National Audit Office´s Working paperBanking Union Considered from the Perspective of Supreme Audit Institutions

National Audit Office´s Working paper

Banking Union Considered from the Perspective of Supreme Audit Institutions

Helsinki 2015

National Audit Office´s Working paper

Dnro 183/39/2015

The National Audit Office has prepared this Working Paper on the Banking Union as a background document for the work of the INTOSAI Task Force on Financial Modernization and Regulatory Reform.

This paper is inspired by the goals of the INTOSAI Working Group on Financial Modernization and Regulatory Reform; that is:1. The development of audit tools2. The provision of knowledge sharing opportunities for evaluating

national reforms3. Sharing information on the progress made on reforms and systemati-

cally tracking information of reforms at the national and internation-al levels.

Helsinki 26th February 2015

Deputy Auditor General Tytti Yli-Viikari

Project Advisor Sonja Väisänen

Executive Summary

The landscape of financial supervision and resolution in Europe has changed dramatically with the entry in force of the Single Supervisory Mechanism (SSM) in early November, 2014 and of the Single Resolution Mechanism (SRM) in December 2014. Both mechanisms rely on the single rule book es-tablishing the foundation of the Banking Union: • Establishing a Single Supervisor for a single financial market is embed-

ded in the political and economic goals of the European Union (EU). The SSM is the first pillar of Banking Union1 which is the latest policy response to address the effects of the financial crisis in the Eurozone. The term ‘Banking Union’ refers to a series of policies and laws which harmonize rules on deposit protection, establish a single supervisor for banks across participating member states and create a common fund for cross-border bank resolution. Banking Union complements the broader Economic and Monetary Union (EMU).2

• The Single Resolution Mechanism ensures that if, despite stronger su-pervision, a bank subject to the SSM were to face serious difficulties, its resolution can be managed efficiently with minimal costs to taxpay-ers and the economy. The SRM is backed by a Single Resolution Board and a Single Resolution Fund. The SRM is therefore the second pillar of Banking Union.

• The single rulebook consists of a set of legislative texts that all financial institutions (including approximately 8300 banks) in the EU must com-ply with. These rules, among other things, lay down capital requirements for banks, ensure better protection for depositors, and regulate the pre-vention and management of bank failures.

This report mainly focuses on SSM. The SSM modifies the current architecture of banking supervision by

creating a system in which the European Central Bank (ECB) and National Competent Authorities (NCA) share responsibilities in the supervision of credit institutions. The new arrangements seek to intensify the partnership between member state banking supervisors by boosting information shar-ing amongst them and implementing a common set of standards.

The SSM leads to changes in the audit mandate of some European Un-ion Supreme Audit Institutions (SAIs).

By making the ECB the lead financial supervisor in Eurozone member states, the SSM limits the scope given to national auditors. The accountabil-ity of financial supervisors is not guaranteed at all levels in the SSM.

This report discusses generally recognized risks linked to the SSM and proposes a series of performance indicators that SAIs could potentially use to identify the strengths and weaknesses of supervisory tools.

This briefing paper is intended to introduce readers with varying lev-els of familiarity to the SSM, its consequences for Supreme Audit Institu-tions and the macro-level risks of its operationalization to financial stabil-ity in Europe.

Executive Summary 5

1 Introduction to the Single Supervisory Mechanism 9

2 A Snapshot of the SSM: Where are we now? 12

3 An Introduction to the Single Resolution Mechanism 13

4 Implications of SSM for Supreme Audit Institutions 16

4.1 Changes in Audit Scope: Is the SSM ensuring that finan-cial supervisors are accountable? 17

4.2 Ensuring the Accountability of Financial Supervisors 184.3 The Role of SAIs after the Financial Crisis 21

5 Organizational Risks of the Single Supervisory Mechanism 24

5.1 Focusing The Lens on Credit Institutions: Clouding Visi-bility in Identifying Sources of Financial Instability 25

5.2 The Dividing Line between Big Banks and Small Banks: Quis custodiet ipsos custodes? 26

5.3 Ensuring the Separation of Monetary Policy From Bank-ing Supervision at the ECB 28

5.4 The Comprehensive Assessment: The First Test of the ECB as a Supervisor 29

6 Conclusions 30

Appendix 1: A brief note on the European Union and the Eurozone 33

Appendix 2: Bibliography 34

References 43

Table of Contents

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1 Introduction to the Single Supervisory Mechanism

The Single Supervisory Mechanism is a new system of financial supervision authorities created to address the challenges faced in Europe before and during the financial crisis. It is obligatory in the 19 Eurozone countries and optional for all other EU member states. The SSM is a system which con-fers a responsibility to directly supervise a category of credit institutions to the ECB based off of a series of significance related criteria listed below in Table 1. It leaves the remaining credit institutions to be supervised at the member state level by their traditional host, the National Competent Au-thority (NCA). The ECB is able to transfer a bank into its direct supervision if it deems it to be necessary.3

According to the EU regulation establishing the SSM, the ECB is the body which is ultimately responsible for the overall functioning of financial supervision in the Eurozone whereas the NCAs are charged with the su-pervision of “less” significant credit institutions. Thus the ECB is to ensure that the SSM addresses the supervisory weaknesses which contributed to the outbreak of the financial crisis. Credit institutions are supervised by the ECB if they are deemed to be ‘Significant.’ This is based on the following:4

Table 1: Criteria for Shifting a Credit Institution to Direct ECB Supervision

Significance criteria: Specification:

aSSetS The value of assets exceeds EUR 30 billion.

aSSetS to gDp ratio Ratio of a credit institution’s assets exceeds 20% of their given member state’s GDP.

otherwiSe DomeStically Significant If an NCA notifies an institution to be of significant relevance to the domestic economy, the ECB has the option of directly supervising it based off of a comprehensive assessment by the ECB (including a balance-sheet assessment) of that credit institution.

croSS-borDer activitieS The ECB may also, on its own initiative, consider an institution to be of significant relevance where it has established banking subsidiaries in more than one participating Member States and its cross-border assets or liabilities represent a significant part of its total assets or liabili-ties subject to the conditions laid down in the methodology.

recipient of public financial aSSiStance Those credit institutions for which public financial assistance has been requested or received directly from the EFSF or the ESM shall not be considered less significant.

This is a serious layering of the role of the ECB. In order to accommodate it-self to its new function in the European economy, the ECB has made a series of adjustments to its internal structure. Most notably, the SSM establishes the Supervisory Board and Steering Committee inside the structure of the ECB.

Past changes in the organizational formation of financial supervisors have been attributed to the merging of financial sectors, the emergence of inter-

10

national codes and standards as well as the systemic banking crises such as those during the 1990’s.5 However, these past changes have not always met expectations. Despite the term ‘single’ it is clear that the system, sketched out in Figure 1 below is decently complicated.

Despite the fact that European supervisors have scored well in interna-tional reviews of accountability and independence6 their reputation has tak-en a substantial hit considering the scandals that financial regulators and su-pervisors have endured. 7The failure of supervisory architecture as a causal factor of the financial crisis can be cited in two cases: in the United States8 and the United Kingdom with the failure to intervene as a last resort in the Northern Rock Episode.9

Rather than a failure of the supervisory regime, there is a consensus that the following factors contributed to weak supervisory governance:• Weak supervisory independence and accountability, • Industry or political capture i.e. the wrong incentive structures provid-

ed by the political establishment• A severe lack of audacity to probe or to take matters to their conclusion

and to be intrusive • Several authors also point at a general lack of skills to understand the

risks related to the new and sophisticated financial products and un-derlying operations.10

• At the international level (with respect to cross-border supervision) some point at a misalignment of incentives for supervisors to voluntari-ly cooperate, a lack of binding coordinating mechanisms, and differenc-es in levels of supervisory quality.11

The SSM presents a two-fold opportunity for European financial supervi-sors: firstly to improve the reputation of the overall quality of financial su-pervision in Europe and to address issues in protecting national banking champions.12

Figure 1: The allocation of responsibilities between Participating and Non-Participating Countries

National Supervision

ECB Supervision

National Supervision

National Supervision

Non SSM Countries

Significant credit

institutions

Other credit

institutions

Credit institutions

Other financiel

institutions

SSM Countries

11

Figure 2: The New Structure of the ECB

Source: https://www.bankingsupervision.europa.eu/banking/approach/jst/shared/img/jst.PNG

JST coordinator

(Chair)

Core JST Sub-coordinators

(support JST coordinator)

Team of experts from national supervisory authorities and ECB

Support JSTs

Horizontal divisions

ECB intermediate structure DGs

Supervisory Board

………………………………………………

Governing Council

X……… ……… ………………………………

Approval / validation of high-level desicions

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2 A Snapshot of the SSM: Where are we now?

