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IIF Roundtable Discussion with Dr. Elke König 22/04/2022, Washington D.C.

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Friday, 22 April 2022
| Maria DIAZ OLIVER

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[Introduction]

Thank you Tim and thanks Martin for the invitation and opportunity to speak today. It feels good to be back in Washington D.C., and to meet again in person. I value very much occasions for public and private sector interactions like this one. Times like this also remind us how essential the cooperation across borders is, particularly across the Atlantic, and meeting in the real world certainly does help that cooperation. We understand that all the more after the past 2 years!

In my intervention today, I will:

  • Start firstly by mentioning briefly the priorities and progress of the SRB’s work;
  • Secondly I will look at the risks arising for banks from the unprovoked invasion of Russia into Ukraine (and the ensuing sanctions);
  • And finally, I will conclude by looking at the tools we have within the resolution framework to weather such risks.  

[1. Priorities and progress]

So, to my first point - the priorities and progress of the SRB’s work. As the central Resolution Authority for the Banking Union, the key priority for the SRB is the resolvability of banks under our remit. The vehicle to achieve resolvability is our annual resolution planning cycle.

As you will know, our system is a bit different to that of the US, but the end goal remains to achieve financial stability at no cost to the taxpayer. In the EU, or more specifically, in 21 of the EU’s 27 states that form the Banking Union, it is for the resolution authority to draft the equivalent of living wills. These are the resolution plans and we draft them for each of the banks under our remit. In the last cycle, we drafted around 100 plans. Year after year, we go more in-depth with our resolution plans, we make them more operational and executable.

While it is the SRB holding the pen in developing resolution strategies, we do work this in continuous interaction with the banks, to make sure the strategy reflects the reality of the business – for instance when it comes to SPE versus MPE approach or the separability of portfolios and so on. And we expect the banks themselves to work towards becoming resolvable. To this effect, we have set clear “expectations for banks” which is a guidance document we publish in early 2020 on the different dimensions of resolvability. It covers areas from loss absorption capacity to governance, and from liquidity to communication in a time of crisis. The end of 2023 is the deadline to meet all of those expectations, which is by the way also the deadline for having built the necessary MREL, the European equivalent of TLAC.

I will not enter into the details of such expectations, nor of the resolution plans, but of course I would be happy to reply to questions you may have later. The expectations for banks document is available on our website, srb.europa.eu, although in Europe, we don’t publish the actual resolution plans. So, now I will turn to my second point, which is on current global events and how we see the interaction of our resolution planning work with them.

[2. Current global events]

In the EU, our resolution plans are not based on any specific crisis scenario. That is to say that we do not devise the resolution strategy for a bank based on the assumption that it would fail for a specific reason. This is because we want our plans to cater for any potential cause of crisis to the maximum extent possible

This is a wise strategy given that we must always expect - and indeed prepare for - the unexpected. Hindsight is a wonderful thing – but resolution authorities can only operate with foresight, which is a slightly more tricky task, but that is our role.

While scientists had long anticipated a pandemic, financial regulators and supervisors did not. Thankfully it did not lead to failure of any bank under our remit. Not many people could foresee the invasion of Russia into Ukraine and the ensuing coordinated sanctions on Russia. A war at the EU’s doorstep is certainly a scenario nobody wanted to imagine. Yet it is the reality that we are dealing with now, even from the very particular and technical angle of a resolution authority.

The recent resolution case of Sberbank showed that our resolution framework and the SRB – in concertation with many other authorities - are able to address even crises connected to such extreme events.

The bank was truly cross-border, with an Austrian parent fully owned by the Russian ultimate parent, yet sitting above the other entities in the Banking Union and in Europe at large. Its failure was driven by a liquidity crisis: it was due to the loss of trust in Sberbank, connected to the Russian aggression against Ukraine. The SRB reacted quickly and effectively, together with all the authorities concerned. Confirming the supervisor’s assessment, we declared Sberbank Austria and its Banking Union subsidiaries failing or likely to fail.

At the same time, we also instructed the national authorities to impose a moratorium on those entities. This was done to avoid their further deterioration and buy some hours to assess whether resolution was in the public interest and devise the best strategy. We found resolution necessary for the two subsidiaries, in order to protect financial stability and avoid disruption to the Croatian and Slovenian economies, whereas we assessed that winding up the Austrian parent under insolvency proceedings would not have a negative impact. The SRB then adopted the decisions for the three entities on a Tuesday evening, before the moratorium expired. We used the sale of business tool and transferred all shares of the group’s Croatian and Slovenian subsidiaries to Croatian Postbank and Nova ljubljanska banka d.d., respectively. The two banks opened the morning after, on the 2nd March, with no disruption to depositors or clients. National insolvency procedures are instead carried out for the Austrian parent, and eligible deposits are protected by the Austrian deposit guarantee system. 

The SRB’s decisions achieved our resolution objectives, in particular:

  • the safeguarding of financial stability;
  • the protection of taxpayer money;
  • as well as protecting depositors.

