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January 17, 2019

Sabine Lautenschläger of ECB spoke at the Risk Management & Supervisory Conference in Ireland about the impact of Brexit and new technologies on banks and banking supervision. Ms. Lautenschläger emphasized that the European banking supervisors have made their expectations about Brexit clear and have spoken directly with banks. Brexit not only affects the banks but also regulation and supervision, which must adapt too. She also identified and examined the areas of concern for individual banks—particularly those that plan to relocate from the United Kingdom to the EU.

Ms. Lautenschläger emphasized that "we would not accept 'empty shells'" and comprehensive back-branching practices, where banks would provide services to EU clients only from branches in the United Kingdom. She added that banks are not as adaptable as supervisors would like them to be because, regarding booking models, there are still a small number of banks that have not fully adjusted in line with the expectations. However, she emphasized that "many of these banks are big enough to shoulder these changes and to bring staff to the EU" and "these banks have now started to take action." Also, EC plans to take temporary measures to preserve access to UK CCPs. However, these measures are just a stopgap and banks must make sure that they are prepared for what happens next. Keeping in mind the highly concentrated central clearing arrangements, she believes that supervisors must examine whether they want big banks to rely on a single CCP for important asset classes.

She added that Brexit preparations of the European banking supervisors must be rooted in the existing regulatory framework, which is still fragmented when it comes to supervising globally active banks. ECB still lacks the powers to directly supervise the provision of cross-border banking services. National authorities have some powers in this area, but their reach is limited too and it varies from country to country. This is a concern, as a number of global banks, located outside the EU, currently access EU markets via the United Kingdom. After Brexit, they will have to find new ways of entering EU. They might set up subsidiaries in EU, but they might also set up branches or provide services directly from non-EU countries, or third countries. European banking supervision would cover subsidiaries but it does not cover third-country branches or services provided directly from third countries, thus leaving European banking supervision without a full picture of what banks are doing and what risks they pose. Banks can seize the opportunity and engage in regulatory arbitrage. Since supervisors do not make the rules, these issues are for legislators and "I hope, though, that they will recognize that revised rules would go a long way toward mitigating post-Brexit and other risks."

The supervision of investment firms is another area where legislation urgently needs to adapt. A proposal is being discussed in Brussels to ensure that the largest investment firms in the euro area would be supervised by ECB. Giving ECB powers to supervise large investment firms will allow it to monitor and mitigate these risks. Progress on the legislative side is crucial, as several banks are still finalizing their post-Brexit plans. The clear message to be sent now is that "arbitrage of post-Brexit EU rules will not be an option." Other countries are leading the way here. The UK prudential regulator, for instance, has the powers to supervise the largest investment firms. An investment firm which provides almost all the same services as a bank, except for deposit-taking, should be supervised like a bank—by ECB. Another issue is the requirement for large non-EU banking groups to consolidate their EU activities above a certain threshold under a single intermediate parent undertaking (IPU). ECB welcomes the outcome of recent negotiations on introducing this requirement, which would enable supervisors to have a better overview of activities within the EU. However, this approach is not ideal either, as third-country branches do not have to be consolidated under an IPU.

She suggested that all banks need to keep an eye on cyber risks and work on cyber resilience, adding that the "ECB Banking Supervision will do its part." ECB will launch a number of on-site inspections on cyber risk in 2019 and will continue to monitor the situation under the Single Supervisory Mechanism (SSM) cyber incident reporting process. Referring to the impact of technology on supervision, she added that the greatest gains from what is known as suptech—supervisory technology—would be made in the collection and analysis of data. For example, automated reporting could ease the burden on banks and make data collection more efficient. Machine learning could enhance the validation of data. Virtual assistants could be programmed to address user complaints during data collection. In addition, suptech could help to improve the analysis of credit and liquidity risks. In addition to the rules-based and principles-based approaches, there would be a data-driven approach. The Austrian central bank has developed a reporting platform that bridges the gap between the IT systems of supervised entities and supervisors. The Italian central bank is exploring ways of using machine-learning algorithms to forecast loan defaults. Additionally, the Dutch central bank is working on the use of neural networks to detect liquidity risk. Some experts even argue that suptech could become a third approach to supervising banks. 

Related Link: Speech

Keywords: Europe, EU, Banking, Banking Supervision, Brexit, Third Country, Cyber Risk, Suptech, ECB

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