Events & News


The European Banking Union: A Research Seminar by Dr Christian Hofmann

Dr Christian Hofmann, Assistant Professor, NUS Faculty of Law

29th August 2014
Seminar Room 5-4, 5th Floor, Block B, NUS Law School
469G Bukit Timah Road, Singapore 259776

12.30pm to 2.00pm


One of the outcomes of the recent crises in the European Union (EU), the financial and sovereign debt crises in the eurozone, is the realization that sovereigns and systemically relevant banks can find themselves caught in a perilous embrace. Financial difficulties of one can trigger or aggravate financial difficulties of the other, potentially leading to defaults on debt and a financial and economic crisis of national, regional and global impact.

The EU has reacted by enacting a number of reforms of remarkable magnitude. The most significant ones are summarized by the term “banking union”. This banking union comprises a centralized supervision of significant banks in the euro-zone (the Single Supervisory Mechanism), restructuring and resolution regimes for credit institutions in the euro-zone (the Single Resolution Mechanism) and funding mechanisms available for and financed by banks (the Single Resolution Fund).

This seminar on the European Banking Union co-organized by the EU Centre and the NUS Centre for Banking & Finance Law discussed these reforms and their consequences for non-EU institutions and creditors, e.g. Singaporean banks and investors.

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Dr Christian Hofmann opened the seminar by highlighting the recent history and prospects of the banking union. An international standard of regulation for banks had been discussed earlier within academic circles and it was only in the aftermath of the financial crisis that such proposals were taken seriously in the European Union (EU). Such a banking union system, as Dr Hofmann argues, could even be a blueprint for the regulation of global banking supervision and resolution.

The phenomenon that the EU is trying to resolve through the banking union is the fact that sovereigns and their financial institutions are so interconnected in today’s financial markets. Unless a country is fortunate enough to have a lead currency such as the U.S. dollar or is a safe harbour for international investments, sovereigns are dependent on financial institutions for financing their expenditure.  At the same time, they are also obliged to bail out some of these financial institutions during a financial crisis to reduce the risk of contagion. During the peak of the crisis, measures to resolve the failure of financial institutions include quantitative easing (the expansion of money supply), bailouts by sovereigns and Emergency Liquidity Assistance of the Euro system by the European Central Bank. At the same time, the EU also saw the troika bailouts of Eurozone sovereigns through the use of the EFSF (European Financial Stability Facility) and the ESM (European Stability Mechanism).

The focus in Europe is now on long-term measures in order to prevent similar scenarios from happening and to stabilize the situations of financial institutions and sovereigns. The key underlying principle is to try and make sovereigns and financial institutions less dependent on each other, and to provide mechanisms to deal with worse case scenarios such as defaults of sovereigns or credit institutions. However, insolvency regimes for sovereigns are still difficult to implement – although this was discussed during the peak of the sovereign debt crisis, such a mechanism would require the surrender of fiscal sovereignty to an international institution for a certain amount of time. Politically, this is an intolerable situation for sovereigns, so the EU has settled for a two-step solution with the establishment of the ESM and putting in place collective action clauses in sovereign bond issues.

Moving on to the European Banking Union, Dr Hofmann explained that the new regime is built on three pillars: (1) a single rule book, the Single Supervisory Mechanism, for financial regulation of all EU credit institutions and centralized prudential supervision of significant EU credit institutions; (2) a Union-wide restructuring and resolution regime for financial institutions and funding mechanisms, and (3) a Union-wide Single Deposit Guarantee scheme. For the time being, the deposit guarantee scheme is still being discussed by sovereigns and it remains to be seen whether this will be implemented at all.

In terms of the first pillar, the new regime will replace an old regime where national supervisors apply national rules of banking supervision. The harmonization of rules is currently limited as they are based on EU directives and the transposition into national law left substantial space for national approaches. The home country principle applied: banks and their branches are supervised by National Competence Authorities (NCAs) in the country where they are incorporated and authorised, but subsidiaries are supervised by host country NCAs. In the new regime, there will be centralised prudential supervision by the ECB. ECB acts as the central supervisor of significant banks – initially supervising 130 banks – and this will be limited to participating member states from all the 18 Eurozone countries.  The new regime has also put into place Capital Requirements Regulation (CRR-IV) which will be complemented by further rules based on directives which member states will have to implement.

