Cross-border banking supervision for small host countries in Central, Eastern and South Eastern Europe
Ismael Ahmad Fontán, Thorsten Beck, Katia D’Hulster, Pamela Lintner, Filiz Unsal 20 May 2019
The primary objectives of the euro area’s Single Supervisory Mechanism (SRM) and Single Resolution Mechanism (SSM) are to enhance financial stability and foster financial integration (Gros 2012). However, this new supervisory structure, as well as the broader EU regulatory reforms, have important repercussions for countries that are not part of the monetary union or the European Union, but whose banking systems are dominated by EU or, more specifically, euro area-based banks. In a recent report, we analyse the effects of these regulatory and supervisory changes within the EU and euro area on host regulation and supervision in Central, Eastern, and South Eastern Europe (CESEE) and on their cooperation with home supervisors and resolution authorities in Western Europe (Ahmad et al. 2019).
The banking systems in CESEE are dominated by subsidiaries of multinational banks, many with parent banks from the EU, making cooperation between prudential supervisors important. In most countries, subsidiaries of multinational banking groups make up the majority of banking system assets. And while since 2008, we have seen some retrenchment of banks from Western Europe, most prominently Greek but also some Austrian banks, banks like Unicredit, Intesa San Paolo, and Raiffeisen still have large market shares across banking markets in the region (Claessens and van Horen 2015).
Countries facing a clear asymmetry between the systemic importance of the subsidiary in the host country and the irrelevance of the host country operation for the overall operation of the parent bank and thus the home supervisor are referred to as ‘small host countries’. Take some examples from Table 1: the Austrian Raiffeisen Bank has a market share of 17% in Albania, but the Albanian subsidiary makes up 1.4% of its overall balance sheet; Intesa San Paolo has a market share of 16.7% in Serbia, but its Serbian subsidiary makes up only 0.6% of its overall balance sheet. This asymmetry results in diverging interests and powers, both during normal times, but even more so in crisis times between home and host supervisors (D’Hulster 2012).
Table 1 Market share in host country and share of assets in group’s total assets in 2017
The global financial crisis has led to significant reforms in cross-border supervisory cooperation (Lintner 2017). The failure of big international financial institutions (e.g. Lehman Brothers) and cross-border banks (e.g. Fortis, Dexia, and the Icelandic banks), and their rather chaotic resolution, played a prominent role in the unfolding of the crisis (Allen et al. 2011). In the EU, binding cross-border cooperation and consensus-based joint decision making among supervisors and resolution authorities have been introduced. Within the euro area, the most important initiative has undoubtedly been the (incomplete)1 construction of the European Banking Union. The SSM has been complemented by a largely centralised SRM, even though it is still reliant on national execution and provides the European Commission and European Council veto rights.
These reforms have important repercussions for the small host countries of CESEE. An important distinction has to be made, however, between three or four different groups of countries: (i) small host countries within the euro area (e.g. Slovakia), (ii) small host countries outside the Eurozone but within the EU (e.g. Croatia), and (iii) small host countries outside the EU. Within the latter category, one can further distinguish between candidate (e.g. Albania) and non-candidate host countries (e.g. Moldova).
While fewer than five years have passed since these reforms, it is possible to draw first conclusions for their impact on the relationship between home and host supervisors, based on reading of the laws and regulations and first experiences, which we collected through a survey of host supervisors in CESEE and direct conversations with several of them. This analysis also allows us to provide recommendations to both home and host supervisors.
Small host countries in the euro area: Being part of the action
The implementation of the Banking Union has resulted in the elimination of the traditional ‘home-host’ distinction within the euro area for significant institutions as prudential supervision and resolution has now been attributed to the SSM/SRM. Thus, for a cross-border significant banking group headed by a euro area bank where one of its subsidiaries is based in a small host country within the euro area, the ECB (SSM) is the supervisor and the SRB (SRM) the resolution authority for both the parent entity and the subsidiary, even if they are located in different euro area member states. Local supervisors and resolution authorities participate in the supervision as part of the joint supervisory teams and the resolution planning as part of the internal resolution teams.
This centralisation has important repercussions for local authorities:
- There can be stability and efficiency gains for the local banking market, if the dominating banks are supervised on a supranational rather than national level, with SSM/SRM taking a broader view, less biased toward the interests of the home country.
- However, more centralised supervision by the SSM is more biased in favour of the consolidated level and may favour branches against subsidiaries, thus reducing the influence of host country supervisors even further.
- Host authorities of euro area subsidiaries of parent banks that fall under the SRB’s remit no longer have legal responsibility on resolution planning nor the taking of resolution decisions as this is now centralised under the SRM, implying a further loss of influence.
Small non-euro host countries in the EU: A balance of rights and obligations
Contrary to euro area hosts, other EU member states retain their full competences as individual or sub-consolidated host supervisors and resolution authorities. However, they are bound by new rules on supervision and resolution at the EU level. They have the right to participate in Supervisory and Resolution Colleges, thus gaining access to critical information on the consolidated level about the subsidiaries in their countries. At the same time, dealing with one supranational authority as home supervisor rather than several national ones can be an advantage.
