Interview Central Banking by Levente Koroes with Denis Beau

The Banque de France’s deputy governor speaks about suppression of the systemic risk buffer, proposals for a TLAC floor, and simplifying bank regulation and resolution.

You sit on the supervisory board of the Single Supervisory Mechanism (SSM). Can you provide some context on the current debate around modernising the regulatory framework in Europe?

I’ve been on the supervisory board of the SSM for nine years. There is an ongoing debate at European and international level about modernising the regulatory framework. From the supervisory side, we have already undertaken a number of reforms, including the ‘Next Level Supervision’ programme and the reform of the Supervisory Review and Evaluation Process, with the broad objective of simplification. Separately, the European Commission is preparing a report on the competitiveness of banks, which may lead to proposed changes to banking regulation. 

Is there a level of urgency to this, given the deregulation winds blowing from the US?

Independently of what is happening in the US, this is a normal and recurring question: is our regulatory framework still fit for purpose? We actually embarked on a supervisory reform agenda a few years ago, when Andrea Enria, as chair, commissioned an independent review after nearly 10 years of the SSM. It looked at what we were doing right, or what could be improved. The current drive is not driven by the US agenda. It is a regular reflection on adapting our framework to the evolution of the financial system and the risks banks face.

On macro-prudential buffers: how do you see those evolving, and what is your proposal?

The number and scope of current buffers can be simplified. I see simplification ahead: we have been advocating for the suppression of the systemic risk buffer, which is a European addition to international standards. Our proposal, which is shared by others and reflected in European Central Bank reports, is to move towards a single releasable buffer covering both cyclical and structural risks.

Would that reduce the firepower available to fight systemic risk, especially given all the talk of hidden ‘pockets of risk’ in the financial system?

No. Both cyclical and structural risks would remain covered. In fact, simplifying in this direction could make it easier to deploy and release buffers. It would in no way reduce the firepower of European authorities. 

Your argument consistently rests on simplification rather than deregulation. Where does one end and the other begin?

We have observed that the banking system has become significantly more resilient over recent years, tested by Covid, the fall of the Silicon Valley Bank, the war in Ukraine and waves of inflation. That resilience is the result of post-financial crisis international standards, 10 years of SSM supervision, and improvements by banks in their risk management and financial resources and structures. 

Simplification becomes deregulation when changes to regulation or supervision reduce requirements in ways that undermine that resilience. On solvency risk, for instance, this means sticking to the overall Common Equity Tier 1 capital requirements against risk-weighted assets. You can simplify the capital stack without deregulating so long as the overall requirement is not reduced.

Some would argue it is not rules holding European banks back, but fragmentation, scale and weak profitability. How do you know simplification is fixing the real problems?

Banking system robustness has improved significantly. Integration has not kept pace. It has not evolved as positively as robustness. Regulation and supervision are among the factors that explain this, notably because they have unduly constrained the circulation of liquidity and capital within banking groups. This makes cross-border activity within the EU more costly and less scalable than purely domestic activity. Reducing those undue regulatory and supervisory costs would have a positive bearing on cross-border integration, competition and the ability of banks to exploit economies of scale.

Is the current method for calculating Pillar 2 requirements too arbitrary? Would you recommend changes, including greater transparency?

By law, Pillar 2 requirements are designed to cover risks not covered or insufficiently addressed under Pillar 1. If the calibration is grounded in a solid supervisory assessment of each institution’s risk profile and Pillar 1 requirements, I do not see any ground for criticism of arbitrariness. This is the objective of the SSM’s methodology, which has been refined over the years. The process should not lead to an arbitrary definition of Pillar 2 requirements.

Would you recommend reforms to the resolution framework?

Yes, the resolution framework is a strong candidate for simplification. The current version has an unnecessary level of complexity and gold-plating compared to total loss-absorbing capacity (TLAC) standards – unnecessary in terms of ensuring a bank’s resilience in a resolution scenario.