The SSM entered into force on the 4th of November 2014, which is one year after the regulation was agreed to by the European Parliament and the Council of the European Union. In the meantime, a series of developments have occurred; inside the ECB, the Supervisory Board and the Steering com-mittee have been assembled and steps have been taken to prepare both the ECB and the NCAs for the new system of financial supervision in partici-pating member states.

This has been no mean feat for the ECB. Modifying not only its inter-nal structure, recruiting nearly 1,000 new members of staff and adjusting or building working relationships with external actors are only a few of the major transitions that the ECB has undergone.13 The changes have been cod-ified in the publication of a new internal ECB regulation to accommodate the organization to its changing role in the European economy.14 The ECB’s SSM Regulation had to be submitted to a public consultation to receive com-ments on the collection of fees levied on a credit institution or branch, in-cluding underlying calculations.

The Supervisory Board was established with the responsibility to organ-ise and oversee the supervisory tasks of the ECB as well as make propos-als to the ECB Governing Board.15 At the time of writing, the Supervisory Board and its Steering committee have met to establish procedures. They have also decided upon which banks the ECB will be directly supervising after the SSM enters into force.16

A key component of the SSM that has been established during the course of the last year are the Joint Supervisory Teams (JSTs). These matrix-style teams form the link between the NCAs and the ECB. They are composed of supervisors from various member states and brought together according to their respective supervisory expertise in order to perform on-site visits and capitalize off of professional and linguistic capacities. One JST will be des-ignated for each significant credit institution.17

The ECB is also undertaking what is referred to as the Comprehensive Assessment, which is composed of the AQR (Asset Quality Review) and a series of Stress Tests. The Assessment, which was taken out in partnership between the NCAs and the ECB, is intended to give the ECB a full under-standing of the state of the financial system in participating member states. It is also intended to bring a higher degree of transparency in the market, which should boost investor confidence.18

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3 An Introduction to the Single Resolution Mechanism

The second of pillar of Banking Union is the Single Resolution Mechanism SRM), which is a way to address another problem faced by Eurozone coun-tries during the crisis: the recovery and resolution of failing banks which operate across borders. This is commonly considered the alternative to cor-porate insolvency and allows for banks to fail in an orderly way to prevent systemic contagion.19 The case of Dexia is an example of what can happen without a strong resolution framework which operates at the internation-al level,20 hence “banks are international in life and national in death.”21Ad-dressing issues with cross-border bank resolution is commonly viewed as one of the most effective ways to move forward in terms of bank-sovereign interdependence.22

The SRM is composed of the Single Resolution Fund and Single Reso-lution Board. Its legal basis is the Bank Recovery and Resolution Directive (the BRRD) and it establishes the European System of Financing Arrange-ments (Figure 4). There is also the intergovernmental treaty between Eu-rozone member states and a Crisis Resolution Directive.

The purpose of bail-in is to recapitalize an institution in order to to rein-state it to its capacity to meet the requirements of authorization, to be able to provide capital to bridge institutions or potentially to minimize the amount of debt that is transferred under the sale of business/asset separation tool.23

A bail-in of a bank, as opposed to a bail-out, ensures that taxpayer’s money doesn’t need to be used to recapitalize a credit institution.24

The BRRD gives the Resolution Authority four tools sale of business, bridge institution, asset separation, and bail-in, which are outlined in Fig-ure 3.25 Under the BRRD, the Resolution Authority has the powers to decide whether or not the requirements have been met for a bail in (Art. 32). It is also for the board to decide whether or not resolution tools will be used in-cluding the potential move to nationalize an insitutiton.

Recovery (or “early intervention”) proceedings involve measures intend-ed to stabilise a bank (or banking group) and enable its recovery from finan-cial stress. Recovery proceedings are targeted at a stage before resolution, when the bank (or group) in question has not breached the triggers for res-olution, and therefore its economic recovery is still possible.26

There are several mechanisms included in the BRRD for bank recovery: group recovery plans, intra-group financial assistance and coordination of early intervention measures regarding groups.The reliability of this system is dependent upon how well supervisors coordinate across jurisdictions, and whether or not they reach decisions on time.27

14

Figure 3: Resolution Tools at the disposal of the Resolution Authority

Figure 4: The European System of Financing Arrangements28

Sale

Enables the commercial sale of all or a part of a bank’s business without obtaining shareholder consent or complying with other procedural requirements that would otherwise apply.

Bridge

The transfer of all or part of the business of an institution to a publicly-controlled entity, with the promise of a future privatization when market conditions improve.

Asset separation

Involves the transfer of impaired or problem assets to an asset management vehicle to allow them to be managed and worked out over time.

Bail-in

The option of writing down or even zeroing or cancelling the claims of the unsecured creditors of a failing institution, to convert debt claims to equity, and to change the terms of debt instruments .

Mandatory national funding arrangements.

Voluntary borrowing between national financing arrangements.

The limited mutualization of national financing arrangements in the case of a group resolution.

15

Lastly Under Article 287(1) of the Treaty, the Court of Auditors is the au-ditor of all agencies set up by the Union in so far as the relevant constitu-ent instrument does not preclude such examination. The European court of Auditors has recently stated regarding the Single Regulation Board that “since the SRM regulation does not preclude it, the Court shall therefore be the auditor for the accounts of the Board and the transactions underly-ing them. Article 287(4), second subparagraph, of the TFEU, in providing for the Court to submit observations and deliver opinions to the Europe-an Parliament and Council, enables the Court to carry out performance au-dits of the Board.”

Key points from Part III in brief:• The SSM will change the scope of national audit practices, thus threat-

ening to alienate national auditors• The accountability of financial supervisors is not guaranteed at all lev-

els in the SSM• SAIs could discuss the development of performance indicators to ad-

dress audit issues and identify common problems and trends.

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4 Implications of SSM for Supreme Audit Institutions

As these developments begin to take place across the Eurozone, the activ-ities of SAIs will be affected both directly and indirectly. The implications of the SSM for SAIs will not be symmetrical. This development will fuel the debate in which SAIs develop their activity, as some SAIs are moving towards a clearer role in the monitoring and warning of financial crises. Here we will consider the consequences for those institutions which can and those that cannot audit their respective national financial supervisor.

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4.1 Changes in Audit Scope: Is the SSM ensuring that financial supervisors are accountable?

