Financial Services Regulation & Compliance - Banking September 2018

DOMESTIC

Governor Philip R. Lane delivers speech discussing the importance of macro financial risk management

Governor Philip R. Lane delivered a speech on the importance of macro-financial risk management. It was noted that macro-prudential policies such as the counter-cyclical capital buffer contain pro-cyclical behaviour during expansion phases and improve resilience for future downturns. It was also noted that tackling the excessive stock of non-performing loans (NPLs) improves the stability of financial system. He advised that the sale of loan portfolios to international investors is important in macro-financial risk management by reducing national exposure to adverse shocks. Governor Lane noted three reasons to set more ambitious fiscal targets; it cannot be ruled out that the surge in corporation tax revenues may have some temporary elements, some of these revenues should be categorised as a windfall. Secondly, the current low interest rate environment is not expected to persist indefinitely, so a tighter non-interest budget balance offers protection against future increases in debt servicing costs. Thirdly, the legacy of high public and private debt levels mean that Ireland is relatively more vulnerable to reversals compared to other countries with less-leveraged public and private balance sheets.

Central Bank of Ireland (CBI) publishes note on Cures and Exits: the drivers of NPL resolution in Ireland from 2012 to 2017

The CBI has issued a note advising that NPL balances in the Irish retail banking system declined from €85bn in 2013 to around €25bn in 2017. It was noted that this decline came about using regulatory return data and loan-level data for all property-related lending segments. The note highlighted that NPL resolution is a gradual process: the majority of NPL balances in one year remain as NPLs a year later and also advised that loan “cure” (the return of previously-defaulted balances to Performing Loan status) is the key driver of NPL reduction in the residential mortgage segment. This is particularly true for principal dwelling home mortgages, where loan restructuring has played a pivotal role. In contrast, loan exit, through liquidations, write-offs and sales accounts for a large majority of the NPL reduction in the commercial real estate segment, where concerns about borrowers’ access to housing are less central to the policy discussion.

Deputy Governor Ed Sibley delivers speech titled "Banking Crisis – a decade on"

Deputy Governor Ed Sibley of the CBI delivered a speech at the Trinity College, Behind the Headlines series discussing the banking crisis. It was noted that a myriad of decisions both large and small, including decisions not to act, led to the global financial crisis and its catastrophic effects in Ireland. There is also a strong argument that Ireland, as a small and open economy, was and is more susceptible to the economic cycle and is likely to experience more froth in the good times and is at greater risk of severe downturns than larger, less open economies. In the 10 years since the onset of the crisis, rules are used to support a more assertive, outcome focused approach to supervision so the construction of today’s system has been driven by the lessons of the last 10 years. Mr. Sibley outlined that legacy issues remain including the remaining high level of NPL's and capability issues in critical areas, including in IT risk management. Mr. Sibley stated; "Building resilience now, for individuals, governments and banks will serve us well for future downturns".

Deputy Governor Sharon Donnery delivers speech titled "Lessons from the crisis 10 years on - Ireland learned the hard way"

Speaking at the Dublin Economics Workshop in Wexford, Sharon Donnery, Deputy Governor of the CBI, outlined five key lessons from the Irish financial crisis. The lessons outlined in the speech are; the need to mitigate the build-up of systemic risk, with both macro-prudential and micro-prudential policy tools, the need for all sectors of the economy to build resilience, the type and quality of regulatory capital, and not just the level, are important for banks. It was also noted that whilst some banks will inevitably fail, in order to protect taxpayers, we must actively prepare for their failure and ensure that impediments to resolvability are removed and the crisis showed the need for cross-border authorities, but further work must be undertaken to sustain the Banking Union. Deputy Governor Donnery said: “The crisis affected every aspect of Irish society, of the Irish economy, of the Irish banking system. A decade later, significant numbers of people across the country are still dealing with its legacies.”

