The European Central Bank (ECB) and the euro-area supervisors are working hard at preparing the introduction of the new European banking supervision regime. Following the acceptance at the end of October by the European finance ministers of the Regulation establishing a European Banking Authority, joint European banking supervision is set to start in November 2014.
The new supervisory mechanism will have a major impact on the banking sector in the euro area and the Netherlands. From the end of 2014 onwards, large banks will for instance be directly subject to ECB-led supervision, in cooperation with the local supervisory authorities. Smaller banks will remain subject to supervision by their own, local supervisory authority - De Nederlandsche Bank (DNB) for the Netherlands - but they will also be impacted by the new supervisory mechanism that will cover the entire European financial community.
The introduction of European banking supervision will be an important step towards restoring confidence in the European financial sector. Joint supervision will reduce the negative correlation between national budgets and banking balance sheets that has been a recurring theme in the European financial crisis these past few years. The financial risks for taxpayers will diminish, a level playing field for the supervision of the largest and most internationally branched banks will be created and cross-border supervision will be improved.
A crucial step towards the new supervisory regime is the scheduled large-scale health test of the balance sheets of the top 130 banks in the euro area countries, which together account for some 85% of European bank assets. The review is currently being started and will be performed in several stages until October 2014. In the Netherlands the following banks will be tested: ING Bank, Rabobank, ABN AMRO, SNS Bank, Nederlandse Waterschapsbank, BNG Bank, and Royal Bank of Scotland N.V. These banks together account for almost 90% of total assets of the Dutch banking sector.
The balance sheet review breaks down into three stages. First, an analysis will be made for each bank with the purpose of determining which of their portfolios may be classified as high-risk. Then follows the actual asset quality review, in which the quality of the portfolio will be evaluated on such items as creditworthiness of counterparties, the level of provisions made, and the value of collateral including real estate. The quality of the data provided by the banks will also be subjected to a stringent review. It has been determined that the core capital emerging from the review should at least represent 8% of a bank's risk-weighted balance sheet total. The review will be concluded with a stress test in which the banks' balance sheets will be subjected to a number of stress scenarios in cooperation with the European Banking Authority.
The review of the balance sheets of the European banks is considered to be a crucial step towards restoring confidence in the European financial sector. A clear perception of the state of health of the banks may help to dispel the doubts that the financial markets have about the banking sector, and thereby contribute to the recovery of lending. The review is of crucial importance to bring to light possible capital shortfalls at the banks in question and to take action where necessary.
The review results will be published in October 2014. Any shortfalls remaining by that time will then have to be resolved under the watchful eyes of the ECB and the local supervisors within a timespan still to be decided. As agreed, in the first instance recourse will have to be taken to private capital market funding. If private funding proves to be insufficient, shortfalls will have to be cleared up by means of public backstops from the national governments. Before these public backstops can be used, the banks' own funds and subordinated liabilities should be deployed first. The last resort will be support from the European Stability Mechanism (ESM).
All of this makes next year's full-scale review a momentous exercise, both for the banks and for the ECB and the national supervisors (including DNB) which will be required to perform a stringent review under pressure of time and public scrutiny. In addition, Brussels will still have to decide on a number of essential elements of the banking union. Backstops at national level will for instance be necessary as a means of covering any capital gaps that may come to light at individual banks. Another issue prompting vigorous debate is that of the Single Resolution Mechanism, the joint settlement mechanism for troubled banks. In order to achieve a credible start of the banking union, of which joint supervision and the joint settlement mechanism are part, it is essential that these uncertainties are cleared up in time.