Almorò Rubin de Cervin

Almorò Rubin de Cervin is head of the banking regulation and supervision department at the European Commission’s Directorate-General for Financial Stability, Financial Services and Capital Markets Union. He talks about the recent crisis in the banking sector, the state of play of the negotiations on the banking package, and the role of the European Commission in the latter.

We have recently witnessed a bank crisis, in the US and Switzerland. What was the impact on the EU banking sector? And which lessons do you draw for the EU?

The first lesson is that it is a reminder that banks are exposed to risks due to the role they play in our economy: they provide credit and liquidity (deposits) to households and firms. As a result, banks are vulnerable to losses on their exposures and liquidity runs. Hence, the importance of having sound regulation, strong supervision, and adequate public safety nets. This is particularly relevant in the US case, where questions are being asked, for example by the International Monetary Fund (IMF) in their recurrent assessment of the financial framework (“FSAP”), about the adequacy of the regulation and supervision which had only limited application for some of their banks, which are actually quite large. And the US are drawing lessons from that. The Swiss case raises different questions because this was a very large bank, one of the global systemically important banks (G-SIBs), which was subject to all the capital and liquidity ratio requirements – on paper, at least, it was solid. However, it had a number of problems in its business model. Given the turmoil in financial markets following the US bank failures, it faced significant deposit outflows in a week, which forced it to liquidate portfolios against a loss, and was bought by its competitor.

From the point of view of the EU, the main lesson is that two choices we made in the last 10 years have proved extremely important. The first was to apply the international Basel standards to all banks, so we avoid the distinction between different categories of banks that we see in the US, and we have now a banking system that is overall much more stable. Secondly, we put supervision in the hands of the single supervisory mechanism (SSM), to ensure sound and consistent supervision across the EU. This has also proven a very strong point because it has ensured that banks were particularly strong from a liquidity point of view, as well as when it comes to managing interest rates risk, which is very important now with interest rates rising.

Some people in the US have said that what happened with the Silicon Valley Bank and Signature Bank was in part due to the Trump-era rollback of the Dodd–Frank regulations. What’s your take on this?

The US authorities are carrying out their assessment and will come out with their analysis at the beginning of May. It is difficult to attribute all the responsibility to a single element. Banking supervision in the US is an extremely complex framework. There are several supervisors in play and the rules are applied differently depending on the size of the bank. There is also the question of governance. In both cases, Silicon Valley and Signature, there was also an issue of concentration of clients and its deposit funding base was not very diversified. They also had a large share of uninsured deposits. It's a business model issue as well. So, I would say a combination of factors is more likely rather than just one root cause, although deregulation probably contributed.

In the EU, I believe the situation is different. First, the banks don't usually have such extreme business models. Here banks are not so reliant on corporate deposits. They amount to 96% of all deposits for Silicon Valley Bank – in Europe it is rather between 60-70%, or even lower. And corporate deposits are less concentrated and less volatile. Retail deposits are also in general much more stable. Banks are well regulated, and have to respect liquidity requirements, both short term and medium term. They are also supervised closely – including for their exposure to interest rate risks. This is a risk on which the SSM carried out a dedicated exercise last year. And finally, there is the regular stress test exercise. The EU-wide 2023 stress test is actually taking place now, and the results will come out in July. One can never say with complete certainty “this would not happen here” but overall, all the above puts European banks in a good position. And I think that was made clear by analysts and also understood by markets.

The EU has put in place a raft of legislation since the 2008 global financial crisis. What is the state of play of the negotiations on the 2021 banking package? And what is the role of the Commission?

The main point is that the recent turmoil has shown the importance of well-supervised and well-regulated banks and the importance of international standards. So it should help focus minds to reach an agreement rather swiftly. We hope this could be by June, which would allow for an 18-month period of implementation. This would mean entry into application on 1 January 2025, in parallel with other jurisdictions.

In the previous banking packages, we significantly tightened the regulation of capital, liquidity, leverage, and large exposures. With this package, we are looking more at enhancing how banks measure risk in a consistent way – how they measure credit risk, operational risk, market risk. This implies a lot of changes – in the way banks carry out lending, how they manage their operational risk, and the way they measure their exposure to the short-term risks of market volatility. The key plank is a technical measure, called the ‘output floor’. The output floor is a measure that sets a lower limit (‘floor’) on the capital requirements that banks calculate when using their internal models (‘output’) and is introduced to reduce the excessive variability of banks’ capital requirements calculated with internal models. These models were allowed for banks to set their capital in terms of the data they have on their counterparties and the risks of default of their counterparties. With the introduction of the output floor, the difference between banks using standardised approaches and banks using internal models is narrowed. This has an impact on a relatively small number of banks, particularly large banks which are the ones using models. It is broadly accepted that we introduce the floor. However, we don’t underestimate the impact it has especially on mortgages and corporates, and we've given a bit more time for banks to adapt and for companies to get more ratings and then be risk-weighted accordingly.

These are the main elements. We've also included in the package a number of proposals on supervisory aspects for ‘ESG’ (environmental, social and governance risks), for instance to require banks to put in place transition plans and to empower supervisors to ensure banks are organised to manage their risks related to climate change and to foster an orderly green transition. There are also proposals to improve the fit and proper assessment of managers, proposals on supervisory aspects such as prudential consolidation and sanctioning powers. And there is a proposal to better frame non-EU – or ‘third-country’ – branches and operations in the EU.

You mention this third-country branch provision in the banking package. Could you clarify what we did compared to the previous package – and whether it would have changed anything to recent events overseas?

What happened overseas is a reminder of the risks of contagion linked to internationally active banks. There was contagion because the bank was also present abroad. Without that presence, the channel of transmission would have been slower and less significant. So that’s an important reminder. Also important is that the branch – and also the subsidiary – is only as strong as the parent. If the parent goes down, the branch will likely go down as well, and the subsidiary also. So these are reminders of the risks that derive from cross-border banking activity and banking presence.

Now, in the proposals, we are doing two things. One is to better frame the way third-country branches are supervised and regulated. We propose to keep them supervised and authorized at national level, but also to ensure that there is information for all supervisors on the activities of the branches. This is because the supervisor of the subsidiary of the same banking group needs to know what the branches of the same banking group is doing, and today that is not the case.

There is a second element, which is a legal clarification of something that is already the case, but has not been clearly spelled out and that is if you want to provide banking services in the EU, you need to have either a subsidiary or a branch in the EU. It’s the same everywhere in the world, but we want to put this down in black and white, because it emerged during the Brexit process that there was some uncertainty around it.

The SSM report was also recently published. What is this exactly and what are some of its findings?

The SSM report is assessing the functioning of the SSM, something that the Commission has to do regularly under the SSM regulation. We’ve carried out the review by desk research, but also by speaking to the SSM, to all the 21 national competent authorities within the SSM and to the six competent authorities outside the Banking Union. We sought their feedback on how the SSM is working. We also spoke to all industry associations at EU level. The overall feedback we got from everybody on how the SSM has been working was very positive. It is seen as effective and credible. Of note is the work it has done to ensure consistency across supervision. Cooperation with the authorities of the participating member states as well as cooperation with the six non Banking Union authorities was also praised. The review also shows that the SSM has been good at reacting to crises – for example the Covid crisis and the events in Ukraine.

Overall, the SSM comes across as a mature, solid, and credible supervisor.  The US banking crisis in March was confirmation that such a solid supervisor is a very important asset for the European banking system and for financial stability in the EU.