CBI publishes research technical paper titled "An Early Warning System for Systemic Banking Crises: A robust model specification"

The paper outlined that during a systemic banking crisis, a country’s financial and corporate sectors may experience a large number of defaults, whereby the impacted financial institutions may face difficulties meeting their contractual obligations. During such periods, more than one bank faces the threat of insolvency and the state maybe required to intervene in order to shore up confidence in the country’s financial system. Since the financial crisis of 2008, the development of various systemic crisis Early Warning Systems (EWS) had occurred, whose objectives’ are to provide a reliable advanced warning signal to allow national authorities to consider the activation of macroprudential instruments early in the cycle. In the paper a new benchmark multivariate EWS combining local/global variables was put forward which aims to allow for timely intervention to help deflect the scale and extent of the damage which might otherwise occur in a banking crisis.

CBI announces countercyclical capital buffer rate (CCyB)

The CBI announced that the CcyB rate on Irish exposures is to be maintained at 1 per cent. The 1 per cent rate was originally announced by the Central Bank in July and comes into effect in July 2019.The Central Bank considers a 1 per cent rate to be consistent with its objective for the CCyB of promoting resilience in the banking sector in order to mitigate the risk of a pro-cyclical reaction of bank lending to the real economy in any future downturn or period of systemic stress

EUROPEAN

Peter Praet delivers speech titled "Creating an enabling environment for pan-European banks in the Banking Union"

Peter Praet, member of the Executive Board of the ECB, advised that in recent years the European Union has achieved major progress towards financial integration. Mr Praet noted that the Banking Union contributes to providing effective mechanisms for cross-border risk-sharing and broadening the sources of funding within a country, thereby promoting macroeconomic stability and growth. However, it was noted that we still observe a number of obstacles that hinder the fungibility of capital and liquidity of banking groups. Firstly a number of national options/discretions are hindering the practical application of cross-border liquidity waivers within the Union and secondly the proposal to have cross-border capital waivers within the EU was not taken forward in the on-going review of the CRR, which was a missed opportunity. Peter noted that the progress made in the Banking Union should be recognised in the international regulatory framework.

Sabine Lautenschläger, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB issues speech titled "European banking supervision - towards a common culture"

Ms Lautenschläger discussed the steps taken since 2014 in establishing a truly European system of banking supervision and embracing a common supervisory culture. It was noted that the ECB strive to increase the number of cross-border on-site missions, with more on-site supervisors working on banks outside their home country. However the success of this initiative will largely depend on the number of on-site supervisors the national authorities are willing to send. It was also noted that the ECB have established a rotation scheme for members of the Joint Supervisory Teams which will help to spread a common culture and avoid supervisory capture. It was noted that the ECB cannot create a common supervisory culture by itself and the national authorities should contribute too by embracing the European idea. It was advised that national reporting requirements should be dropped and we should aim for a single European reporting framework.

European Banking Authority (EBA) publishes quantitative impact study (QIS) templates to be used in assessing the impact of the finalised Basel III standards in 2018

The EBA released two sets of templates, which will be used in the 2018 impact assessment of the finalised Basel III standards. These two sets of QIS templates will ensure that the data collection burden is proportionate to the institutions' size and complexity. Following the European Commission's Call for Advice on the implementation of the revisions to the Basel III standards, the EBA launched a data collection exercise in August, which runs in parallel with Q2-2018 EBA-BCBS Basel III regular monitoring exercise. To ensure that this data collection remains proportionate to the size and complexity of each institution, the EBA distributed two different types of QIS templates, building on the EBA-BCBS Basel III regular monitoring templates. The ‘full' template was distributed to banks participating in the monitoring exercise and to those that are defined as large by Tier 1 capital higher than EUR 1.5 billion. The ‘reduced' template was distributed to banks that are defined as medium or small by Tier 1 capital equal or lower than EUR 1.5 billion.

