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Sebastiano Laviola's speech at the AFME Financial Services Policy Dinner

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Introduction

Good evening ladies and gentlemen, I would like first to thank AFME for the invitation to the SRB, and to myself in particular, to speak to you tonight.

Barbara has shared her thoughts on the role of financial services in supporting the broader competitiveness goals of the EU. I will share my thoughts on the initial lessons learnt after almost one year from the 2023 bank failures in the US and Switzerland, which may be relevant for the evolution of financial regulation and crisis management.

As we all know, a well-functioning, stable financial system enables growth through an efficient allocation of resources, better risk diversification and innovation. Bank prudential regulation and supervision aim at minimising the probability of liquidity and solvency crises, therefore strengthening the trust of clients and other stakeholders. In the same spirit, when a failure happens, bank resolution aims at safeguarding financial stability, minimising disruptions to the real economy and shielding taxpayers from losses. The resilience of the European financial sector is, therefore, a precondition for our markets to be competitive. To some extent, the fact that EU banks were not fundamentally affected by the March 2023 events confirms that the reforms put in place on capital, liquidity and loss absorbency rules after the great financial crisis - applied to any type of banks, large and small, although in a proportionate way - are an important safeguard for financial stability. In Europe, financial stability is closely tied to a better functioning and greater integration of the internal market. By removing fragmentation, both Banking Union (BU) and Capital Markets Union (CMU) offer the potential of significant economies of scale and increased competitiveness in the financial sector. 

In the US we witnessed the failure of three regional banks, whose combined assets amounted to almost $550 billion, whereas in Switzerland we saw the demise of a G-SIB, which was in the end acquired by another G-SIB. Most notably, in a single day (March 9) SVB endured over $40 billion of outflows—roughly 25% of its uninsured deposits. By contrast, in 2008 it took 16 days for Washington Mutual to lose $19 billion of deposits. These cases brought the unprecedented speed and volume that outflows can have nowadays under the spotlight, a development accelerated by the new technologies and coordinated behaviour on social platforms, particularly where depositors are highly connected and where large amounts of uninsured deposits – over 90% in case of SVB - are accumulated.

The authorities stabilised the situation both in the US and Switzerland. While no depositors suffered losses, in the US shareholders and unsecured debtholders took losses, in Switzerland shareholders of Credit Suisse were severely depleted and all the outstanding amounts of Additional Tier 1 instruments were wiped out.  These events have prompted a range of policy questions about the adequacy of the prudential and supervisory frameworks and the credibility of the resolution regimes. Both the Basel Committee and Financial Stability Board reports, published in October 2023[1], discuss some preliminary lessons from the bank failures. 

Lessons Learnt 

Prudential Supervision and regulation

The first element which emerges is that the ultimate cause of the recent bank failures on both sides of the Atlantic was bad governance, shortcomings in basic risk management practices and unsustainable business models, coupled in certain cases with weak application of the international standards. Higher capital and liquidity requirements cannot by themselves restore banks’ ability to remain profitable when the business model is fundamentally flawed. It comes out that greater effectiveness of supervision is needed to identify and challenge poor strategic decisions, governance and risk management leading to weak business models. In addition, authorities have to use all the instruments of the toolkit at their disposal, including sanctions, to enforce appropriate actions promptly, and to have the appropriate quality and quantity of supervisory resources.

As concerns prudential regulation, the Basel Committee will pursue targeted analytical work to assess whether specific features of the Basel framework performed as intended during the turmoil – for example, the operationalisation and calibration of liquidity standards and the appropriate implementation of the interest rate risk provisions in the banking book, the treatment of held-to-maturity assets and the role of AT1 in the capital framework – and assess the need to explore policy options over the medium term.

Resolution

In terms of crisis management, the review of the FSB upholds the appropriateness and feasibility of the framework, identifying at the same time a number of implementation issues for global and other systemically important banks. Among the positive aspects, resolution planning and capabilities, as well as the build-up of sufficient loss absorbency capacity, proved useful and provided an executable alternative to the solution preferred by the authorities for Credit Suisse. In addition, cross-border cooperation and crisis communication within the core Crisis Management Groups (CMG) worked well and allowed for thorough contingency planning in the build-up of the crisis. 

Turning to implementation issues, for reasons of time I underline only three of them: 1) the first one concerns the need to have effective backstop funding mechanisms in and post-resolution, in order to quickly restore confidence of market counterparties in the resolved bank. In the case of Credit Suisse, we have witnessed the huge amounts of funding put at disposal of the bank, which helped restore market confidence and after a short period of time was fully reimbursed. At international level[2], work has therefore started on the design features (size, duration, collateral, etc.) of such mechanisms, and on the assessment whether the lack of an adequate and explicit public liquidity backstop arrangement could be perceived as making resolution less credible; 2) the second one concerns the opportunity to investigate the choice and feasibility of resolution strategies, including bail-in tool in various scenarios, for example liquidity crises. Other strategies, for example transfer tools, or a combination of strategies, could be more appropriate in certain situations. This implies the need to preserve optionality and flexibility in the use of resolution tools in crisis preparation, to cater for different failure scenarios. In Europe, the SRB is working intensively on the operationalisation of resolution tools and procedures, according to different scenarios, also through dry-runs involving national authorities and other EU authorities. 3) the third one refers to the need to work further on the operationalisation of the bail-in tool in a cross border context, where loss absorbing instruments are issued to non-domestic investors. In such a case, compliance with applicable securities laws, such as the US one in the case of Credit Suisse, requires detailed preparation including potential disclosure of pro-forma financial statements to the market in the event of resolution. It is crucial that the main countries facilitate the recognition of resolution actions exercised by foreign authorities in other jurisdictions. In this regard, the SRB is working with its partners in the FSB working group on cross border crisis management.