However, a common concern of non-euro area EU small hosts is that insufficient attention is paid by the SSM/SRB to the systemically important subsidiaries in the host country because they do not represent a significant share of the assets, liabilities, revenues, or capital of the banking group.
One specific point of tension between home and host supervisors within the EU has been the issue of whether subsidiaries are treated as separate points of entry in the case of resolution or as part of the same point of entry as the parent bank. Constituting a separate point of entry provides the local authorities in a small host country with the flexibility of ring-fencing its subsidiary if trouble starts in the parent bank or another part of the banking group. On the other hand, constituting a separate point of entry would involve locally issuing bail-inable debt that can serve to fulfil MREL (Minimum Requirements for own funds and Eligible Liabilities) obligations under the Bank Recovery and Resolution Directive (BRRD). However, issuing such paper comes with its own challenges given small and shallow capital markets.
One important tool for small host countries in the EU is mediation by the European Banking Authority (EBA), which can be used in cases of disagreements between supervisors and, despite its name, is binding as long as it does not infringe on fiscal policy.
Small host countries outside the EU: An uneven playing field
The rights and obligations of non-EU host countries differ substantially from that of EU members. Candidate countries typically aim at adopting EU regulations as a requirement to becoming an EU member. Non-candidate countries do not have to adopt EU regulations. Nevertheless, they are treated the same way under the current EU framework. They can both be invited as observers to join supervisory and resolution colleges, but have no right to be invited and their participation is conditional on an equivalence assessment by the EBA and agreement by the college members. The centralisation of supervision in the euro area might have pushed non-EU supervisors further to the side lines; some non-EU host supervisors observed that the colleges currently organized by euro area national supervisory authorities have a higher engagement level with non-EU hosts than the colleges organised directly by the SSM for significant institutions. And participation in supervisory colleges remains much more widespread than in resolution colleges.
One specific concern for non-EU host countries (and emerging markets more generally) has been that home supervisors enforce non-zero risk weights and exposure limits on holdings of sovereign debt issued by non-EU hosts at the consolidated level, which increases the risk weighting for subsidiaries holding such paper. Given the importance of these banks in the provision of liquidity of government securities, the financing costs for small host governments could face upward pressure. Similarly, and specific to the situation in some of the countries in the region, home supervisors might force banks to divest from certain non-EU non-performing loans (NPLs) to which the banks are exposed through their subsidiaries, which might trigger the sale of NPLs and impact the credit conditions in the host country.
Unlike EU members, non-EU hosts do not have access to the EBA mediation process and there is no basis for joint decisions as under BRRD for home and host supervisors in the EU. This reduces the bargaining position of non-EU small hosts rather drastically and results – in our opinion – in an uneven playing field.
Conclusions and recommendations
The above analysis and discussions take us to several recommendations, directed at authorities both at the EU level and in the small host countries:
- Non-EU hosts, particularly candidate countries, should participate in all relevant EU supervisory and resolution colleges, as well as crisis management groups as observers. This can be facilitated by the EBA issuing a non-binding recommendation to EU authorities on the treatment of observers i.e., as regards to access to documents, provide a platform for sharing of common concerns etc. This would facilitate communication between home and host supervisors, with benefits for both, but especially for financial stability and development in the host country.
- EU authorities should reach out to non-EU small host countries and improve cooperation with them. This would include better communication and cooperation with small hosts before taking decisions, including on reducing NPL levels and exposure of sovereign bonds. It is also critical that EU home supervisors, and particularly the SSM, consider the effects on small hosts when authorising cross-border M&A transactions between EU banking groups to avoid further concentration in these markets. Finally, more transparency in defining the main criteria for selecting the resolution approach for EU banking groups – single versus multiple points of entry – would be helpful for host resolution authorities.
- Small EU host countries outside the Banking Union should make more use of the EBA mediation service when relevant to ensure their interests are properly protected when it comes to joint decision making in colleges.
- Non-EU host candidate countries should adapt EU regulations to fit their national circumstances rather than adopting them blindly, while non-candidate countries should take an even more flexible approach.
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D’Hulster, K (2012), “Cross-border banking supervision: Incentive conflicts in supervisory information sharing between home and host supervisors”, Journal of Banking Regulation 13: 300-319
Gros, D (2012), “Banking Union: Ireland vs. Nevada, an illustration of the importance of an integrated banking system”, VoxEU.org, 27 November.
Lintner, P (ed.) (2017), Understanding bank recovery and resolution in the EU: a guidebook to the BRRD, World Bank, FinSAC.
 The funding mechanisms, including a European Deposit Insurance Scheme (EDIS) as proposed by the European Commission and a backstop mechanism, await political approval and implementation.