ECB launches public consultation on the risk-type-specific chapters of its guide to internal models

The ECB published the credit risk, market risk and counterparty credit risk chapters of guide to internal models for consultation. The Consultation period ends on 7 November 2018. Risk-type-specific chapters outline how ECB aims to ensure uniform understanding of existing legal framework. The chapters on credit risk, market risk and counterparty credit risk are intended to ensure a consistent approach to the applicable regulations on internal models for banks directly supervised by the ECB. The risk-type-specific chapters focus on providing transparency regarding the way the ECB understands the applicable regulations for using internal models to calculate own fund requirements for credit risk, market risk and counterparty credit risk. The guide draws on the experience gained from on-site investigations in the context of the targeted review of internal models (TRIM) project in 2017/2018 and the feedback received from institutions on a first version of the guide that was made available on 28 February 2017.

ECB publishes FAQs on public consultation on the ECB guide to internal models - risk-type-specific chapters

The ECB published FAQs on the ECB's guide to internal models, in particular the risk specific chapters of the guide. The guide provides transparency on how the ECB understands the most significant aspects of the applicable regulations governing the internal models used by the institutions it directly supervises to compute own funds requirements for credit, market and counterparty credit risk. The FAQ's cover topics such as the purpose of the guide, the purpose of the three risk specific chapters, the link between the ECB guide to internal models and the TRIM guide published in 2017 and the next steps following the consultation.  

Basel Committee on Banking Supervision (BCBS) issues revised instructions for Basel III monitoring

The BCBS issued revised instructions for Basel III monitoring. The BCBS is monitoring the impact of Basel III: A global regulatory framework for more resilient banks and banking systems (Basel III standards), the Basel III leverage ratio framework and disclosure requirements (the Basel III leverage ratio framework) and Basel III: The Net Stable Funding Ratio (Basel III NSFR standards) on participating banks. The BCBS is also monitoring the overall impact of Total Loss Absorbing Capacity (TLAC) and banks’ holdings of TLAC instruments, of the revised securitisation framework, the treatment of sovereign exposures, the revised minimum capital requirements for market risk as well as the Committee’s finalisation of post-crisis reforms. For market risk, the Committee is also collecting data on back testing and profit and loss (P&L) accounts related to the revised internal models-based approach (IMA) for calculating minimum capital requirements for market risk more specifically. The exercise will be repeated semi-annually with end-December and end-June reporting dates. 

BCBS issues FAQs on Basel III monitoring

The BCBS issued FAQ document on Basel III monitoring which intended to facilitate the completion of the monitoring questionnaire. The Committee published the FAQs as its official response to questions of interpretation relating to certain aspects of the Basel III standards. The BCBS has advised that banks should also take into account the frequently asked questions on capital, counterparty credit risk, the Basel III leverage ratio and the net stable funding ratio (NSFR) published by the Committee.

EBA issues revised list of validation rules

The EBA issued a revised list of validation rules in its Implementing Technical Standards (ITS) on supervisory reporting highlighting those, which have been deactivated either for incorrectness or for triggering IT problems. Competent Authorities throughout the EU are informed that data submitted in accordance with these ITS should not be formally validated against the set of deactivated rules.

European Banking Federation (EBF) publishes 2018 Facts and Figures on Banking in Europe

The EBF published its annual update detailing the facts and figures for banking in Europe in 2018. The publication shows that the contraction in the European banking sector, both as measured in terms of staff numbers and branches, continued in 2017 as the industry continued to improve efficiency while enhancing its profitability. The update seeks the consolidation of European banks to boost efficiency and enhance profitability. It outlined that the total number of credit institutions in the EU is down by 31% since 2008. It outlined that EU NPL stocks declined considerably due to the enhanced loan selling activities of banks, showing that NPLs are no longer a specific European problem.

EBA revises standardised Non Performing Loans (NPL) data templates

The EBA published a revised version of the standardised NPL data templates that aim at facilitating the NPL sale transactions across the EU. The revised templates include minor changes following the feedback received from the testing of the original version published in December 2017. The practical experience from the use of the EBA NPL templates by various institutions and the EBA's engagement with stakeholders since their publication in December 2017 has resulted in additional feedback. As a result of this feedback, the EBA published a revised version of the NPL templates. The EBA standardised set of NPL data templates provide a common data set for the screening, financial due diligence and valuation during NPL transactions in the EU.

