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February 28, 2018

Ignazio Angeloni, Member of the ECB Supervisory Board, suggested taking another look at proportionality in banking supervision, at the Thirteenth Asia-Pacific High Level Meeting on Banking Supervision in Singapore. During his speech, he examined how proportionality principle is translated into legal and regulatory framework; what does European Banking Supervision do to conform to that principle; and what are the challenges one faces and the limits one must respect in applying proportionality in supervision.

He outlined the work and guidelines in this area, both at the international (by BCBS and BIS) and the EU level (via Capital Requirements Regulation and Directive—CRR and CRD IV). He also discussed the areas of Single Supervisory mechanism (SSM) where proportionality applies. These areas relate to significant banks, for whom reporting requirements and fees already differ; less significant banks, for whom the scope and frequency of information requests for reporting requirements depends on the nature of the entity concerned; and the less significant banks that are prioritized into High, Medium, and Low priority entities. Next, he mentioned some initiatives under discussion at the international and European levels to enhance proportionality in banking supervision. Within BCBS, simpler approaches for calculating capital requirements (for example, credit risk, operational risk, credit valuation adjustment risk) have been developed. At the EU level, in the ongoing review of the CRR and CRD IV, EC has proposed simplified market and counterparty credit risk measures for smaller institutions as well as reductions in the frequency and scope of supervisory data reporting and disclosure.

Mr. Angeloni stated: "ECB does not support lowering the reporting frequency for such entities. Frequent reporting is a key source of information for supervisors, especially in relation to smaller institutions, which do not undergo sufficient market scrutiny. Early warning systems are effective only if data are sufficiently frequent. Another challenge stems from setting the thresholds to categorize institutions, because quantitative thresholds are difficult to apply and at the margin may create cliff effects and distortions." He then discussed the challenges and limits of proportionality in banking supervision. Although smaller banks transmit little or no risk to the system, this does not imply that they are individually less risky. He added that, in both US and EU, the number of bank failures has been much higher in less significant than in significant banks, both in absolute terms and in relative terms. Thus, he argued that prudential soundness must remain the overarching principle, regardless of size. Additionally, small banks promote diversification in the banking system; hence, reducing concentration and correlation, if they act independently from each other. However, especially in Europe small institutions are often part of larger groups or associations (such as institutional protection schemes), which reduces the benefit from diversification. The tendency to aggregate in groups or protection schemes clearly confirms the existence of powerful economies of scale and scope.

Finally, he discussed the potential social role of small banks. Small and cooperative banks are still widely recognized as having a social role by granting access to finance, or the provision of other social benefits, particularly in certain areas and for specific population groups. In Europe especially, savings and cooperative banks maintain a strong historical and cultural rooting. However, most of the cooperative sector has moved away from its original social and charitable function and, today, performs standard banking business, providing services indistinguishable from those of its competitors. There may be cases justifying a support to smaller banks that provide financial services where other banks are less present, but there seems to be no compelling reason why such support should be embedded in the prudential framework, added Mr. Angeloni. He concluded that proportionality should not lead to supervisory laxity or deviations from the single rule book. "Arguments and evidence do not support, on balance, a more favorable treatment to small banks by the micro-prudential regulator or supervisor. If deemed justified, for example for social reasons, such support should be provided otherwise. In SSM, prudential soundness, harmonization, and competitive level-playing field have been and should remain the overarching guiding principles," according to Mr. Angeloni.

Related Link: Speech

Keywords: Europe, EU, Banking, Banking Supervision, Proportionality, SSM, Basel III, ECB

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