Completion of BU

What are the implications for the European Union? In my view, it is time to put in place the Basel III final reform and finalise the review of the crisis management framework, which has to be followed by the completion of the Banking Union. 

On the prudential side, the implementation of the final Basel III reforms, in addition to the measures already in place, will further increase the resilience of the banking system. Co-legislators agreed to have most of the new rules in application from 1st of January 2025, with appropriate transitional arrangements[3]. The implementation of several level two mandates will instead cover entirely the next legislative cycle. 

In the area of crisis management, the EU has already put in place a robust resolution framework. However, experience has shown that there is room for improvement, on the legislative and the implementation side (see also above). The Crisis Management and Deposit Insurance proposal presented by the Commission in April 2023 aims at addressing the shortcomings of the framework. In a nutshell, it increases the options and tools available to supervisory and resolution authorities for the management of a banking crisis and provides a pragmatic and efficient solution for the problem of mid-sized banks. Indeed, it introduces an alternative way of funding a market exit of the bank in crisis, if it is in the public interest, by allowing the use of Deposit Guarantee Schemes and possibly of the Single Resolution Fund, to facilitate the sale of the ailing bank. At the same time, this would allow uninterrupted access to deposits and shield uninsured depositors from losses where needed, hence contributing to prevent contagion and financial stability risks. The estimations published by the SRB[4] show that the impact on industry funds would be limited, because MREL would be the first line of defence for the banks earmarked for resolution, and because of the relatively small size of the banks in question. Any compromise the co-legislators will find on the core elements of the proposal, for example around the creditor hierarchy and the depositor preference, has to take into consideration that sufficient funding has to be unlocked for resolution and alternative measures. I do hope that Council and Parliament agree their respective stances before the European elections, and that the negotiations can be concluded at the beginning of the next legislative cycle.

As concerns implementation, the bank turmoil has shown that liquidity in resolution is key. Banks’ ability to estimate and report their liquidity needs is therefore a priority. In the BU we have also the SRF and the ESM backstop, pending ratification by one Member State. However, as mentioned above the Credit Suisse case has shown that in certain cases a tail-risk would still remain; therefore European authorities have to work together to confirm the credibility of resolution.

Finally, I dearly hope that in the next legislative cycle the process of completion of the BU is taken up again, even in the form of liquidity-only EDIS to start with. This hybrid model could be followed at a later stage by the introduction of loss-sharing provisions. This reform would encourage more cross-border banking and further strengthen competitiveness and resilience of the banking sector. Without these safety nets, it is very hard to remove the hurdles that stand in the way of the integration of our banking market.

Completion of CMU

I have briefly illustrated some of the preliminary lessons learnt from the banking failures and the on-going works at global and EU level. In closing, I want to underline that to achieve a real integration and to maintain the competitiveness of our economy we need also a much greater level of circulation of funds and investments across the EU, that is, to complete also the CMU. Indeed, an economy is stronger and more attractive for foreign investors if, in addition to a stable and competitive banking sector, it can also rely on a well integrated and deep capital market. While progress has been achieved through the various action plans and set of proposals, the CMU is far from complete. According to a study released by AFME in November 2023[5], the Key Performance Indicators showed no strong progress in developing capital markets. The work has therefore to continue, also to support the goals of sustainable and digital economic transformation. The BE Presidency of the Council has mentioned a number of measures to be advanced or finalised. In my opinion, a few proposals which may be promising to achieve the goal of deeper and more integrated capital markets are: a) a revision of the securitisation framework, which would enable additional financing of the economy; b) an increased access to venture capital funds through product labels and incentives; c) an increased retail participation in long term investments or savings products, which would have the potential to make available significant amount of capital to fund common goals. Other long-standing, more ambitious proposals concern a greater harmonisation of insolvency laws and progress towards more integrated supervision, where the former would strongly reduce uncertainty of investments across jurisdictions and the latter eliminate inefficiencies and achieve greater level playing field. To achieve these goals, we likely need a change of method and perspective: policy makers should first establish the goals to reach through a top-down approach, and then legislative proposals would follow. A preventive agreement among decision makers should pave the way for substantial changes on the various topics, and not only modifications at the margin.

In conclusion, the initial lessons learnt from the banking turmoil call banking and resolution authorities to reflect on a number of aspects and operational procedures to further increase the level of adequacy and preparedness in case of crises. EU policy makers should proceed swiftly towards the completion of Banking Union. If this process is coupled with a relaunch of the CMU, this would allow to achieve integration of the single market in support of growth and competitiveness. Thank you for your attention. 


 


[1] FSB (2023), 2023 Bank Failures: Preliminary lessons learnt for resolution, October; Basel Committee on Banking Supervision (2023), Report on the 2023 banking turmoil, October. 

[2] FSB (2024), FSB Work Programme for 2024, January.

[3]Given the importance of international competition, a point of attention will be the implementation of the Fundamental Review of the Trading Book, the impact of which can be adjusted or postponed by the Commission by two years in relation to the situation in the other main jurisdictions.

[4] Biraschi, P., De Bosio, R., Langella, M., Mata Garcia, N., Orszaghova, L. (2023), The Commission proposal to reform the EU Crisis Management Framework: a selected analysis, SRB Staff Working Paper n. 3, December.

[5] Afme (2023), Capital Markets Union Key Performance Indicators – sixth edition, November.

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