The relationship between national supreme audit institutions and finan-cial supervisory authorities varies considerably across member states par-ticipating in the SSM. According to a study on the access of the SAIs in EU member states to their respective national financial supervisors, only 7 of the 14 SAIs which participated in the study have the rights to audit their national supervisors. Even amongst those which have access, some of it is only partial, such as access to documents limited due to legal boundaries of bank secrecy. 29

For example, in Finland, Italy and Estonia, their respective National Au-dit Office’s mandates do not include the local NCA. On the other hand, the Dutch Audit Office has traditionally engaged in performance auditing for its NCA. As the ECB begins to directly supervise ‘significant’ banks, this will have an impact on not only the mandate of any given NCA, but a knock-on effect on that of their SAI. This is a development which complicates the SAI’s ability to report on a NCA.30

From the perspective of a member state such as the Netherlands which has an SAI fully mandated to audit its NCA, the SSM is seen as causing a negative outcome. In a letter to the Dutch Ministry of Finance, the Presi-dent of the Court of Audit wrote:

“The introduction of the SSM will restrict the Netherlands Court of Audit’s ability to exercise independent external control of the functioning of supervi-sion in the Netherlands. In other words, the Court will no longer be able to audit the functioning of supervision of significant Dutch banks. This supervision will in the future be exercised by the ECB, and the Court cannot audit the ECB.”31

In this letter, we can see a clear expression of concern over the quality of audit which is possible for a SAI to obtain over their respective national financial supervisor. As part of the responsibilities shift to the ECB, which the SAIs cannot audit, they lose valuable information and skills to assess fi-nancial stability, an important economic indicator.

The SSM Regulation (EU) no. 1024/2013 stipulates that the ECA will take the new banking supervision activities into account in its audits of the ECB’s operational efficiency.32 However, it is not exactly clear what this means and there is growing concern that there will an audit gap i.e. a dete-rioration of independent external control.33

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4.2 Ensuring the Accountability of Financial Supervisors

Given the importance of accountability in democracy, and the spotlight un-der which the financial industry and its regulators have found themselves as a result of the crisis, ensuring a well-functioning system of accountabil-ity is a high priority.34 This has been an issue taken into debate by a num-ber of actors including SAIs of EU member states and the European Court of Auditors (ECA).35

Due to the emergence of financial conglomerates and incredibly com-plex financial products that are often securitized, repackaged and resold, this is no simple field to supervise.36 However, the organizational structure of the SSM (as is depicted in Figure 1) hardly makes it easier, thus making their accountability important to ensure.

In a perfect world, financial institutions would be separated in terms of their credit taking, insurance, and deposit taking functions to suit the SSM. However, European financial institutions frequently house insurance and other forms of financial activity under the same roof. Thus, the NCAs will be put in the maladroit position of supervising specific activities which finan-cial groups engage in in their allocated districts, but not the entire organiza-tion. This division of financial activities may cause supervisory divergence and confusion.37 A lack of information sharing across credit institution su-pervisors and supervisors for other institutions may make it difficult to iden-tify systemic problems. Auditing financial supervisors can help ensure that strategic and operational gaps are identified, which in a new system such as the SSM are not necessarily clear.

In considering the accountability arrangements for the SSM, it is clear that there is cause for concern due to the considerable grey area on this mat-ter addressed in several reports by the European Court of Auditors. There will be a series of ex post arrangements including the following:

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Table 2: Accountability Arrangements Under the SSM

form of accountability DetailS

legiSlative • Annual and Quarterly reporting to the competent EP Committee on Banking Supervision.

• Public and/or confidential exchanges of views between the Chair of the Supervisory Board and the competent EP Committees.38

• The ECB is to be accountable to Council of the European Union and the European Parliament.39

• Annual report released to National Parliaments.

executive • Meetings with and reports submitted to the Euro Group, a body composed of Eu-rozone finance ministers.

• The ECB Supervisory Board will submit an annual report to the Council of the EU as well as the Euro Group on a confidential basis.

• The Council of the EU will receive a quarterly report on the operational preparations for the SSM.

• Exchanges of views twice annually in the presence of non-Eurozone member state representatives as well as at the invitation of the Euro Group president.40

financial • The ECB is subject to audit for sound financial management by the ECA.41

aDminiStrative review • A five person Internal administrative review board established for banks to challenge supervisory decisions. The Decisions and recommendations of this board are non-binding.42

This series of legislative, executive and financial oversight arrangements were established in order to ensure public policy implementation in ac-cordance with legislative intent. The SSM is independent, and this is en-shrined in the law which establishes it. The proper accountability ar-rangements are useful for ensuring that agency independence is effective.

Nevertheless, gaps certainly exist in this system. Despite the inclusion of NCAs in the SSM, the ECA only audits the ECB, but not the NCAs un-der its auspices. There are no existing provisions in place for the assess-ment by auditors of the supervisory system as a whole. It is possible that a deeper level of cooperation with SAIs in the respective Member States might allow for some more comprehensive assessments, but no such ar-rangements currently exist. Without a mandate, it is unlikely that ad hoc proceedings will be systematic and effective. National parliaments will lose their degree of accountability of their national supervisors consider-ing that level of supervisor is no longer responsible for the overall func-tioning of the system.43

Even if more informal structures such as working groups are established to fill these gaps, there will be further challenges. For some SAIs, includ-ing the European Court of Auditors, banking supervision is not included in their mandate making this unfamiliar territory. Holding banking supervi-sors and central bankers to account are not entirely similar and the transi-tion will require changing methodology. Banking supervisors have to make greater judgement calls, and thus their accountability is more pertinent.44

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Firstly, the goals assigned to central banks are much more straightfor-ward: they usually are given a quantifiable inflation target and the results of their work can be assessed against that. On the other hand, only on very ra-re occasions are the goals of supervisory agencies articulated in law. There is a higher degree of confidentiality required in the work of regulatory and supervisory authorities than there is in monetary policy. This ties into the fact that the former have a different function; they very frequently are in-volved in the creation of rules and their enforcement which places them in a special position in society in terms of their accountability function to the judiciary and the industry. Finally, banking supervisors are subject to what is referred to as a multiple principles environment. Their work affects not only the judiciary and executive branches of government but the consum-er end groups as well.45

The repercussions of new legislation, which in the field of finance en-dure high degrees of complexity need to be fully understood to prevent neg-ative externalities.46

The European Court of Auditors considers that successful EU-wide banking supervision requires a clear division of roles and accountability between EBA (European Banking Authority), the ECB and the NSAs, both those in and those outside the SSM. To avoid the risk of overlapping tasks and unclear responsibilities in some areas between the ECB, NSAs and EBA the European Court of Auditors has recommended that roles and responsi-bilities be further clarified in legislation or memoranda of understanding. Overlapping tasks are risky, administrative resources are wasted and com-municating results becomes more difficult.47

From an accountability perspective, the SSM is complex. It is important for national audit institutions not to find themselves isolated. Due to the fact that their auditing powers are limited to the scope outside of the SSM, this may prevent the SAI from seeing “the big picture” of the economic situa-tion in their jurisdiction. As the trend in financial supervision is moving to-wards more macro-prudential oversight, this may conversely isolate SAIs from being able to access crucial information.

Democratic oversight in financial supervision has the benefit of ensur-ing that the debate over the regulation of an industry doesn’t suffer from group think as this is to the detriment of regulatory competence. Ensur-ing accountability respects the principle of public goods and provides the conditions to do what is possible so that regulators do not suffer from cul-tural blind spots.48

As the SSM will operate across many member states, a degree of inter-national coordination will be required to ensure a fully functioning audit.

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4.3 The Role of SAIs after the Financial Crisis

The argument for a more interactive role for SAIs has been advanced on many fronts.49 Auditing the effectiveness of financial market governance reform plays into this exceptionally well.

For example, the United States Government Accountability Office and Chinese National Audit Office are moving past their traditional roles.50 The research component of their role has enabled them to provide early warn-ing signs of economic imbalances.

SAIs could develop a scorecard of performance indicators in terms of conforming to the principles set out in for example the FABRIC report by the UK government.51

The UK underwent the process of adapting to a new system of financial supervision. In order to react to the establishment of two new regulatory agencies, the Financial Conduct Authority and the Prudential Regulation Authority, the UK NAO developed an audit approach to examine the per-formance of their new financial services regulators. This could potentially be emulated by a working group to begin assessing the SSM.

