Europe’s New Banking Supervisor Promises Transparency and Rigor

France’s Danièle Nouy believes ECB’s asset-quality review and stress tests can resolve concerns about banks’ health once and for all.

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Recruited by the Banque de France after scoring highly on her civil-service entrance exam, Danièle Nouy decided to take the practical path of banking supervision rather than pursuing the high theory of monetary policy. “It looked to me as if it was a real job, checking concrete things: balance sheets, accounting, provisions,” she recalls. “I thought I would do that for three to five years.”

Talk about an underestimate. Forty years later Nouy is capping a career in supervision by taking on what may be the biggest job in Europe: chairing the European Central Bank’s new single supervisory mechanism. The SSM, as it’s known, is due to take over supervisory duties from national regulators in the 18-nation euro zone late this year, making it a pillar of the bloc’s so-called banking union. In advance of that transition, Nouy and her colleagues are gearing up to perform an asset-quality review and stress test of nearly 130 top banks in the euro area this year. Most analysts regard this as the last chance to stabilize the banking sector and draw a line under Europe’s financial and economic crisis. Nouy, a former secretary general of the Basel Committee on Banking Supervision who turns 64 this year, spoke recently with Institutional Investor International Editor Tom Buerkle.

Institutional Investor: The perception in the market is that previous stress tests by the European Banking Authority weren’t rigorous enough. What were the biggest failings?

Nouy: In my view, the EBA has not failed. They have done their best with the framework — the powers they were given. It’s not a surprise that we need to have something more integrated, some kind of federal institution. The legal texts are quite good. We are building the supervisor with the credibility and the reputation developed by the ECB. Of course, this is also an obligation. Doing a great job as a supervisor would add to the reputation of the ECB.

What’s the biggest difference under the new setup?

Harmonization is very important. There are far too many national options in the European legislation, and I would prefer for this to come to an end, to have some kind of sunset clause. Starting in November the ECB will be the supervisor, so the possibility to decide what national options to use will disappear.

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For the second part of the exercise, the stress test, we probably will feel free to test whatever we think needs to be tested. We will have a common exercise for everybody. There is good reason to believe that this time the result will be different. We are really committed to doing a very transparent exercise. Rightly or wrongly, the markets are concerned about European banks. I think that this transparency we are striving for will bring confidence. And thanks to this new confidence, banks will be in a better position to get what they need from the markets: equity and funding. And they will be able to get back to their original role, which is financing the real economy.

You told the European Parliament that banks should be holding capital against sovereign debt, but those debts currently have a zero risk weighting. How tough can you be?

Well, in fact, it’s not zero risk weights for banks that are using models. It is zero in the standardized approach. So what I said to the Parliament is that we should not have regulations that are incentives for the banks to hold more sovereign risk. For example, the liquidity coverage ratio in my view is an incentive — a too-strong incentive — to hold more sovereign risk. It’s important to keep room in the balance sheets of the banks to finance the real economies more than to finance, for example, public deficits.

What will the asset-quality review produce in terms of a result?

The idea of the AQR is really to make sure that there is zero uncertainty as far as the balance sheets of the banks are concerned. It is really about transparency. We have to be sure that all the provisions needed have been taken, that all the valuations that are used are correct. This is necessary because we need a solid base for the stress test and for our work as supervisors going forward.

The objective is to target the most-risky portfolios. For example, regarding the French banks, everybody wants to look at real estate portfolios — commercial real estate and mortgages. We consider in France that we learned our lesson, painfully, in the ’90s with the commercial real estate crisis and that we have been extremely tough after that.

Will the exposure of Italian banks to small and medium-size companies be a priority for you?

I’ll wait until I know what exactly the situation is before I take a view. I’m quite happy that there will be this exercise that will be done in a very transparent fashion, very consistently. Everything will be on the table.

Does the slow progress on a single resolution mechanism and resolution funding concern you?

Indeed. I would like very much that we have a single resolution mechanism in place as close as possible to November 2014. The SSM provides its true effect only if we have a single resolution mechanism. I also would like to have the best possible one. It should address the situation not only of the roughly 130 significant banks that the SSM will supervise directly, but it should be able to take care of all the banks. The ECB, on its own initiative, can take direct control even of small banks. We probably can live for a short period of time with something which is not the optimal solution.

Frankly, what has been done regarding the banking union in Europe is quite impressive. It has gone very fast. So I am quite hopeful.

What do you think you’ll be able to say one year from now?

We stopped all uncertainty once and for all. That will happen; there is no doubt about that. Then, of course, we will be building on this transparency, making sure that the transparency is maintained and making sure that we are able to have the intrusive supervision which is needed.

See also “Europe Looks to the ECB to Restore Region’s Banks to Health.”

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