ECB divided over supervisor's tough stance on banks

A year since the European Central Bank took over as the euro zone’s top banking watchdog, a rift has opened up between the new supervisory division and the ECB’s monetary policy arm, four sources close to the matter told Reuters.

The tough love for banks from Daniele Nouy’s supervisory arm, ranging from raising capital requirements to proposing a cap on holdings of sovereign bonds, has not gone down well with colleagues in the ECB’s headquarters, who have been trying to stimulate bank lending to revive inflation.

These frictions risk slowing the ECB’s efforts to clean up the banking sector and break a link between banks and governments that exacerbated the 2010-2012 euro zone debt crisis.

The Single Supervisory Mechanism is separated by a ‘Chinese Wall’ from the monetary side of the ECB, meaning they have separate staff and offices, and the flow of confidential information between both arms is restricted.

SSM decisions, however, have to be approved by the ECB’s Governing Council, which includes the bank’s executive board members and the governors of the bloc’s 19 central banks. While the Governing Council has never rejected a deliberation by the supervisory board, some issues have had to travel back and forth before being formally submitted to the council, the sources said.

“There are thousands of conflicts, big and small, and the SSM is under fire from both ends, from the ECB side and from national bodies,” a source familiar with the matter said.

“There is tremendous lobbying going on by the Governing Council members, who are themselves lobbied by banks.” A spokeswoman for Nouy and the ECB declined to comment on whether there was disagreement between the two divisions.

In a speech for the SSM’s first anniversary last week, Nouy defended the current set-up and the independence of her division.

“Being ‘under one roof’ ensures that no relevant macro-level information gets lost between the supervisory authority and the monetary policymaker,” Nouy said. “At the same time, the division of competences and the separate responsibility of the ECB Banking Supervision are firmly anchored in European law.”

One of the sources also said the SSM has benefitted from the ECB’s infrastructure, knowledge and clout when dealing with other European institutions.

A major point of contention relates to the amount of extra capital, known as Pillar 2, that the SSM has asked the 122 banks on its watch to set aside for next year. Pillar 2 requirements for 2016 have gone up slightly, on average, meaning lenders may come under market pressure to top up their capital levels to keep them well above the minimum. While it is accepted that solid banks can better withstand shocks and lead to more sustainable economic growth in the long run, some within the ECB and national central banks feel this is not the right time to ask lenders to set aside more money, the sources said.

A senior Eurosystem source said the across-the-board increase in Pillar 2, coupled with uncertainty about future demands, risked discouraging banks from lending and strangling the euro zone’s fragile recovery. “This looks like a stealth capital increase,” the source said. “Is this a one off or the first in a long series? The former would just be painful front-loading, the latter would be recessionary.”

Nouy appeared to address some of these concerns on Tuesday, when she said the 2016 Pillar 2 buffers were likely to provide a blueprint of what capital requirements will look like in a “steady state”.

The ECB spokeswoman said empirical work suggested capital requirements have a small negative effect on the supply of credit but this is more than offset by their positive long-term impact. One of the specific issues the SSM has been asked to look at is how the Pillar 2 buffer it sets as part of its Supervisory Review and Evaluation Process (SREP) fits with other cushions that lenders have to build up for rainy days, one of the sources said.

Part of the problem is that an EU directive on banking resolution does not specify whether the Pillar 2 add-on should be factored in when calculating how much a bank can pay in dividends, bonuses and coupons on some convertible bonds if its capital falls below the minimum requirement. Nouy said in a recent interview the SSM is looking into this issue but had yet to come up with an answer.

In some cases, differences of opinion have already spilled over in public. A proposal, which had been publicly backed by Nouy, to scrap a rule allowing banks to count capital from their insurance arm towards the parent firm’s capital base, albeit at a discount, was voted down by the supervisory board.

Doing away with this rule, known as the Danish compromise, would shave off billions of euros from the capital of banks such as France’s Credit Agricole and Belgium’ KBC, according to JPMorgan estimates.

On another occasion, ECB vice president Vitor Constancio said a plan, which had been put forward by Nouy among others, to cap a bank’s holdings of a country’s sovereign bonds had “serious flaws” and could disrupt the banking sector, financial markets and the economy.

A different mindset and organizational structure between supervisors and central bankers may go some way in explaining these differences.

Each joint supervisory team, which includes staff from the SSM and from national central banks, focuses on one bank and makes decisions based on that firm’s specific situation.

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