For Buch, Resilience is the Watchword

The SSM Chair urges banks to be ready for all scenarios

As I mentioned last week, resilience has been a key theme of Claudia Buch’s tenure so far as Supervisory Board Chair. In her 13 May written statement to the Eurogroup, Buch developed the idea and set out its implications for supervisory policy.

Resilience, Buch’s statement noted, is a broad concept with ‘several key dimensions’. It encompasses not only banks’ solvency and liquidity, but also their ability to keep their core systems and infrastructure running and the quality of their internal governance. Arguably, this stretches the concept of resilience a little too wide: good governance, in particular, is more of an input to resilience (well-governed banks will be better able to react effectively to exogenous shocks) than a measure of strength like solvency. Stretching the idea of resilience so broadly thus feels a little artificial (as if Buch felt no supervisory objective could be ‘left out’ of the framework). And it could make the idea less useful as a guide to setting priorities in day-to-day supervision.

Those quibbles aside, it is helpful that Buch has set out so clearly the idea that forms the basis for her approach to supervision. (And it is revealing – though given her background perhaps unsurprising – that Buch’s conceptual language is so closely aligned with that of the ECB’s macroprudential function in its latest Financial Stability Review, released this month.)

Boosting the buffers

It is worth noting a few implications of Buch’s focus on resilience. First, it suggests an essentially defensive or reactive mindset, imply that banks operate in a potentially hostile environment and need robust protection to ensure their survival. This is fair enough given the history of financial crises – and the ECB’s legal mandate as a supervisor. But we should recognise that it is a fundamentally conservative approach that favours preserving the system of today over pursuing any bold visions for the future. As I have written before, banks should not expect the ECB to follow other goals (such as promoting the green transition or European financial integration) at the expense of maintaining safety and soundness.

At a more concrete level, concentrating on resilience points to continued pressure on banks to increase ever further their capital buffers. Indeed, in public comments in February, March and this month, Buch herself has told banks that they should use their current elevated profits to expand their buffers, and invest in IT upgrades, in the name of resilience. Given that Eurozone capital ratios are at record highs (with an aggregate CET1 ratio of 15.73% for ECB-supervised banks in 2023 Q4, the highest in the history of SSM), some banks may be wearily asking if any amount of capital will ever be enough for supervisors.

(There is a similar story on liquidity: Buch’s Eurogroup statement noted that aggregate liquidity ratios are at a ‘comfortable level’, but the ECB still considers some banks’ funding plans to be overoptimistic. These banks at least will be facing pressure to further expand their liquidity buffers.)

What could possibly go wrong?

Capital and liquidity ratios, however, are essentially backward-looking measures. Resilience, Buch argues, must have a forward-looking component as well: banks must anticipate and prepare for future shocks. This requires banks to analyse and assess emerging risks such as adverse geopolitical or macroeconomic developments or changes in the competitive landscape.

Buch has previously pointed out that banks’ current risk models do not fully capture these novel risks, and the ECB is therefore pressing banks to use more sophisticated model adjustments. Buch has also said banks should supplement their statistical models with scenario planning tools to understand the impact of different possible futures.

One such tool that already exists is stress testing – and in her Eurogroup statement Buch wrote that banks need to capture the new geopolitical, macroeconomic and other risks in their internal stress tests. So banks should prepare themselves for more intensive ECB scrutiny of their internal stress tests. The ECB may also look for evidence of banks considering a range of scenarios during their business, capital and liquidity planning processes.

How prescriptive the ECB might be in its expectations on this front is not yet clear. But in her critique of banks’ liquidity planning, Buch highlighted that the scenarios underlying firms’ plans are ‘quite diverse and sometimes not sufficiently prudent.’ The juxtaposition suggests that the ECB does not regard diversity as a source of strength in this context - and may press banks to consider a more consistent set of scenarios when making their plans.

Prepare for the worst

As Buch acknowledged, European banks have shown themselves resilient in the face of several severe shocks in recent years, including Covid-19, war in Ukraine, and the sudden spike in inflation. This will not, however, win them a reprieve from ECB expectations to keep on building up their buffers and planning for risks that could emerge in the years ahead.