The NAO approach can be summarized in four steps:1. They identified the responsibilities and objectives of the new regula-

tors as well as the organizations which are charged with coordinating their activities as well as their accountability arrangements

2. They identified the changing strategic objectives of the regulators in terms of how they were to interact with the industry, how these new objectives are being implemented in authorization, supervision and enforcement

3. They examined how the regulators are adapting their approaches to skills, information collection and their use and coordination

4. They then outlined how the regulators use evaluation to direct their re-sources and how they measure and publish information on their per-formance .

In broad terms, performance indicators of financial supervisors can be grouped into two categories: hard and soft.52 Below we suggest several per-formance indicators for further consideration.

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Table 3: Types of hard indicators, their nature and applicability to the SSM 53

inDicator name SpecificationS anD goal applicability anD juStification

market Data • Credit Default Swap spreads • Credit ratings • Equity ratios• Goal: These are meant to give the

risk profile of a financial institution as perceived by the private sector

• Yes, these data are widely available

SuperviSory ratioS • BIS and Tier 1 and 2 capital ratios, leverage ratios and liquidity ratios for banks

• Solvency ratios (insurers and funding ratios)

• Goal: this gives an idea of the causal relationship between sol-vency/liquidity ratios and the need for intervention during different stages of the economic cycle

• Yes, these are included in the CR-DIV Directive and Regulation54

• Solvency ratios are reported to su-pervisors under CRDIV

failureS anD loSSeS • Performance entity ratios • Money protection ratio• Pay-outs to Deposit Insurance

Fund• Number of bankruptcies and other

losses due to failure • Goal: to measure the cost of finan-

cial failure to demonstrate• Used by the US Federal Reserve

and the Australian Prudential Reg-ulation Authority

• There is potential, further informa-tion required

• Deposit insurance fund could be comparable to the CDGS

economic benefitS • Annual economic benefit for con-sumers

• Costs of financial crises• Goal: to quantify the amount of

money saved in a given year in sanctioning illegal activities e.g. cartels, tariff regulations etc.

• Recommended, impact analysis of this manner is carried out quite frequently by e.g. European Social Partners

efficiency inDicatorS • Throughput time for procedures and applications

• Number of supervisory reports completed on time

• Number of supervisory staff per unit of currency protected

• Goal: to measure the responsive-ness of the organization to the market/consumers

• Yes, if data is collected on these is-sues

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Table 4: Types of Soft Indicators, their details and applicability to the SSM

SpecificationS anD goal applicability

public opinion • Household and consumer aware-ness surveys

• Goal: understand levels of public confidence in the financial sector

• Perhaps

SuperviSory regimeS • Total number in the highest risk category, average length of stay in said category and total number of institutions migrating between cat-egories

• Used by: BaFin, DNB, AUS APRA

• Plausible, especially as some of the Significant banks will be ones that have received public financial sup-port from the EFSF/ESM.

compliance anD Soft aSSeSSment criteria

• Non-compliance with criteria re-garding business models and gov-ernance

• Yes

international StanDarDS aSSeSSmentS • IMF FSAP/ROSC• EBA Surveys• BCBS/RCAP• Compliance with international su-

pervisory standards

• Yes

StakeholDer SurveyS • Firm feedback and other views of industry observers

• Surveys among peer supervisors

• Yes

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5 Organizational Risks of the Single Supervisory Mechanism

There is a considerable amount of literature on the organizational risks which the SSM will face. This section intends to give the reader the key points which are of interest to Supreme Audit Institutions.

Key points:• The exclusive focus on credit institutions may cause supervisors to ig-

nore developments in other fields of financial markets which affect sta-bility

• Without proper accountability arrangements, national supervisors may continue to succumb to pressure in order to protect their national bank-ing champions (A focus on large banks ignores the economic importance of smaller ones which also pose a threat to financial stability)

• New supervisors, and institutions in general, often find themselves the sources of scepticism from the markets

• Banking supervision may not be as cleanly separated from monetary policy as is hoped.

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5.1 Focusing The Lens on Credit Institutions: Clouding Visibility in Identifying Sources of Financial Instability

The choice of treaty article as a legal basis for the SSM regulation has had an impact on the scope of industries which fall into the SSMs responsi-bility.55 The use of this article means that the SSM’s remit thus will not extend to shadow banking, investment banking, the insurance indus-try nor hedge funds or pension funds, counterparties for securities and derivatives, brokers-dealers and asset managers.56 Shadow in particu-lar has been pointed out as a source of financial instability by the IMF.57

This means that there will be a single supervisor for banks in the Eurozone but not for all financial activity.

The term “visibility” in financial supervision indicates the ca-pacity to identify factors leading to financial crises or instabili-ty. It is alternately referred to as “horizontal data.”58 Part of the jus-tification of centralizing financial supervision is that supervisors will have more resources, notably in the form of information.59

Through giving the ECB a “bird’s eye” view of supervision, the idea is to enhance the overall foresight of the supervisory authorities.60

Most commentators would agree that increasing visibility is one of the key advantages of the SSM and thus it is important that it is fully ensured to function as expected.61

The focus has be placed exclusively on large banks due to the rela-tionship between sovereigns and banks, but also because even though these industries form a part of the financial sector, they are not defined as Banks by EU law. This is peculiar, as in member states such as France, investment firms are counted as banks due to their financial activity.62

In any case, in operational terms, this will cause some peculiar scenarios. For example, the department of a financial institution which engages in the insurance business will be supervised at the national level whereas its bank-ing department will be supervised by the SSM.

This reflects the nature of the SSM as dependent upon tight superviso-ry cooperation between the NCAs and the ECB.

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5.2 The Dividing Line between Big Banks and Small Banks: Quis custodiet ipsos custodes? 63

According to a calculation by the IMF, although the “less significant” banks have a smaller amount of assets, approximately 98% of Eurozone banks will be covered by the national supervisors.64

This gives them core operational responsibility in the functioning of this new system.65

NCAs Directly supervises

76% of Credit institutions

(3,700 in total)

ECB Directly Supervises

24% of Credit Institutions

(1,200 in total)

Figure 5: A Numerical Comparison of Responsibilities Between the NCAs and the ECB

Small banks have also been shown to be threats to financial stability, mak-ing “less significant” banks still important; this does not indicate that they necessarily carry a lower level of risk.66 Small, fast-expanding banks have posed a risk to financial stability in the past such as the case with the Span-ish cajas.67 Another example is the large number of Savings and Coopera-tive banks, which are prevalent in Austria and Germany. Although these banks are small and generally considered to be low risk institutions, they form sectors which may pose risk on a larger scale than is generally admit-ted. Sabine Lautenschläger has discussed this concern.68

The SSM Regulation admits in Article 16: “recent experience shows that smaller credit institutions can also pose a threat to financial stability.”69 More-over, the Regulation goes on to encourage the SSM to respect the variety of credit institutions in the banking industry.70 nb71 However, it is the ECB which is ultimately responsible for the SSM’s functioning. Thus, if possible, the ECB will have to closely monitor the national supervisors themselves.72

For the greater part of modern history, the relationship between banks and governments in Europe has been extremely important and interdepend-ent. Political interference in regulation has been known to cause banking crises.73 A structural weakness of the European economy is that European countries are very reliant upon bank credit for financing the real economy as well as sovereign debt.74

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Whereas the Banking Union has the opportunity to profoundly redis-tribute the underlying structure of financial ecosystems in Europe, it is more likely that ties at the national level will not be broken.75 This is due to three trends which have emerged during and after the financial crisis: the repa-triation of government debt across the Eurozone, the provision of credit on an unprecedented scale to the private sector by central banks and finally the return of public credit institutions such as the Caisse des dépôts et con-signations in France and the Kreditansalt für Wiederaufbau in Germany.76Keeping the Landesbank supervision at the national level was extremely important for Germany as they are seen as having a public function which cannot be sacrificed to the ECB.

