The European Central Bank (ECB) published its annual report on supervisory activities in March. It provides useful insight into the 2016 priorities and workings of the ECB as a supervisor. The report summarizes the ECB’s supervisory priorities and acknowledges that the key priorities are unlikely to be fully addressed within one year and will remain on the list in future years.

The report confirms that the biggest Banking Union challenge is business model and profitability risk at significant institutions – return on equity (RoE) was 4.6 percent on average in 2015. The EBA’s most recent estimate of EU banks’ cost of equity was 9.15 percent¹. The ECB reiterated its message that the large amount of non-performing loans (NPLs) is clearly dragging RoE down and impairs bank’s abilities to generate capital. One of the keys to addressing this is to proactively address NPLs. The supervisory pressure to develop a profitable strategy is likely to lead to loan disposals as banks exit less profitable lines and enter core profitable markets. Of course, this raises capital management issues.

The SSM’s three special initiatives of 2015: Options and National Discretions; the Supervisory Review and Evaluation Process (SREP); and Non-Performing Loans remain on the agenda for 2016. Of note, the rules for Options and National Discretions came into force in March 2016. 

Besides the aforementioned and already well known strategic stance of the ECB, the report outlines some interesting details on supervisory activities and organizational design:

• The ECB is now nearly operating at full capacity with permanent staffing of approximately 1,000 people. However, KPMG’s ECB Office understands that this number is being significantly supplemented by national experts seconded to the ECB giving the institution a significant pool of manpower. This healthy resourcing contrasts with institutions such as the EBA who are forced to manage with significantly smaller staff resources.
• Supervisory fees levied in 2015 were €296 million. This is a relatively high figure but not unexpected given the startup phase. For comparison, BAFIN charged just over €200 million to industry for the 2014 industry levy. BAFIN had over 2,500 staff and covers banking, insurance and securities firms. The ACPR in France with a staff of just over 1,000 charged approximately €185 million to the banking and insurance industry in 2014. Of note is that the ECB recently announced a budget of €404 million for 2016. With this escalation in costs, it seems inevitable that budget and cost control may become an issue soon for the SSM.
• While discussing cooperation with other regulators, the report mentions that Memorandum of understanding with priority third countries will be presented throughout 2016. This area of cooperation between supervisors is something that global banks are keen to get a fix on.
• The report discusses the first cycle of harmonized SREP for the significant banks. Average total capital requirements increased by 50 basis points. Average Pillar 2 capital requirements for banks were increased by 30 basis points from 2015 to 2016. An additional 20 basis points of capital requirements are the effect of the phase-in of the systemic buffers.
• The capital conservation buffer will be phased in by 2019; the Pillar 2 requirements currently imposed should be reduced in equal fashion.
• The ECB conducted 250 on-site inspections in 2015. Credit, governance and operational risk accounted for almost 70 percent of these inspections. Inspections typically last 8-12 weeks.
• A network of senior model experts from National Competent Authorities (NCAs) and the ECB has been established to execute the Targeted Review of Internal Models (TRIM). It foresees on-site investigations of selected credit, market and counterparty credit risk models from 2017 to 2018 (or to 2019, if the project is extended for credit risk), while 2016 will be devoted to the required horizontal analyses that will define the harmonization goal of the project.
• The report also gives detail on the range of decisions made by the Supervisory Board in 2015 as well as reporting of breaches to it and the extent of recourse to the Administrative Board which can be used to challenge SSM decisions. It is also implicit in the report that the ECB’s current decision making approach requires refinement – this will need to be addressed in the near future. Simply, too many small decisions require Supervisory Board approval, thus clogging the decision making process. This is consistent with feedback from clients awaiting decisions on operational issues such as fit or proper reviews or model change requests. 

For those seeking a better understanding of the mechanics of the Single Supervisory Mechanism (SSM), the report (PDF 1.68 MB) is essential reading.