Dr Hofmann then touched on the requirements for ECB supervision in this new regime. The new regime will apply to significant credit institutions, financial holding companies, mixed financial holding companies established in participating member states, and the branches of significant credit institutions in non-participating member states established in participating member states. He then elucidated the distinction of “significant” and “less significant” institutions which is set out in Art. 6(4) SSMR, The “significance” takes into account the size, the importance of the institution to the economy of the EU or participating member states and the significance of cross-border activities. For example, a financial institution is considered significant when its total value of assets exceeds 30 billion Euros, or is one of the three largest credit institutions of a participating member state, or has received financial assistance from the ESM.

To enforce regulations of the banking union, the ECB and NCAs will co-operate more strongly on a permanent basis.

In terms of ECB tasks, the Governing Council will remain as the highest decision making body in the ECB, but several new sub-bodies will assist in the policymaking at the ECB level. First, a new Supervisory Board will be created to prepare draft decisions proposed for adoption by the Governing Council. Second, a mediation panel will be created to resolve differences of views in cases where the Governing Council objects to the Supervisory Board’s draft decision, and lastly, day-to-day work will be carried out by four new Directorates Generals (DGs). In terms of supervision, Joint Supervisory Teams (JSTs) will be created. Each JST will carry out the operational supervision of each significant banking group or credit institution: each team – which will be headed by an ECB coordinator – will comprise supervisors from the ECB and the NCAs and will be in contact with the supervised financial institution on a daily basis.

The next major measure in this new centralised supervisory regime is the authorisation procedure, which is now a two-step procedure. A compromise was struck between the ECB and member states in the negotiation of authorisation powers – the ECB is now the main competent authority that decides on an application, and the NCAs are involved in the authorisation by gathering the necessary information. If the NCA accepts the application, it submits it to the ECB for its ultimate decision and notifies the applicant on the success of its assessment. Should the ECB reject the application, then this will be brought to the Court of Justice of the European Union (CJEU) for adjudication.

Dr Hofmann then moved on to talk about cross-border scenarios in the EU. In the existing regulatory regime, home country principle and the EU passport applies. In this case, the European Banking Authority is the mediator, and supervision of branches is taken on a consolidated basis with the leading role of the home country’s supervisory authority. In contrast, the new system sees the ECB as the supervisor of significant credit institutions in three distinct scenarios: the “in-in-scenario”, the “in-out-scenario” and the “out-in-scenario”. The “in-in-scenario” applies when a credit institution that is authorised in a participating member state opens a branch in another member state (e.g. German bank opens a branch in France) a significant credit institution will be supervised by the ECB and a less significant credit institution will follow the existing regime and inform its home country’s NCA about its intention to open a branch in a participating member state. The “in-out-scenario” covers credit institutions from participating member states that open branches in non-participating member states (e.g. German bank opens branch in UK). Here, the significant credit institution is supervised by the ECB which will then notify the relevant NCA, while the existing regime continues to apply for less significant credit institutions. Last, the “out-in-scenario” involves credit institutions from non-participating member states establishing a branch in a participating member state (e.g. UK bank opens a branch in Germany). In this case, the ECB is able to supervise the branch of a significant credit institution, but it will not have any supervising jurisdiction over the actual credit institution itself.

Is there, then, a difference between non-participating EU members and non-EU countries (third countries)? Yes, says Dr Hofmann. Non-EU credit institutions stay outside of the scope of application of the new regime, but EU branches of significant credit institutions headquartered outside the EU will be supervised by the host country’s NCA. Subsidiaries of non-EU credit institutions will be supervised by the ECB, but a branch of the same bank will be supervised by BaFin. In the opposite scenario where a significant credit institution from a participating member state establishes a branch outside the EU, the ECB is the relevant supervisory authority and will therefore supervise the bank branch jointly with the host country’s NCA. In terms of less significant EU banks, the host country’s NCAs has supervisory jurisdiction.

