The harmonisation of banking in Europe

A look at how growth in cross-border banking and the centralisation by banks of key business functions are the main market trends affecting banking supervision in Europe today


Growth in cross-border banking and the centralisation by banks of key business functions are the main market trends affecting banking supervision in Europe today. These trends create a misalignment between the legal and operational structures of cross-border banking groups; and they present challenges to the smooth functioning of a decentralised supervisory framework and to the implementation of European banking legislation. In reality, the vast majority of the 10,000 credit institutions and investment firms in the EU operate either on a purely national or regional level. This suggests that specific national rules and practices may still be required. In these circumstances, the main objective of the Committee of European Banking Supervisors (CEBS) is as follows: to respond to these challenges by promoting cross-border supervisory co-operation, as well as the safety and soundness of the European financial system, without creating unnecessary supervisory costs or restricting fair competition. CEBS aims to pursue these objectives in an effective and efficient way by adopting good international supervisory practices and by encouraging its members to implement these in a convergent and consistent manner. CEBS’ guidelines foster a common understanding between national supervisors. Co-operation and the exchange of information on the conduct of day-to-day supervisory tasks are encouraged among the relevant national authorities.

New capital requirements
The Capital Requirements Directive (CRD) represents a paradigm shift in banking supervision. The new capital adequacy framework for banks and investment firms not only harmonises capital requirements but also encourages institutions to improve their risk management processes. At the same time, this regime change has provided CEBS with a unique opportunity to foster convergence in supervisory practices. As of January 1, this year the CRD now transpose the Basel II capital framework into EU legislation and complete a long transition from rules-based supervision to a risk-based approach. This new approach relies on internal safeguards being developed by banks themselves and on their ability to apply best practice developments in the marketplace. The more advanced the methods they have in place, the more effectively they can use their capital for business expansion. Good risk management should ultimately benefit customers in the form of a lower cost of capital. The banking sector faces another major challenge in the new International Financial Accounting Standards (IFRS) which will also benefit harmonisation of reporting and public disclosure of financial statements. CEBS is also seeking to seize this opportunity to develop standardized reporting frameworks for European banks.

The role of CEBS
CEBS was established as part of the Lamfalussy approach to financial regulation in the EU – so named after Baron Alexandre Lamfalussy who chaired the process which gave rise to the final report of the Committee of Wise Men on the regulation of European securities markets. This report proposed a four-level regulatory approach which is designed to make the decision-making procedures faster and more flexible, while still ensuring the uniform application of community law. New powers were given to supervisory committees known as Level three committees. They are expected to deliver convergence in supervisory practices and to contribute to a level playing field across Europe. Commencing operations in January 2004, CEBS was mandated with three main tasks: (i) to provide advice to the European Commission; (ii) to ensure consistent implementation of community legislation in the banking field and convergence in supervisory practices; and (iii) to promote supervisory co-operation and exchange of information. These three tasks mirror those set for the other two Lamfalussy committees; the Committee of European Securities Regulators (CESR) and the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS). CEBS issues regulatory guidelines and standards in order to harmonise the supervisory approach across the EU. Although based on voluntary co-operation between members, common guidelines are expected to lead to a gradual convergence of supervisory practices. Decisions are made on a consensus basis and are fully endorsed by the member state authorities.

Level playing field
In working to ensure that banks and investment firms face similar prudential requirements across the EU, CEBS frequently has to take various considerations and challenges into account when drafting guidance. The legal responsibilities of national supervisors do not always correspond with the operational structures of cross-border banking groups, which can be characterised by centralised business lines and risk management functions. Also, small and large banks have different demands and expectations with regard to supervision. Furthermore, the retail markets are still fragmented whereby, for example, deposit guarantee schemes are based on national solutions. The structure of today’s cross-border banking market poses a serious challenge to risk-focused supervision. The bank as a legal entity is not necessarily a self-contained body which performs all the functions relating to the provision of services in that same jurisdiction and which directly controls all the attending risks. By contrast, supervisory responsibilities are allocated on the basis of the country of residence of the legal entity, while the monitoring of the risks may well require access to information that is outside that supervisor’s jurisdiction. The CRD reflects awareness of this issue. By enhancing the tasks of the consolidating supervisor, greater co-ordination between competent authorities is facilitated. This should minimise the scope for duplication and for additional compliance costs. However, all of these provisions – particularly those requiring a joint decision to approve validation of the internal ratings based and advanced measurement approaches – call for supervisory guidelines which more appropriately define the respective tasks of all of the parties involved. CEBS has published guidelines governing co-operation and exchange of information between home and host authorities. These provide a framework for the effective and efficient supervision of cross-border groups – one that should allow for a clear division of labour between all of the authorities involved. It is important to recognise that the degree of involvement and co-operation should be defined according to the significance of a banking entity, with respect both to the business group and to the local markets in which it operates. This principle of proportionality is reflected in all CEBS guidance. The banking sector has been quite vocal in its demands for principle-based guidance as opposed to the more detailed approach adopted by CEBS. In many areas CEBS has not been able to build on existing practices and some detail in the guidelines has been deemed necessary in order to achieve convergence and to deliver a level playing field.

A European supervisory culture
The ultimate challenge of achieving a common European supervisory culture and approach is complicated by differences that are evident across the national supervisory authorities. In some countries the emphasis is more on contacts between the supervisor and the supervised entity through on-site inspections as well as the use of published data. In other countries, supervisors base their assessments on specific data which they request in addition to that already in a public domain. In practice, CEBS has to work towards the development of in-depth convergence in day-to-day supervision and active cooperation across the operational networks of supervisors. These networks will monitor consistent implementation of the CRD and the CEBS guidelines and will aim to address outstanding issues. One important aspect in building a common supervisory culture is the open and transparent manner in which CEBS itself operates. CEBS consults with interested parties before drafting new guidance and all consultation papers, together with responses, are published on the CEBS website). Transparency of banking supervision practice will not be restricted to the EU level but will be applied at national level. Also, CEBS guidelines on supervisory disclosure through the proposed web-based framework will provide a meaningful comparison of rules and guidance implemented across the EU. This greater transparency will help to identify authorities who are diverging from the common approach and will bring about greater consistency. A common supervisory culture can be promoted through training and a programme of staff exchanges. In the future CEBS members could establish joint examination teams to validate internal systems and models and to engage in staff exchange. It is still early days but the first steps have been taken on the road to supervisory convergence. Convergence is not a magic wand that can change the world overnight. It is an ongoing process towards a regulatory level playing field across Europe.