[67]

The quality of the ECB’s banking supervision is dependent on the effectiveness of the Single Resolution Mechanism as well as on the creation of a deposit insurance scheme. In 2018, 17 economists published a paper calling for a reform of the banking union. These economists emphasised the necessity to consolidate the Single Resolution Mechanism, enabling the establishment of real risk-sharing mechanisms.[68] With regards to the deposit insurance scheme, it has been subject to a first proposal by the Commission in November 2015 but no tangible progress has been made since then to achieve its implementation.[69]

Thirdly, as laid down in articles 130 and 282 of the TFEU, the independence of the ECB from political actors should be guaranteed. However, the ECB has to rely on the European Parliament and the Council to take decisions regarding the reporting of its supervisory activities and the appointment of its members.[70] The perceived need of democratic legitimacy that is at the basis of these procedures can be thought to create a shift of accountability from the ECB to the institutions – or member states – of the Union.

A final important question arises when prudential supervision and monetary policy are at stake, as it is the case at the ECB: as these two areas are intertwined, how to avoid potential conflicts of interest?[66][71] The Supervisory Board is theoretically in charge of preventing these issues from happening. In practice, the ECB has already interfered with the solvency assessments of its supervised banks by, for example, purchasing asset-backed securities issued by these same banks.[72]

In 2017, Banca Monte dei Paschi di Siena, an Italian bank, was subject to a national insolvency procedure following multiple unsuccessful recapitalisations.[73] Later that year however, the ECB declared the bank to be solvent on the basis of the stress tests performed by the EBA in 2016, which was a requirement for the bank to benefit from a precautionary recapitalisation by the Italian government.[74][75] Many member states such as Germany criticised the ECB's methodology and considered it as vague and non-transparent.[73]

In 2019, the European Commission concluded a contract with the American asset management company BlackRock.[76] The company has been mandated to advise the Commission on prudential risk matters to implement sustainability in the banking regulation ecosystem.[77] This is not the first time that the ECB has been working with BlackRock: in the aftermath of the Eurozone debt crisis, in 2014, the private firm already helped the ECB conduct its comprehensive assessment of the European banking market.[78] Concerns over potential conflicts of interests have been raised regarding the choice of a private company because of the potential influence on the rulemaking of the ECB, as well as on the credibility of BlackRock to perform such a task. The Commission and BlackRock rejected any wrongdoings and respectively invoked independence and transparency.[79]

The COVID-19 crisis has highlighted new limitations concerning the methodology of stress tests. During the first half of 2020, financial markets underwent unprecedented fluctuations far from what had been considered in the most severe forecasts (e.g., in the most adverse scenarios of the EBA, oil would lose 15% of its value whereas oil price actually fell by 60% at the peak of the crisis in 2020). This Covid-19 crisis could actually be considered as a real-life stress test whose macroeconomic factors could later be used to readjust the EBA-ECB most severe scenario in their subsequent evaluations. This health crisis has also illustrated the dual role of the ECB: its actions during the crisis reflected a mix between its mandate as banking supervisor and its initiatives in support of the stability of financial markets.[80]