Reforming the SREP
The ECB unveils an overhaul of its annual bank health check
New Kid on the Block
The ECB is well aware of its status as the youngest major bank supervisor in the world. It is, after all, only ten years since the ECB took on supervision of ‘significant institutions’ in the Eurozone in the autumn of 2014. By contrast, US and UK regulators – not to mention the national European authorities from whom the ECB took over – have had several decades’ experience of overseeing ‘their’ local banks. So the ECB recognises that to some extent it is still feeling its way and continuing to develop its supervisory approach.
SREP Upgrade
As part of that learning process, ECB Supervisory Board Chair Claudia Buch this week announced changes to its Supervisory Review and Evaluation Process (SREP): its annual review of all the banks under its remit. These changes, which follow an independent review of the SREP conducted last year, aim to make supervision more tailored, more intrusive and more coherent.
Focusing on the risks
Tailoring supervision involves focusing on the specific risk profiles of each individual bank. The ECB has been repeatedly criticised for its inflexible, ‘tick box’ approach. As well as the sheer volume of inspections and data requests, banks have complained of supervisory requests that bear little relation to their specific business models (for example, wholesale banks sent detailed questionnaires on their ATM and cash handling procedures). In their view, supervisors are too often unwilling or unable to deviate from a rigid checklist of topics and questions in their review of every bank.
The ECB has acknowledged this criticism. Last year, Buch’s predecessor Andrea Enria argued that as the ECB matured it should move beyond the focus on consistency that he argued had been necessary while building a common European supervisory culture. The ECB would therefore adopt a Risk Tolerance Framework and allow supervisors to exercise greater judgement in their approach to each bank. Buch’s announcement this week follows in this vein: supervisors will be able to set priorities over several years, focus on the most significant risks for each bank (and potentially skip reviewing other issues in some years).
The key question for banks will be how far supervisors will actually use this flexibility. Prioritising inevitably involves accepting a measure of risk (that the topic deemed safe to ignore this year suddenly becomes serious) and risk-aversion runs deep in the culture of supervision. So it will be interesting to see how the ECB can encourage its staff to follow their judgement rather than take the safer option of falling back on the checklist.
Pushing harder: capital and sanctions
Buch was clear that more flexible supervision does not mean ‘light touch’ supervision. Indeed, the second major change to the SREP concerns capital. The ECB, Buch announced, is revising its methodology for calculating bank-specific Pillar 2 capital requirements, to be published by the end of this year. Banks will not be thrilled. Given Buch has repeatedly told them to build up their capital buffers to boost resilience, banks will surely assume that the new methodology will only increase their capital requirements.
Beyond capital, Buch also repeated past threats of sanctions against banks that do not meet supervisors’ expectations. The ECB, she reaffirmed, will use its full enforcement toolkit (including periodic penalty payments) to ensure banks remedy any shortcomings that supervisors identify.
Coherent and Clear
Finally, Buch promised to make supervision clearer and more coherent. The ECB will be more joined up in its planning, to better integrate bank-specific investigations with multi-bank thematic reviews. Banks will be given a clearer overview of supervisory plans, and SREP letters will be made clearer and more concise. All sensible ideas (why did no-one think of them before?), as is the ECB’s commitment to explore using AI and other cutting-edge technology, though how groundbreaking this will prove in practice remains to be seen.
One Solution: Evolution
This week’s SREP reforms represent the latest evolution of the ECB’s supervisory approach. How significant they will prove to be in practice remains to be seen. Above all, it will depend on supervisors’ willingness to take the risk involved in tailoring their activities to each bank. But these latest reforms hold out the prospect of the ECB continuing to evolve into a more flexible and pragmatic supervisor.