Shape up - or pay up

The ECB talks tough about sanctions for non-compliant banks. But will any actually have to pay?

Fine times

ECB Supervisory Board Chair Claudia Buch warned again last week that banks not complying with ECB requirements will face daily fines. In an interview with the Financial Times, Buch gave a reminder of the ECB’s decision to impose periodic penalty payments (PPPs) on banks that failed to meet its expectations on climate and environmental risk management. These banks, she explained, had been set a deadline to rectify the shortcomings supervisors had found. After that date (which the ECB has not publicly disclosed), delinquent banks must pay a fine for each day until they return to compliance.

Warning shots

The decision to impose PPPs followed several months of escalating rhetoric from ECB leaders, warning of tougher consequences for banks that do not comply with supervisory requirements.

Last April, an independent assessment of the Supervisory Review and Evaluation Process (SREP) recommended that the ECB make greater use of its full range of enforcement powers. Since then, we have heard repeated warnings from then-SSM Chair Andrea Enria, Vice-Chair Frank Elderson as well as Buch herself that the ECB will use its full ‘supervisory toolkit’ in an ‘escalation ladder’ to compel banks to comply. This sanctions toolkit includes restricting banks’ business models, (re)assessing the fitness and propriety of bank leaderships – and imposing PPPs. Elderson took a particularly tough line in a December speech, detailing the supervisor’s various enforcement powers – and proclaiming that the ECB is not afraid of potential legal challenges.

Beyond Capital

In the past, Pillar 2 capital add-ons have usually been seen as the ECB’s primary tool for forcing banks to address shortcomings. The greater emphasis on other sanctions tools is in line with a broader shift in the ECB’s focus to look ‘beyond capital’ as Enria put it last September. This shift reflects both the continued improvement in European banks’ capital positions, and the lessons the ECB took from the sudden collapse of US and Swiss banks last spring.

The ECB saw the failure of those banks – which met or exceeded their capital and liquidity ratios until shortly before they suffered catastrophic runs – as rooted in poor governance and risk management. These were issues that supervisors had to address, but for which capital add-ons were in Enria’s words sometimes ‘not effective enough in compelling banks to take the necessary corrective actions.’

So the decision to fine banks for shortcomings in climate and environmental risk management (according to the ECB annual report, 18 banks in all) looks set to be the start of a new trend in ECB enforcement. Indeed, in her FT interview Buch called PPPs a ‘general escalation tool that we would use for other issues.’ Judging from her and Elderson’s latest remarks, potential target areas for future PPP use could include weaknesses in banks’ climate transition plans or their risk information systems and broader governance problems.

Fine judgements (Do you feel lucky?)

With the deadline approaching, the immediate question is how many banks will actually have to pay? The ECB may hope that just the threat of daily fines will prove enough to make banks comply. If so, then actual penalties would be unnecessary.

Or might the ECB judge that, as with stress tests, giving all 18 banks a clean bill of health would undermine the credibility of its PPP deterrent? That it needs to make an example of at least one bank pour encourager les autres?

Bank executives can be excused a little nervousness as they wait to find out.