Banking confidence the key for new regulator

From next week, Europe’s banks will have a new regulator. Frenchwoman Danièle Nouy moves into the role as the head of the Single Supervisory Mechanism (SSM), the body in charge of banking regulation, bringing together the European Central Bank and national supervisors, including the Central Bank of Ireland.

The stress tests of bank loan books completed last week was the prelude to this transfer of regulatory control, designed to ensure that national regulators hadn’t missed anything – or that there was nothing they had not told Frankfurt about.

One thing is clear in this new structure. Frankfurt will call the shots, albeit within a structure in which all the national supervisors are represented.

National banking regulation failed abysmally in the run-up to the crisis and Nouy is the woman at the head of the new body designed to fix this by bringing all regulation in Europe under one roof and using one set of rules.

Nouy has been a regulator for most of her working life. She was employed for many years in the Bank of France before becoming secretary general of the Basel Committee on Banking Supervision for five years.

She returned to Paris and became head of France’s banking regulator and her candidature for the top job in the SSM was helped by the fact that France’s banks, while like others hit hard by the crisis came through it in reasonable shape.

Nouy is diplomatic when asked about the movement of control from national capitals to Frankfurt, emphasising the continuing role of the national regulator but it is clear where the final say will lie.

She has previously spoken about the need for distance between the banks and those who make the final decisions – and the need for regulators to move quickly if they are not happy with the answers they get. Nouy argues that the new regime brings the best of two worlds.

“At the end of the day, the decision will not be taken in Dublin but by a European supervisory board [the SSM board chaired by Nouy] inside a strong European institution, the ECB. So we will have the European dimension, the consistency and level playing field, but still will benefit from the experience and expertise of our Irish colleagues.”

It will be a new world for the three domestic Irish banks – Allied Irish Banks, Bank of Ireland and Permanent TSB – which are among the 130 banks across Europe that will come under the direct supervision of the ECB.

The two main banks passed the recent stress tests, but Permanent TSB failed on the scenario where a judgement was made on whether it had enough capital on its balance sheet to weather a future recession.

While loath to comment in detail on an individual institution, Nouy indicated that Frankfurt recognises the importance of PTSB in the Irish market.

“I welcome the comments of the Minister for Finance that he and his officials will work with PTSB and other stakeholders to ensure a successful exclusion of capital plan in 2015,” she says. “I believe that Permanent TSB will find an appropriate solution.”

Under threat

These comments are important as, a few years ago, PTSB’s independent future as a heavily loss-making bank appeared under threat amid suggestions it might be merged with another Irish player. The European Commission’s competition arm was seen as a supporter of the bank’s survival arguing that it was needed if the market was not to be dominated by the two big players.

Questioned about competition in the market, Nouy says PTSB “has been assessed as one important element, [of the competitive market in Ireland] and I share this view”.

Nouy is supportive of the work of the Central Bank in overseeing the restructuring of the banking sector here and believes it is now doing enough “to pressure them to deal with the problem loans on their books”.

“It is also encouraging to note positive economic data regarding Ireland over the last months,” she says. “That will help to improve the business and economic environment and the banks’ situation as well. The important thing for me is that those banks are sound and healthy institutions, that they can now lend prudently to the economy.”

It is when asked about the new moves by the Irish Central Bank to tighten control on mortgage lending that she is most animated. The Central Bank recently proposed tough new limits on the amount of loans banks could give as a proportion of the borrower’s income. It also said that in most cases borrowers should have to save 20 per cent of the value of their new home.

This latter proposal, in particular, has been criticised for effectively shutting out many new borrowers.

But wherever these new rules were thought up, it is clear that they have strong support in Frankfurt, and – perhaps – were born in Paris. In particular, Nouy refers to the experience in France where tight controls were implemented in the wake of the Crédit Lyonnais bust in the late 1990s.

Loan ratios

In France mortgage lending is controlled using a formula that also takes into account repayment on other debts and generally involves low loan-to-value ratios. This tough approach may well have influenced the senior Irish banking regulator, Frenchman Cyril Roux, who previously worked with Nouy in the Bank of France.

What does Nouy think?

“I strongly welcome such measures. They have been in place in France for some time and they have been very effective. They have a real impact on stopping asset bubbles in their tracks. So I think those are good measures,” she said.

Criticisms of the new rules are understandable, she says, as they can have a disproportionate impact on those who cannot get cash to fund the deposit to buy a new house.

“However, on balance, I believe that the most important thing is to avoid destabilising the banking system . . . In my view it is irresponsible to give loans to people who possibly will not be able to repay them. It is so much worse for people to find that they cannot afford their commitments than to be declined credit because they do not fall within the loan-to-income or loan-to-value caps.”

Asked specifically about the proposed requirement that most borrowers have deposit of a 20 per cent, she said: “Maybe I am not the right person to ask the question because in my country this is the case and I have always known that to be the case. It does no good for people to be placed in a situation where they cannot meet their commitments. This is something which has been shown by the subprime crisis.”

Overall this stability first approach will clearly inform the decisions of the ECB in its new supervisory role. Nouy disputes the contention of some in the financial sector that we are moving from an era of so-called light touch regulation to one of over-regulation. “I don’t think we have over-regulated the banks,” she says, adding that most of the changes related to them having more capital of better quality.

“Before the crisis, there was not enough capital of sufficient quality. Supervision will not be about ticking boxes, it will be about being inclusive, asking a lot of questions, totally understanding the business models of the banks, their operations and ensuring the risks they take are properly assessed and managed and mitigated.”

The stress tests were the first key step in this, she argues, aimed at providing confidence to potential bank investors and funders that balance sheets are sold.

Critics say this has encouraged banks to hoard capital and not lend it out as they prepared for the tests. However Nouy argues that the first requirement was to have a belief that the balance sheets of the banks were fixed – or being fixed.

Can this lead to credit growth in the euro zone economy? “ I think that to have a sound banking system, solid banks with clean balance sheets are a very important pre-condition, so that banks can do their job of making loans to the economy, to corporates and to individuals,” she says. “That is a preliminary condition. But it is not the only condition. Supervisors have done their jobs and this precondition in my view is met.”

Those providing equity and funding to banks should now be more comfortable doing so, she says, with full visibility of the state of the banks’ balance sheets.

Others too must now play their part if recovery is to kick in, she says. ECB president Mario Draghi has repeatedly called on Europe’s governments to speed structural reform to boost recovery.

A significant plus is that many banks which were found to have a shortfall have already taken steps to try to fill it. Some €10 billion of the €25 billion shortfall identified in the tests has still to be raised but Nouy sees this as manageable.

“We expect the banks to find private capital solutions. And we will review the capital plans that they produce and assess whether they are solid and credible.”

‘Cautious people’

Nouy is loath to engage on some subjects. “Supervisors are cautious people,” she jokes. So she will not comment on her preferred pace of sale of the remaining state stakes in the banks. And she brushes off questions about Ireland’s banking supervisory record and the proposed banking inquiry with the comment that she is a newcomer to the job having been appointed less than a year ago.

We will hear more from her in the months ahead however. Together with Roux and Central Bank boss Patrick Honohan, she will be a central figure in overseeing the remaining restructuring of the Irish banking system.

She has repeatedly made clear that this will be an activist regulatory regime: if Frankfurt does not feel it is getting the right answers, it will move quickly. In public, she will only say that the stress tests have been a key step in the right direction for banks across Europe and in Ireland. In practice, she will know that her work is only getting started as control finally moves to Frankfurt next week.