In its current form, banks can face up to six requirements applying in parallel at group level, and the framework is further complicated by a number of other features such as triggers of restrictions on dividend distribution. Our proposal is to realign the framework with the international TLAC standard, which would serve as a uniform floor for large EU banking groups, complemented by a resolution Pillar 2 add-on set on a case-by-case basis by the resolution authority. This is simpler and more consistent with the international standard. 

On Basel III and the global systemically important bank (G-Sib) surcharge: if the US is going capital neutral on those rules, why should Europe hold the line?

We need to wait and see what the US proposals actually become in final form. I think it’s premature to draw conclusions of what are being considered in the US. In addition, we need to distinguish between reductions in gold-plating and genuine deviations from international standards. International standards were conceived precisely to provide a baseline for internationally active banks and to contribute to global financial stability. Moving away from them would trigger a race to the bottom that must be resisted, because it would be detrimental to everyone, including those who initiated it.

Haven’t US regulators already been dragging their feet on implementing some of these standards?

For now, it remains under discussion. We will see what comes out of it.

EU banks appear to carry loss-absorbing requirements roughly 3.5 percentage points higher than their US peers. Is this not a disadvantage, and how much of the minimum requirement for own funds and eligible liabilities proposal is about closing that gap?

This quantitative gap exists, and the Autorité de Contrôle Prudentiel et de Résolution (ACPR) has published research on it, acknowledging however the limits of any international comparison. Any international comparisons are inherently complex. But there is also a complexity gap, which makes European banks’ resilience harder to assess and compliance more costly. Our proposal primarily addresses this gap, through realignment with the TLAC standard, as a Pillar 1 floor with a bank-specific Pillar 2 add-on. But this approach could also help address the quantitative gap.

Your TLAC-based floor suggestion goes further than what the Single Resolution Board appears comfortable with. How do you reassure them that credible bail-in plans would not be weakened?

The proposal is about simplification, not dilution. Ensuring sufficient resources for bail is an objective that is not compromised by our proposal. The TLAC floor already covers extreme resolution scenarios with resources well above double the Pillar 1 requirements. On top of that, the bank-specific Pillar 2 add-on provides additional safety. Together, these give resolution authorities a solid and sufficient resource base.

Your proposal does not address a European-wide deposit insurance scheme. Can cross-border waivers really work without one?

A fully overhauled deposit insurance scheme is not a precondition for making progress on simplification and foster integration. There are significant steps that can be taken now, including creating a public liquidity backstop mechanism for deposit guarantees schemes. The full overhaul and integration of deposit insurance is the end game, but there are a number of significant steps that can be taken in the name of simplification and integration that merit attention first.

What would change the trust between national supervisors when it comes to capital and liquidity waivers?

between authorities in the regulatory framwork, the SSM and the SRB can contribute to explain this. I think that view is misguided when you look at the achievements. The SSM has been a real success and has significantly contributed to strengthen European banking resilience. So, going forward supervisors should use the tools regulation already gives them, when the conditions are met. Doing so would deliver tangible benefits: more integrated, competitive banking markets, felt directly by borrowers and savers.

How many years away are we from supervisors disregarding a bank’s nationality when deciding on waivers, and what has to change politically?

The journey has already started. Supervisory reform is under way, and we are awaiting complementary regulatory initiatives. The tools already exist. The time needed to reach this goal should not be long, relative to the history the SSM has already built.

If no new legislation is passed this year, what can supervisors deliver on simplification alone?

Quite a lot. We are already revising supervisory guides to streamline implementation, and we have introduced fast-track procedures for a number of decisions. We can also be more risk-based, selective in our supervisory cycles. And on cross-border liquidity waivers, we can do more without any change to regulation. There is a substantial list of improvements available to us today.

If these reforms stall over the next two years, who bears responsibility?

I will not engage in a blame game. Europeans have important tools in their hands, and the single market is a considerable strength if fully exploited. Simplification of regulation and supervision is an important lever, but not the only one to foster the cross-border integration of the banking market. Other levers include company, tax law, competition frameworks. The general point is that we Europeans have our destiny in our hands. All those who can contribute positively should do so, in the interest of a better-integrated European banking sector and, ultimately, of European consumers and businesses.