EBA publishes speech delivered by Andrea Enria titled "Fragmentation in banking markets: crisis legacy and the challenge of Brexit"

Andrea Enria, Chairperson of the EBA delivered a speech at the BCBS-FSI High Level Meeting for Europe on Banking Supervision and discussed financial integration during these challenging times. It was outlined that, despite achievements in terms of balance sheets cleaning, regulatory harmonisation, and deepening institutional integration within the Banking Union, where the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) are up and running, financial integration is lagging behind. The global framework to restore trust and support cross-border banking business has been laid down in Basel: strong international standards, close monitoring of compliance with those standards and a framework for crisis preparedness, management and resolution that should allow choosing cooperative approaches rather than ring-fencing policies. It was noted that a renewed focus on the openness of the Single Market and cooperation with authorities from third countries should gain prominence in a post-Brexit environment.

European Parliament publishes briefing on Money Laundering – Recent cases from an EU banking perspective

The briefing provides insight into recent cases of breaches or alleged breaches of AML rules by SSM supervised banks and identified some common prudential features. The briefing also outlines the respective roles of European and national authorities in applying AML legislation that have been further specified in the 5th AML Directive adopted by the European Parliament Plenary on 19 April, and ways that have been proposed to further improve the AML supervisory framework.

ECB published speech delivered by Mario Draghi titled "The Benefits of European Supervision"

The ECB has published a speech delivered by Mario Draghi, President of the ECB, at the ACPR Conference on Financial Supervision. It was outlined that the global financial crisis exposed weaknesses in the regulation and supervision of banks within the EU which were exacerbated by fragmentation. From the early stages of the crisis the banking sector fragmented along national lines, driven by diverging macroeconomic conditions in different countries and by governments’ diverging responses in dealing with failing banks. It was noted that what ensures a steady flow of bank lending to the economy, even in times of unforeseen stress or disruption, is a growth-friendly environment, which can only be assured by the appropriate government policies.

ECB publishes report on the outcome of SSM thematic review on profitability and business models

From 2016 to 2018 the European banking supervision authorities undertook a thematic review in order to assess the profitability drivers and business models of the significant institutions. The aims of the review were to assess banks’ ability to strategically steer their business models and to monitor the consequences of weak profitability for banks’ risk-taking behaviour. The main conclusions drawn by the report are that profitability and business models remain under pressure, the profitability situation differs widely across institutions, insufficient strategic steering of profitability may exacerbate banks’ challenges and banks’ responses to profitability challenges vary. The results of the thematic review feed into the 2018 Supervisory Review and Evaluation Process (SREP) and may trigger on-site inspections and “deep dives” where further analysis is required.

EBA publishes report on Funding Plans

The EBA published a report on Funding plans. The objective of the report is to analyse the feasibility of submitted funding plans for the EU banking system. To assess the feasibility of asset growth forecast by banks on an aggregated level, as well corresponding forecasts on deposit and market-based funding, the report compares submitted data with market and statistical information, such as historical issuance volumes and economic forecasts. The report discusses recent developments of liquidity and funding conditions in the EU, asset and liability trends and trends in pricing for assets and liabilities. The report concluded that banks expect growth in both assets and liabilities over the next 3 years and that there was a sharp decrease in the public sector funding projected by banks in some countries which raises the question of how this source of funding is to be replaced, so banks' strategies in this respect should be monitored.

EBA publishes report on Asset Encumbrance

The EBA published its fourth annual report on asset encumbrance. It contributes to the ongoing monitoring of the composition of funding sources across the EU. The report outlined that the quarterly data for the year 2017 shows a slight increase in the level of asset encumbrance across the EU compared with 2016 and 2015. It was noted that whilst the asset encumbrance ratio has increased steadily since 2014, its recent increase is not an issue of immediate concern in the funding structure of EU banks, as it is mostly driven by a reduced volume of total assets as opposed to an increase in encumbered assets. The report advised that the main source of asset encumbrance, balance sheet liabilities for which collateral was posted, continues to be repos. The report also advised that the share of ‘other sources of encumbrance’ has increased further and warrants attention.