Moving on to the second pillar, Dr Hofmann then talked about the measures behind the union-wide restructuring and resolution regime for financial institutions and mechanisms. Namely, these are the Bank Recovery and Resolution Directive (BRRD), the Single Resolution Mechanism (SRM) and the Single Resolution Fund (SRF). Although the BRRD and SRM have identical resolution objectives, principles and tools, they cover different geographical scopes, authorities and financing. BRRD applies to the entire EU, while SRM applies only to the Eurozone and voluntarily participating EU member states. That being said, the biggest goal of these two mechanisms – which have more superior financial means than local or national funds – is to break up the negative feedback loop of sovereigns, banks and the real economy. All credit institutions, parent undertakings, investment firms and financial institutions established in the EU are subject to BRRD, while those that are established in participating member states and are subject to consolidates supervision by the ECB fall under the SRM regulation.

A new European institution will also be set up to decide on matters of insolvency and resolution. The Brussels based Single Resolution Board (SRB) will work alongside national resolution authorities (NRAs) to adopt a resolution scheme when a credit institution is failing or likely to fail, or when failure cannot be avoided by supervisory action or private solutions (e.g. Takeover or capital increases), and the SRM is require in the interests of the public. Here, the ECB is responsible for declaring whether a bank is likely to fail, the SRB or NRAs will assess whether other solutions are available and develop the resolution scheme, and once approved, the NRAs will execute the scheme. This resolution scheme will place an entity under resolution, determine the resolution tools that apply, and whether SRF funding is needed. The European Commission, too, is ultimately involved in the adoption of the resolution scheme – it may endorse or reject the scheme, and in the case of the rejection, the SRB will have to modify the scheme in accordance with the Commission’s objections.

Once again, different rules apply for different authorities: the SRB applies SRM rules while the NCAs are competent supervisory authorities for less significant domestic bank groups in the Eurozone and all financial institutions in non-participating member states. These authorities have to follow certain principles in the SRM and BRRD, namely: ensure continuity of critical functions and avoid significant adverse effects on financial stability; protect public funds and depositors; replace management; burden shareholders with first losses, and lastly, avoid disadvantages to creditors in comparison to ordinary insolvency procedures (i.e. Creditors can later claim funds from the resolution fund if they would have suffered less in ordinary insolvency procedures). In order to achieve these principles, the resolution authorities can implement the bridge institution tool, the assent separation tool, bail ins, and the replacement of management (or even temporary take-over by NRAs).

On  the funding of the funding mechanisms, for the  BRRD, EU countries are obliged to establish and fund national funds for the restructure of financial institutions, while the SRF as of 2016 will replace national funds established under the BRRD for its 26 participating member states (minus the UK and Sweden). The SRF – in contrast with the ESM and EFSF funding mechanisms that was funded by sovereigns to be made available for both indebted sovereigns and Eurozone credit institutions – will be funded by Eurozone credit institutions and is available to Eurozone credit institutions and has a legal base in  the SRM regulation and the intergovernmental agreement (IGA) treaty of May 2014. The SRM determines the establishment of the SRF, calculates the contributions and obligations of participants, and administers the SRF, while the IGA treaty has set out the rules for the transfer of funds from the national funding mechanisms to the SRF as well as conditions on the use of SRF funds. At the moment, the SRF cannot receive funds from the ESM, but Dr Hofmann thinks that this may change in future if a large enough failure of a financial institution spurs further financing. What we will see are contributions by national authorities that will most certainly consist of a flat rate and risk-adjusted amounts – countries such as Germany and Spain favour the risk-adjusted contributions while countries such as France with large banks prefer the flat rate. As of August 2014, the calculation methods are still being negotiated by member states. Ultimately, the goal of the SRF is to raise 1% of the protected deposits of all credit institutions in the Banking Union (currently estimated at 55 billion Euros).

In concluding, Dr Hofmann reminded the audience that the regime is currently based on the currency union, but not on the free movement of capital. Indeed, the new regime currently focuses on classic banking activities but not the emerging shadow banking sector. This may be an area that the EU would have to look at in the near future.