What is clear from the past is that forbearance in banking happens and it is a reality which must be addressed.77 Whilst it is true that the propor-tion of assets held by these banks do not amount to more than 15% on aver-age for the Eurozone, their proportion is much higher in countries such as Germany and Italy. This causes a risk in terms of regulatory asymmetry.78

What may cause regulatory asymmetry is the sheer number of options and discretions given to national supervisors in the CRDIV directive and regulation of which there are over 100.79 The goal here is to move towards minimizing the amount of these discretions available to national supervi-sors during the next few years.80

These options and discretions include capital buffers and macro-pru-dential tools.81 This may cause national supervisors to act in an entrepre-neurial way, possibly trapping capital and liquidity at the local level. It also is possible that national supervisors cater to national interests during the resolution phase.

Thus what we see is that the relationship between governments and banks is such that it continues to incentivize the protection, and lobbying on behalf of national banking champions. This may challenge the visibili-ty of the SSM as a whole.

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5.3 Ensuring the Separation of Monetary Policy From Banking Supervision at the ECB

The basis of this concern is that the tasks of the organizational development do not do enough to quarantine monetary policy from financial supervision. The President of the Deutsche Bundesbank, Jens Weidmann has been par-ticularly vocal about this issue.82

Monetary policy affects the availability and price of credit in order to ful-fill the Central Bank’s goals. The reaction of banks is watched with great de-tail as they can intensify the impact of monetary policy. Banks are depended upon for the translation of the policy into the real economy.83

There are some critics who claim that by merging the two tasks, there are inherent conflicts of interest at the ECB.84 This issue has been raised by academics and analysts but also members of the European Systemic Risk Board’s (ESRB) Advisory Scientific Committee. The concern is to take steps to ensure the institutional and functional separation of the policy and the task whilst respecting the principle of sharing information on market con-ditions.85

The dilemma is perfectly encompassed by the following quote by Ed-wald Notowny, the Director of the Austrian Nationalbank:

“No central banker with a healthy survival instinct will therefore actively try to obtain an encompassing mandate for banking supervision. On the oth-er hand, given the huge potential for market failures in this field – like differ-ent forms of asymmetric information and problematic incentive structures – there is a clear need for public intervention – and somebody has to do it.”86

Monetary policy has a propensity to be pro-cyclical whereas supervision is rather anti-cyclical.87 Thus there may be interference between the objec-tives, placing the quality of banking supervision into jeopardy. In this way we can see how the independence of supervisors must be assured. This will also be called into question when the ECB becomes a creditor. The ECB will have to balance the authority of withdrawing a license to that of resolving banks and facing the losses by bank claimants.88

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5.4 The Comprehensive Assessment: The First Test of the ECB as a Supervisor

The Comprehensive Assessment is intended to monitor the health of the Eu-ropean financial sector and to provide supervisors, as well as markets, with the information they need on trustworthiness of the banking sector. It has three main goals: to increase transparency in improving the quality of infor-mation of banks, to contribute to the repair of the banking sector by identify-ing actions necessary to correct deficiencies and thirdly to build confidence in the soundness of banks. As it is one of the early steps which the ECB is taking towards its role as the Single Supervisor, it reflects the transition.89

In this light, the AQR has been considered by a number of analysts to be a potential risk to the ECB and SSM. If the results prove to be inadequate or unrepresentative in the face of what is bound to be a methodological-ly critical audience90 the SSM could fall victim to public pressure. The ex-pectations riding on this assessment were quite high and the political con-sequences arguably considerable. This is because if the AQR gave a highly negative assessment of the state of the financial industry, there might be a need for a bail out or bank resolution, something which is highly unpopu-lar with European tax payers. Without a robust, tried and tested resolution mechanism, it was more likely that financial supervisors would tread light-ly in their evaluations of banks, not having to risk recommending a resolu-tion which would result in disorderly failure. This is one explanation for the failure of the 2011 EBA Stress Tests.91

Additionally, as the SRM was not yet operational when the the AQR was launched, it was unlikely that the ECB would incentivized to take responsi-bility for any resolution it may recommend. Thus, the pressure of any “lega-cy” assets would fall upon the member states which may create friction for the newly created body.92

The results, released on October 26th, 2014 were met by the markets positively. However, it was met with criticism by researchers especially by those commissioned by the European Parliament’s Economic and Mone-tary Affairs Committee.

The weaknesses of the Stress Tests included: 1. The fact that bank capital was tested only against one adverse scenar-

io that were modelled on a series of assumptions based on economic data from the years 2002–2013.93

2. The model was designed for micro prudential view, thus ignoring the macroeconomic risks such as chain reactions between bank assets. It is also difficult to assess the risk parameters created by the ECB as they did not make the risk quantification calculations public. The cal-culations for losses given defaults and probabilities of defaults would have been useful.94

3. Furthermore, for the risk modelling, banks used internal models rather than a standardized one created by regulators, which defeats the pur-pose of an even-playing field.

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6 Conclusions

Banking Union presents an opportunity for the Eurozone to move forward from the financial crisis and transform into a more robust and adaptable fi-nancial system in which banks are supervised and failing institutions re-solved in a more standardized fashion. This is a strategic opportunity for the member states to address issues with Bank-Sovereign Interdependence.95

This report has presented a number of ways in which the strategic goals of the Banking Union could be endangered in the face of structural, econom-ic and political challenges. This has hopefully provided the reader with in-formation to give a solid insight into the SSM and SRM, provided food for thought regarding next steps on cooperation new activities or audit tools for SAIs at home as well as cooperation between SAIs.

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Appendices

32

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Appendix 1: A brief note on the European Union and the Eurozone

European Union

The European Union (EU) is a political and economic partnership com-posed of 28 member states and characterized by both supranational and in-ter-governmental institutions. The EU partly aims to achieve the harmoni-zation of laws and standards across areas such as the Internal Market which seeks to provide conditions in which the Four Freedoms (i.e. the freedom of movement for services, goods, capital and people) can flourish. The EU also provides a platform for cooperation across policies such as the Justice and Home Affairs, Humanitarian and Development Aid and the Common Security and Defence Policy.

The European Council, composed of representatives of the member states gives political direction to the Union. The European Commission acts as the executive arm and the directly elected European Parliament acts as a co-legislator together with the Council of the European Union. The EU has its own European Court of Justice and External Auditor, the Europe-an Court of Auditors.

The Eurozone

The Eurozone is a collaboration in which 19 member states of the Europe-an Union have pooled their sovereignty concerning monetary policy and housed this decision-making in the European Central Bank. The European Central Bank’s governing board is composed of the six members of the Ex-ecutive Board, as well as the governors of the national central banks of the 19 euro area countries. The main organizational goal is to preserve price sta-bility. The common currency, the Euro was launched in 1999.