ECB publishes guide to on-site inspections and internal model investigations

The ECB published the guide with the assistance of National Competent Authorities (NCA's) of the Member States participating in the Single Supervisory Mechanism (SSM). In accordance with Council Regulation 1024/2013 of 15 October 2013 (the SSM Regulation), the supervisory authority of the ECB over supervised entities is exercised through off and on-site supervision, the combination of which aims to ensure a detailed analysis of the supervised entities’ business. On-site supervision is performed through on-site inspections (OSIs) or internal model investigations (IMIs), as stipulated in Article 12 of the SSM Regulation. The guide explains how ECB Banking Supervision conducts inspections, it aims to support supervisory practices and to increase transparency.

EBA launches its 2018 EU-wide transparency exercise

The EBA launched its fifth annual EU-wide transparency exercise. In December 2018, together with the Risk Assessment Report (RAR), the EBA will release over 900,000 data points on 130 EU banks. This data disclosure is an important component of the EBA's responsibility to monitor risks and vulnerabilities and foster market discipline. The transparency exercise covers a wide sample of banks and countries and provides consistent time series of semi-annual bank-by-bank financial information since 2011. In 2018, the sample of banks will be aligned with the one used for the 2018 EBA RAR and the exercise will be based exclusively on supervisory reporting data. The data for December 2017 and June 2018 will cover financial information on capital, leverage ratio, risk exposure amounts, profit and losses, market risk, securitisation, credit risk, exposures to sovereign, non-performing exposures and forborne exposures.

ECB publishes working paper titled "Who bears interest rate risk"

The ECB published a working paper which examines the allocation of interest rate risk among euro area banks. It was found that the exposure of the aggregate banking sector is very limited. However, exposures are very heterogeneous across individual institutions, and a significant share of banks would benefit from an increase in interest rates. This observation is at odds with conventional wisdom, according to which banks are maturity transformers that are vulnerable to increases in interest rates.

EBF issues comments on the draft EBA Guidelines on outsourcing

The EBF has published comments on the draft EBA guidelines on outsourcing, advising that it is crucial that the Guidelines strike the right balance between necessary safeguards preserving the integrity of outsourcing institutions, and the required flexibility to adapt to a fast-moving economic and technological environment. In particular, the EBF noted that the specific requirements should only apply to outsourcings classified as critical/important. The key points made by the EBF pertain to the scope and definition of outsourcing and notification requirements. It was noted that standard contractual clauses will be necessary for outsourcing agreements.

EBA publishes Banking Stakeholder Group (BSG) response to EBA Draft Guidelines on outsourcing EBA/CO/2018/11

The EBA published the BSG's response to the EBA's draft guidelines. It was noted that intragroup outsourcing arrangements are considered as especially risky, however the BSG feel that that this perception does not take into account the higher ability of outsourcing institutions to control companies within their consolidation perimeter, nor the complementary measures and controls already required by other financial regulations. It was noted that the Guidelines should recognise the degree of integration reached within many banking groups, where centralized functions at ground level act as a service provider for the other entities of the group. In this context, it was suggested that the proposed requirements on documentation, due diligence, concentration risk and exit strategy prove to be less relevant from an intragroup perspective. It was also noted that clarifications to the definition of outsourcing are required.

ECB publishes working paper on the global effects of global risk and uncertainty

The ECB published a working paper in which it analyzed the effects of a shock to global financial uncertainty and risk aversion on real economic activity. The ECB extracted a global factor, which explains approximately 40% of the variance of about 1000 risky asset returns from around the world and studied how shocks to the factor affect economic activity in 36 emerging small open economies by estimating local projections in a panel regression framework. It found that the output responses were heterogeneous across countries but, in general, negative and persistent. Furthermore, it highlighted that the effects of shocks to the global factor are stronger in countries with a higher degree of trade and/or financial openness, as well as in countries with higher levels of external debt, less developed financial sectors, and higher risk rating.

For further information please contact a member of the Financial Regulation team.

Date Published: 10 October 2018