Banking StandardsWritten evidence from the Prudential Regulation Authority, Bank of England
THE IMPACT OF EUROPE ON THE PRA’S APPROACH TO SUPERVISION
The PRA has adopted an approach to supervision which I have described in summary as “judgement against a framework of rules”. A key element of this is the emphasis on forward-looking judgement (eg what is the possible impact of risks facing the firm(s) as distinct from a backward-looking test of whether a firm has met a rule-based test, which is often described as “box ticking”). This is therefore a crucial change in the approach to supervision.
The framework of rules against which judgements are made is predominantly EU in origin (though in bank supervision a substantial part of the EU rules reflects standards agreed in Basel and then transposed into EU law, though not always exactly). Insurance supervision does not have a Basel equivalent, but there is a substantial body of EU law which is set to expand substantially whenever Solvency 2 comes into effect. Traditionally, EU law has been so-called “minimum harmonisation”, setting minimum standards. Use of this flexibility has been important in order to reflect national features and risks, and where the EU transposition of Basel is thought to be inadequate. It has, of course, also been the source of challenging on “gold plating”.
Until recently, the EU approach has not in principle unduly constrained the use of judgement (here, I draw a distinction with whether or not appropriate judgement was used). However, a number of developments either have, or are likely to, pose a risk in future to the exercise of appropriate judgement.
1.The introduction of “maximum harmonisation” (for instance in the Regulation (CRR) part of the overall CRD4 package for bank capital adequacy) will constrain the ability of the PRA to use the flexibility to go above minimum standards. The important word here is “constrains” because the effect tends to be that, where sensible judgement needs to be exercised, the means by which it is achieved in a world of maximum harmonisation becomes more indirect and thus less transparent. There is a cost to such approaches in terms of the clarity of policies and supervisory actions.
2.The EU processes have moved in the direction of using more detailed rule-making, both at the level of legislation (Directives and Regulations) and the so-called Technical Standards that are developed and implemented by the European Supervisory Agencies (EBA, EIOPA, ESMA). This has led to a major increase in detailed rule-making. Moreover, in my view it tends to be a self-reinforcing process as detailed rules which apply to 27 countries tend to require more detailed rules to deal with the inevitable exceptions to reflect national circumstances. With such a detailed body of rules comes, a much larger overhead of monitoring and compliance in regulatory bodies and firms. Moreover, more rules tend to encourage more effort and cost to “interpret” and apply them. In my view, there is no meaningful process of cost and benefit assessment which has a real impact on whether to adopt such rules.
3.A further extension of this trend towards more detailed rules involves the proposal by the European Banking Authority to create a single Handbook of supervision. This could lead towards attempts to harmonise not just the rules of supervision but also the process of supervising and thus the application of judgement. That said, the outcome could be more benign in terms of compulsion to adopt whatever form the Handbook may take, and thus the PRA is heavily engaged in the process in order to limit the damage. There is also an important link to the Banking Union here because we understand that the ECB will seek to develop its own Handbook. To summarise, there is a substantial lack of clarity in this area, and it is one that we are watching very carefully.
4.Last, the financial crisis has placed a major strain on the operation of the single market in financial services in the European Union, and particularly the freedom of banks to operate across borders without restrictions from the national authorities in which they establish outside their home country. In my view, the root of this development lies in the erosion of confidence in the solvency of some sovereign states and thus the national depositor protection insurance schemes on which depositors in branches of banks operating around the EU depend (ie when a bank from an EU country branches into another country rather than establishes a legal entity subsidiary company in that country, depositors in those branches look to the home country of the bank for the deposit insurance). The root of the problem is not therefore an issue to do with supervising banks. That said, I have observed a pressure from EU institutions to make rules, or seek rigidly to enforce rules, to counter this pressure on the single market. This strikes me as going against the fundamental economic logic of the pressure on the single market, and it raises the danger of a resort to burdensome rules which will fail to achieve their effect because they go against that logic.
I hope that this description of current pressures from European developments is helpful in providing a sense of the threat that we could face to the new approach to supervision. I would be happy to discuss the issues.
11 April 2013