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Gros, D. ‘The Single European Market in Banking in decline – ECB to the rescue?’, p. 53, Chapter pp. 49-54, in Beck, Thorsten (Ed.) Banking Union for Europe: Risks and Challenges Centre for Economic Policy Research, London 2012

Hakkarainen, P. ‘The common banking supervision - what is it about?’ Hel-sinki, 13 May 2014. http://www.suomenpankki.fi/en/suomen_pankki/ajan-kohtaista/puheet/pages/140513_ph_puhe.aspx

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Working papers with a SAI Focus

Algemene Rekenkamer Report of the Working Group on Public Audit Defi-cits ‘Access of Supreme Audit Institutions to the main financial supervisors in EU Member States’ 29-11-2012 Available online for download at: Algemene Rekenkamer ‘Letter to the President of the House of Represen-tatives of the States General European Banking Union’ Published 2.7.2014, Available online for download at: http://www.courtofaudit.nl/english/Pub-lications/Audits/Introductions/2014/06/Letter_to_the_President_of_the_House_of_Representatives_of_the_States_General_European_Banking_Union Challenges that Supreme Audit Institutions Face

INTOSAI Task Force Global Financial Crisis – Challenge to SAIs Report of Subgroup 3

INTOSAI Task Force Global Financial Crisis—Challenges for SAIs Report of Subgroup 2a: Actions to Minimize and Avert the Crisis; What Is Work-ing and What Is Not. - Immediate Response and Management of the Crisis: Towards a SAI perspective

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Masciandaro, Donato ‘Divide et Impera: Financial Supervision Unifica-tion and Central Bank Fragmentation Effect’ European Journal of Political Economy 01/2007

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Whitehouse, Michael ‘Testing Europe’s Stress Tests’ The Bloomberg View 10.24.2014 http://www.bloombergview.com/articles/2014-10-24/testing-europe-s-stress-tests

Wymeersch, Eddy ‘Europe’s New Financial Supervisory Bodies’ Working Paper Series, Financial Law Institute University of Ghent, Working Paper Series 2011-01, January, 2011. Date of access: 10.4.2014, Available online for download at: http://www.law.ugent.be/fli/wps/pdf/WP2011-01.pdf

EU Institutions Articles and Papers

Breuer, Thomas ‘Robustness, Validity and Significance of the ECB’s Asset Quality Review and Stress Test Exercise’ Study provided at the Request of the European Parliament Economic and Monetary Affairs Committee [PDF] October, 2014, Available online at: http://www.europarl.europa.eu/document/activities/cont/201410/20141024ATT91764/20141024ATT91764EN.pdf

Contact Committee Access of Supreme Audit Institutions to the main fi-nancial supervisors in EU Member States 29.11.2012, Available online at:http://www.eca.europa.eu/sites/cc/en/Pages/WorkingGrouponPublicAu-ditDeficits.aspx

Council of the European Union ‘Memorandum of Understanding between the Council of the European Union and the European Central Bank on the cooperation on procedures related to the Single Supervisory Mechanism (SSM)’ 12.12.2013, Available online for download at: https://www.ecb.eu-ropa.eu/ssm/pdf/memorandum-ssm-eucouncil ecb.pdf??d922daf6c03ae2503cd5dff03061ecb5

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European Central Bank, Quarterly Report ‘Progress in the operational im-plementation of the Single Supervisory Mechanism Regulation’ 2014/3, Available online at: https://www.ecb.europa.eu/pub/pdf/other/ssmqr20143en.pdf?3d97856ec05b93ab770be12b7137df64

European Central Bank, Publication ‘Guide to Banking Supervision’ 30.9.2014 Available online at: https://www.ecb.europa.eu/pub/pdf/other/ssmguide-bankingsupervision201409en.pdf?85e39f5cf761e11147f6e828cd4088b1

European Central Bank ‘SSM Framework Regulation’ 15.5.2014, Available online at: https://www.ecb.europa.eu/ecb/legal/ssm/framework/html/in-dex.en.html

European Central Bank ‘Interinstitutional Agreement between the Europe-an Parliament and the European Central Bank on the practical modalities of the exercise of democratic accountability and oversight over the exercise of the tasks conferred on the ECB within the framework of the Single Supervi-sory Mechanism’ Official Journal of the European Union 30.11.2013 L 320/1

European Central Bank, ’Press Release- ECB starts comprehensive as-sessment in advance of supervisory role’ 23.10.2013 Website, Date of ac-cess: 25.10.2013, Available online at: http://www.ecb.europa.eu/press/pr/date/2013/html/pr131023.en.html

European Court of Auditors ‘Landscape review: Gaps, overlaps and chal-lenges: a landscape review of EU accountability and public audit arrange-ments’ Luxembourg, 10.9.2014, http://www.eca.europa.eu/en/Pages/News-Item.aspx?nid=5086

European Court of Auditors ‘European banking supervision taking shape — EBA and its changing context’ 02.07.2014, Luxembourg, Available online at: http://www.eca.europa.eu/en/Pages/NewsItem.aspx?nid=4967

European Parliament BRIEFING Single Supervisory Mechanism (SSM) Main Features, Oversight and Accountability Directorate General for In-ternal Policies Economic Governance Support Unit 25.9.2014http://www.europarl.europa.eu/RegData/etudes/note/join/2014/528750/IPOL-ECON_NT(2014)528750_EN.pdf

Kesnere, R. ‘ Interview with Danièle Nouy, ‘Chair of the Supervisory Board of the Single Supervisory Mechanism (SSM)’ conducted by Ruta Kesnere 29 August 2014 Available online at: http://www.ecb.europa.eu/press/key/date/2014/html/sp140829.en.html

Kolias, Zacharias ‘Developing the capacity to audit EU financial and eco-nomic governance’ Presentation on behalf of the European Court of Audi-tors at The Hague, Netherlands, 18.6.2014

https://www.ecb.europa.eu/pub/pdf/other/ssmqr20143en.pdf?3d97856ec05b93ab770be12b7137df64 https://www.ecb.europa.eu/pub/pdf/other/ssmqr20143en.pdf?3d97856ec05b93ab770be12b7137df64 https://www.ecb.europa.eu/pub/pdf/other/ssmguidebankingsupervision201409en.pdf?85e39f5cf761e11147f6ehttps://www.ecb.europa.eu/pub/pdf/other/ssmguidebankingsupervision201409en.pdf?85e39f5cf761e11147f6ehttps://www.ecb.europa.eu/ecb/legal/ssm/framework/html/index.en.html https://www.ecb.europa.eu/ecb/legal/ssm/framework/html/index.en.html http://www.ecb.europa.eu/press/pr/date/2013/html/pr131023.en.html http://www.ecb.europa.eu/press/pr/date/2013/html/pr131023.en.html http://www.eca.europa.eu/en/Pages/NewsItem.aspx?nid=5086 http://www.eca.europa.eu/en/Pages/NewsItem.aspx?nid=5086 http://www.eca.europa.eu/en/Pages/NewsItem.aspx?nid=4967 http://www.europarl.europa.eu/RegData/etudes/note/join/2014/528750/IPOL-ECON_NT(2014)528750_EN.pdf http://www.europarl.europa.eu/RegData/etudes/note/join/2014/528750/IPOL-ECON_NT(2014)528750_EN.pdf http://www.ecb.europa.eu/press/key/date/2014/html/sp140829.en.html http://www.ecb.europa.eu/press/key/date/2014/html/sp140829.en.html

40

Nouy, D. Speech ‘Launch of the SSM – what will change in banking super-vision and what are the imminent impacts on the banking sector?’ at the Third FIN-FSA Conference on EU Regulation and Supervision, Helsinki, 5 June 2014

Steffen, Sascha ‘Robustness, Validity and Significance of the ECB’s Asset Quality Review and Stress Test Exercise’ Study provided at the Request of the European Parliament Economic and Monetary Affairs Committee [PDF] October 2014 Available online at: http://www.europarl.europa.eu/RegData/etudes/STUD/2014/528761/IP-OL_STU(2014)528761_EN.pdf

http://www.europarl.europa.eu/RegData/etudes/STUD/2014/528761/IPOL_STU(2014)528761_EN.pdf http://www.europarl.europa.eu/RegData/etudes/STUD/2014/528761/IPOL_STU(2014)528761_EN.pdf

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References

42

43

References

1 See the European Commission’s webpage for a comprehensive explanation of Banking Union

2 European Central Bank ‘Banking Union’ website https://www.bankingsupervision.europa.eu/about/incontext/bankingunion/html/index.en.html

3 COUNCIL REGULATION (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions’ Official Journal of the European Union L 287/63, Article 43, Hereafter ‘SSM Regulation’.