What does this teach us on the usefulness of resolution planning?

There was no specific presumption that a bank could fail – albeit indirectly - due to a war or geopolitical tensions, but this does not make resolution plans less essential. On the contrary: the resolution plan was indeed a key starting point for this successful case of crisis management, and so was the work done in the planning phase, including – or rather in particular - the international cooperation structures we put in place, such as the resolution college (that is our equivalent to a Crisis Management Group for a non-GSIB yet cross-border bank). 

So this case, overall, was a reminder that we need to keep flexibility in resolution planning without tying the strategies to specific crisis drivers, and flexibility in the toolset available to resolution authorities. The moratorium tool and sale of business were two tools which proved to be extremely helpful but this does not make other tools, such as loss absorption capacity or (open bank) bail-in, less essential. We should not be complacent on this toolset. I will return on this at the end of my presentation.

By the same token, we should still watch out and not be complacent on the risks that the war in Ukraine and the ensuing economic consequences entail for the markets and banks. It is true that banks so far weathered well the first round of effects of this crisis as they did with Covid-19. The EBA recently confirmed that first-round risks are not a fundamental threat to the stability of the EU banking system, and EU bank capital and liquidity ratios remained strong. The global reforms we have put in place over the last decade, after the global financial crisis, are paying off, and they should not be rolled back.

But we should not take such resilience for granted. The war sadly is still ongoing and the economic consequences will persist. The situation remains highly uncertain and volatile. In fact, many of the consequences probably are yet to unfold. There are many ways that second-round effects on banks can play out. Andrea Enria, head of the SSM, on these second-round effects said that they “could run through concentrated exposures towards sectors or individual customers indirectly hit by the sanctions, through the spike and volatility in energy and commodity markets, through heightened volatility in financial markets, and through the general deterioration of the macroeconomic outlook in the EU”.

And even beyond this, we all know that markets are more interconnected than ever and banks are a key cog in the wheel. Commodities and energy markets saw unprecedented peaks in prices, combined with high volatility last month. This can impact banks, since they often are the counterparty with long positions at aggregated level; and it is again the banks - the large ones in particular - who provide access to clearing for non-financial firms of the energy and commodity sectors. Initial margins and variation margins are therefore natural transmission channels. Moreover, challenges can also come from the need to cover short positions; from the drop in bond prices of commodity/energy firms, or even the potential defaults of clients that could lead to losses to clearing members.

Just as a side note, that the heating of these markets might warrant a reflection on potential pockets of concentration and opaqueness: perhaps something supervisors and the FSB could look into when the dust settles.

All these market and credit risks come at extraordinary times in terms of inflation and thus changes in monetary policy, and of course the current crisis can impact inflation. So this creates a dangerous mix that the supervisory community – as well as the industry - need to continue to watch closely. And I close the side note here, and move on briefly to my third and final point, a quick look at resolution tools.

[3. Resolution tools]

As a bank crisis management organisation: we have no crystal ball, but this is exactly why we put so much effort to prepare for the most adverse scenarios, whatever lies underneath such scenario. In some ways, we are similar to the fire brigade which keep preparing their responsiveness, keep on testing and training, because we never know when, where and how big the next fire might be. A key way to do this is to ensure that banks are resolvable. This year, we are focusing on operationalising all the resolution tools. We are asking banks to test their own capabilities to enact a bail-in, which remains the most common strategy on our resolution plans. But we are also working on the separability of portfolios, as a key element to prepare ex-ante –to the extent possible - for partial sales.

One essential line of defence for all strategies remains the sufficient built up of loss absorption capacity, known as “MREL” in the EU jargon. Also in this area we are well on-track but we should not be complacent. Banks under our remit had a key checkpoint at the end of 2021, which was the deadline to meet an intermediate target. As of today, only a handful of banks have not met it, mostly due to ongoing restructuring. We are seeing a good progression also towards the final 2024 binding targets. The shortfall to final targets has been reduced by almost half since Q4 2019, now amounting to 19 billion euro or 0.26% of the total risk exposure amount.

The most recent data, for Q4 2021, that just came in and is being quality-checked by our team, shows that all banks which had a shortfall to intermediate targets in Q3 reduced it in Q4. We also observed strong issuances from banks under our remit in January and February of this year, of around 40 billion euro, but this came to a halt with the outbreak of the Ukraine crisis. However, the SRB continues to urge banks to issue MREL and develop sound funding plans suitable for any market environment.

In 2021, we carried out the first fully fledged resolvability assessment which will help us produce a 'resolvability heat-map', to be published in the summer. This will then be updated on an annual basis going forward. 

[Conclusion]

To conclude, I would use a quote often attributed to Benjamin Franklin, who said that “by failing to prepare you are preparing to fail”. Pardon the pun, but while we certainly hope not to see many banks failures, we cannot afford to fail crisis management for not having prepared. This is why we push to build the necessary buffers and all the other resolvability conditions, so to be as ready as possible. And, we believe that this work – along with sound cooperation across sectors and across borders- is all the more essential in these uncertain times.

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