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September 18, 2018

At the ACPR Conference on Financial Supervision in Paris, the ECB President Mario Draghi outlined the benefits of banking supervision in Europe and examined ways to improve European supervision to foster banking integration. He also emphasized that progress in completing the Banking Union—namely, first harmonizing options and discretions (O&Ds), completing resolution, and laying groundwork for the creation of an effective deposit insurance—is essential.

Mr. Draghi described the three important benefits of European supervision that have been instrumental in making banks more resilient: it harmonizes supervisory practices, adopts a system-wide perspective when monitoring and mitigating risks, and reduces fragmentation in the supervisory framework. While discussing the benefits of European supervision when compared with the fragmented system of national supervision, he highlighted that European supervisors have identified 175 O&Ds available under the EU law; out of these, 130 O&Ds are available to national supervisors and are applied in a uniform way across the euro area. More harmonized rules have helped rebuild confidence in banks and reduce compliance costs for cross-border groups. However, the remaining O&Ds exercised by the national legislation still stand in the way of a level playing field for banks; thus, further legislative action is still needed. He added that harmonization of national insolvency rules is needed to make European resolution more effective.

Next, he discussed the two "important obstacles that exist in the area of supervision." The first is related to legacy assets, which have weighed on cross-border lending and which include non-performing loans (NPLs) and level 2 and 3 exposures. Although, over the past three years, the NPL stock of significant banks decreased by one third, NPL ratios of euro area banks are still higher than those of U.S. banks. Further efforts are needed from banks, supervisors and regulators to reduce the remaining stock of NPLs, especially in those countries where the NPL ratio remains high. European supervision also needs to continue and extend its work on the valuation of level 2 and 3 exposures.

According to Mr. Draghi, the second obstacle to cross-border integration lies within the prudential framework. Regulatory capital cannot be freely allocated across subsidiaries of cross-border groups. Banks are required to comply with capital requirements on a standalone basis and waivers can only be applied to domestic banking groups. While the free movement of liquidity across borders is made possible by cross-border waivers, the practical application of these waivers is hampered by the remaining national prerogatives in the regulatory framework, which allow national authorities to apply large exposure limits on intragroup lending and ring-fence liquidity. The free movement of funds is a precondition for a single banking market.

Among other regulatory factors that are hampering cross-border integration, the international regulatory framework does not treat the euro area as a single jurisdiction for the purposes of calculating capital surcharges (global systemically important bank, or G-SIB, buffers). Intra-euro area cross-border loans from euro area banks are considered foreign loans, leading to higher systemic risk scores and capital requirements relative to their international peers. Therefore, it is crucial that reforms to complete the Banking Union do not lose steam, so that the euro area can be treated as a single jurisdiction in the international G-SIB framework. In conclusion, the ECB President reiterated the importance of completing the Baking Union and added that he is "confident that significant steps in this direction will soon be taken."

Related Link: Speech

Keywords: Europe, EU, Banking, Banking Union, Single EU Jurisdiction, Options and Discretions, NPLs, G-SIBs, ECB

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