4 SSM Regulation Article 6, Point 4.

5 M. Quintyn, S. Ramirez, and M. W. Taylor ‘The Fear of Freedom: Politicians and the Independence and Accountability of Financial Sector Supervisors’ 2007 International Monetary Fund WP/07/25 p.5.

6 Ibid. p. 30.

7 On the role of regulatory and supervisory failure as a part of the 2008 financial crisis see for example Allen and Carletti (2009), Brunnemeier et al. (2009), Buiter (2008) and Roubini (2008).

8 A. Leijonhufvud, A., 2009, “Curbing Instability: Policy and Regulation,” CEPR Policy Insight, No. 36, July.

9 W. Buiter, 2008, “Lessons from the North Atlantic Financial Crisis,” paper presented at the con-fer-ence “The Role of Money Markets” (Columbia Business School and Federal Reserve of New York, May 29–30) and Financial Services Authority, 2009, “The Turner Review. A Regulatory Response to the Global Banking Crisis,” FSA, London, March.

10 D. Masciandaro, R.Vega Pansini, M. Quintyn, pp. 8–9.

11 See D’Hulster, 2011, for an in-depth treatment of this issue: D’Hulster, K., 2011, “Cross-border banking supervision: Incentive Con-flicts and Supervisory Information sharing between Home and Host Super-visors,” World Bank Working Paper Series, forthcoming.

12 E. Monnet, S. Pagliari and S. Vallée ‘Europe Between Financial Repression and Regulatory Capture’ Bruegel Working Paper 2014/08, Published July, 2014.

13 European Central Bank ‘Organizational Structure at the ECB’ https://www.bankingsupervision.europa.eu/organisation/structure/html/index.en.html.

14 View the legal components of the SSM Framework Regulation online.

15 ECB, ‘Banking Supervision: Organisational Structure at the ECB’

16 European Central Bank, Press release ‘Progress in the operational implementation of the Single Super-visory Mechanism Regulation.’

17 Interview with Danièle Nouy, ‘Chair of the Supervisory Board of the Single Supervisory Mechanism (SSM)’ conducted by Ruta Kesnere 29 August 2014.

18 D. Nouy Speech ‘Launch of the SSM – what will change in banking supervision and what are the imminent impacts on the banking sector?’ at the Third FIN–FSA Conference on EU Regulation and Supervision, Helsinki, 5 June 2014.

19 E. Ferran, op cit., p. 11.

20 D. Valiante ‘Framing Banking Union in the Euro Area: Some empirical evidence’ p. 8. Centre for Europe-an Politics, CEPS Working Documents, Date: 03.02.2014.

21 This is commonly attributed to Bank of England Governor Mervyn King and economist Charles Goodhart.

22 Cf. S. Merler and J. Pisany-Ferry Hazardous tango: sovereign-bank interdependence and financial stability in the euro area’ Banque de France, Financial Stability Review. No. 16, April 2012.

23 The Bank Resolution and Recovery Directive, Art 43.

24 E. Ferran, op.cit., p. 14.

25 BRRD Article 37.

26 V. Babis op cit., p. 2.

27 V. Babis, op cit., p.1.

28 BRRD Art 99–100.

29 Algemene Rekenkamer Report of the Working Group on Public Audit Deficits ‘Access of Supreme Audit Institutions to the main financial supervisors in EU Member States’ 29-11-2012

http://comprehensive explanation of Banking Unionhttps://www.bankingsupervision.europa.eu/legalframework/ecblegal/framework/html/index.en.html

44

30 Ibid

31 Algemene Rekenkamer ‘Letter to the President of the House of Representatives of the States General European Banking Union’ Published 2.7.2014

32 Regulation (EU) No. 1024/2013 of the Council lays down, ‘when the European Court of Audit exam-ines the operational efficiency of the management of the ECB under Article 27.2 of the Statute of the ESCB and of the ECB, it shall also take into account the supervisory tasks conferred on the ECB by this Regulation’.

33 Algemene Rekenkamer ‘Letter to the President of the House of Representatives of the States General European Banking Union’ p. 6.

34 ISSAI 12

35 European Court of Auditors ‘European banking supervision taking shape – EBA and its changing context’ 02.07.2014, Luxembourg.

36 D. Masciandaro ‘Divide et Impera: Financial Supervision Unification and Central Bank Fragmentation Effect’ European Journal of Political Economy 01/2007 p. 5.

37 S. Verheelst, op. cit., p. 15.

38 ‘Interinstitutional Agreement between the European Parliament and the European Central Bank on the practical modalities of the exercise of democratic accountability and oversight over the exercise of the tasks conferred on the ECB within the framework of the Single Supervisory Mechanism’ Official Journal of the European Union 30.11.2013 L 320/1.

39 Article 27(2) of Protocol No 4 TFEU on the statute of the European System of Central Banks and the European Central Bank

40 Memorandum of Understanding between the Council of the European Union and the European Central Bank on the cooperation on procedures related to the Single Supervisory Mechanism (SSM) 12.12.2013.

41 Treaty on the Functioning of the European Union, Protocol No 4, Article 27(2).

42 SSM Regulation Article 24.

43 S. Verhelst p. 30.

44 S. Verhelst p. 29.

45 E. Hüpkes, ,M. Quintyn, and M. W. Taylor ‘The Accountability of Financial Sector Supervisors: Princi-ples and Practice’ March 2005 International Monetary Fund WP/05/51 p. 10.

46 Z. Kolias ‘Developing the capacity to audit EU financial and economic governance’ Presentation on behalf of the European Court of Auditors at The Hague, Netherlands, 18.6.2014.

47 European Court of Auditors ‘European banking supervision taking shape – EBA and its changing context’ 02.07.2014, Luxembourg.

48 N. Dorn ‘Accountability in Prudential Regulation of Financial Markets: A Response to HM Treasury’s 2011 Consultation Paper ‘A New Approach to Financial Regulation’ p. 2.

49 C. Humphrey, A. Loft, M. Woods, ‘The global audit profession and the international financial architec-ture: Understanding regulatory relationships at a time of financial crisis’ Accounting, Organizations and Society, 34 pp. 810-825, 2009, Elsevier Ltd. p. 810.

50 INTOSAI Task Force Global Financial Crisis – Challenge to SAIs Report of Subgroup 3: Challenges that Supreme Audit Institutions Face, p. 4.

51 HM Treasury ‘Choosing the Right FABRIC: A Framework for Performance Information’

52 P. Hilbers, K. Raaijmakers, D. Rijsbergen and F. de Vries ‘Measuring the effects of financial sector supervision’ 8.9.2012 De Neder-landsche Bank Working Paper No. 388, pp. 15–16.

53 P. Hilbers, K. Raaijmakers, D. Rijsbergen and F. de Vries, op. cit., pp.17–24.

54 European Commission Press Release ‘Capital Requirements - CRD IV/CRR – Frequently Asked Ques-tions’ Brussels, 16 July 2013.

55 Treaty on the Functioning of the European Union, Article 127 (6).

56 S. Verhelst, op. cit., p. 15.

57 IMF Global Financial Stability Report (GFSR) ‘Risk Taking, Liquidity, and Shadow Banking: Curbing Excess While Promoting Growth’ October 2014, pp. 67-68.

58 D. Nouy ibid.

59 C. M. Buch, & T. Körner & B. Weigert op. cit., p. 4.

60 T. H. Trögler, op. cit., p. 11.

61 R. Goyal, & B. Koeva, Petya & M. Pradhan & T. Tressel, & G: Dell'Ariccia, & R. Leckow, & C. Pazarbasioglu, ‘A Banking Union for the Euro Area’ European Department, International Monetary

45

Fund, 2.13.2013, p. 14.

62 S. Verhelst, op. cit., p. 15.

63 Translation: Who will guard the guards?

64 S. Verhelst, op. cit., p. 20.

65 R. Goyal, & B. Koeva, Petya & M. Pradhan & T. Tressel, & G: Dell'Ariccia, & R. Leckow, & C. Pazarbasioglu, IMF, ‘Banking Union for the Euro Area’ 2013, p. 7.

66 C. Roux, Banking Union Conference Speech: The New Regulatory and Supervisory Roadmap for Europe Address by Deputy Gov-ernor of the Central Bank of Ireland, 23.6.2014.

67 L. Garicano, ’Five Lessons from the Spanish Cajas Debate for New Euro Wide Supervisor. Chapter pp. 77–84 in T. Beck (Ed.) Banking Union for Europe: Risks and Challenges, London, Centre for Economic Policy Research, 2012.

68 B. Groendahl and S. Riecher ‘ECB Raises Savings Banks Focus on Possible Cluster Risk’ Bloomberg Business Week, 30.9.2014 http://mobile.businessweek.com/news/2014-09-30/ecb-raises-savings-banks-focus-on-possible-cluster-risk.

69 SSM Regulation Article 16.

70 SSM Regulation Article 17.

71 Nota bene The NCAs do have the option of asking the ECB to supervise a bank which is deemed to be “less significant” if they are concerned that an issue of financial stability will arise and the ECB is then to undertake a comprehensive review of the bank in question.

72 S. Verhelst op. cit., p. 20.

73 M. Quintyn, S. Ramirez, and M. W. Taylor, ‘The Fear of Freedom: Politicians and the Independence and Accountability of Financial Sector Supervisors’ 2007 International Monetary Fund WP/07/25 p. 3.

74 E. Monnet, S. Pagliari and S. Vallée ‘Europe Between Financial Repression and Regulatory Capture’ Bruegel Working Paper 2014/08 p. 6.

75 Ibid pp. 15-16.

76 E. Monnet, S. Pagliari and S. Vallée ‘Europe Between Financial Repression and Regulatory Capture’ Bruegel Working Paper 2014/08 pp. 10-14.

77 U. Das, M. Quintyn, and K. Chenard ‘Does Regulatory Governance Matter for Financial System Stabili-ty? An Empirical Analysis’ Paper prepared for a conference on the evolving financial system and public policy, Ottawa, Bank of Canada, December 2003, p. 295.

78 N. Véron ‘Banking Union in Nine Questions’ For the Interparliamentary Conference under Article 13 of the Fiscal Compact Palazzo Montecitorio (Rome), 30 September 2014.

79 S. McPhilemy ‘Integrating rules, disintegrating markets: the end of national discretion in European banking governance?’ Journal of European Public Policy, 21:10,1473–1490, 2014.

80 Interview with Anneli Tuominen, Director of the Finnish Financial Supervisory Authority in Helsinki 12.12.2014.

81 V. Babis European Bank Recovery and Resolution Directive: Recovery Proceedings for Cross-Border Banking Groups pp. 16–18.

82 J. Weidmann, ‘Stable banks for a stable Europe’ Speech at the 20th German Banking Congress, Berlin, Germany 08.04.2014, Date of access: 24.4.2014,

83 T.J. Elliot, op.cit., p. 18.

84 C. Goodhart and D. Schoenmaker ‘Should the Functions of Monetary Policy and Banking Supervision Be Separated?’ Oxford Economic Papers, New Series, Vol. 47, No. 4 (Oct. 1995) pp. 539–560, Oxford University Press, 1995.

85 A. Sapir, & H. Martin, & M Pagano, op. cit., p. 3.

86 E. Nowotny, “Opening remarks by the Governor of Oesterreichische Nationalbank” Oesterreichische Nationalbank, 41th Economics Conference of the OeNB, Vienna, Date of access: 15.4.2014.

87 V. Ioanninidou ’A first step toward Banking Union’ p. 91. Chapter pp. 85-94 in T. Beck (Ed.) Banking Union for Europe: Risks and Challenges (London, Centre for Economic Policy Research 2012.

88 Goyal, R. & Koeva, B. Petya & M. Pradhan & T. Tressel, & G: Dell'Ariccia, & R. Leckow, & C. Pazarbasioglu, op. cit., p. 21.

89 European Central Bank, ’Press Release – ECB starts comprehensive assessment in advance of supervi-sory role’ 23.10.2013.

90 See for example M. Whitehouse ‘Testing Europe's Stress Tests’ The Bloomberg View 10.24.2014.

91 E. Ferran "European Banking Union: Imperfect, But It Can Work", University of Cambridge – Faculty of

http://mobile.businessweek.com/news/2014-09-30/ecb-raises-savings-banks-focus-on-possible-cluster-rihttp://mobile.businessweek.com/news/2014-09-30/ecb-raises-savings-banks-focus-on-possible-cluster-rihttp://www.bundesbank.de/Redaktion/EN/Reden/2014/2014_04_08_weidmann.html%20-%20doc172160bodyText8http://’Press Release - ECB starts comprehensive assessment in advance of supervisory role’ 23.10.2013. http://’Press Release - ECB starts comprehensive assessment in advance of supervisory role’ 23.10.2013. http://Testing Europe's Stress Tests’ The Bloomberg View 10.24.2014

46

Law; European Corporate Governance Institute (ECGI), April 17, 2014 University of Cambridge Faculty of Law Research Paper No. 30/2014, p. 10.

92 M. Levine ’Levine on Wall Street: Stress Tests and Dollar Wars’ The Bloomberg View, 20.10.2014.

93 T. Breuer ‘Robustness, Validity and Significance of the ECB's Asset Quality Review and Stress Test Exercise’ Study provided at the Request of the European Parliament Economic and Monetary Affairs Committee [PDF] October, 2014.

94 S. Steffen ‘Robustness, Validity and Significance of the ECB's Asset Quality Review and Stress Test Exercise’ p.6.’

95 S. Merler and J. Pisany-Ferry ‘Hazardous tango: sovereign-bank interdependence and financial stability in the euro area’ Banque de France, Financial Stability Review . No. 16, April 2012.

http://www.bloombergview.com/articles/2014-10-20/levine-on-wall-street-stress-tests-and-dollar-warshttp://Robustness, Validity and Significance of the ECB's Asset Quality Review and Stress Test Exercisehttp://Robustness, Validity and Significance of the ECB's Asset Quality Review and Stress Test Exercisehttp://Robustness, Validity and Significance of the ECB's Asset Quality Review and Stress Test Exercisehttp://Robustness, Validity and Significance of the ECB's Asset Quality Review and Stress Test Exercise

NATIONAL AUDIT OFFICE OF FINLANDantinkatu 1, p.O.BOX 1119, FI-00101 helsinki

TEL. +358 9 4321, www.vtv.fi

Cover: National Audit Office´s Working paper: Banking Union Considered from the Perspective of Supreme AuditInstitutionsSignaturesExecutive Summary1Introduction to the Single Supervisory Mechanism2A Snapshot of the SSM: Where are we now?3An Introduction to the Single Resolution Mechanism4Implications of SSM for Supreme Audit Institutions 4.1Changes in Audit Scope: Is the SSM ensuring that financial supervisors are accountable?4.2Ensuring the Accountability of Financial Supervisors4.3The Role of SAIs after the Financial Crisis

5Organizational Risks of the Single Supervisory Mechanism5.1Focusing The Lens on Credit Institutions: Clouding Visibility in Identifying Sources of Financial Instability5.2 The Dividing Line between Big Banks and Small Banks: Quis custodiet ipsos custodes? 635.3Ensuring the Separation of Monetary Policy From Banking Supervision at the ECB5.4The Comprehensive Assessment: The First Test of the ECB as a Supervisor

6ConclusionsAppendix 1: A brief note on the European Union and the EurozoneAppendix 2: BibliographyReferences