European Economy

Banks, Regulation, and the Real Sector

Digital Euro: Catching up and Browsing the Daisy

by

Authors

Ignazio Angeloni[1]Senior policy fellow, SAFE (Frankfurt) and non-resident fellow, IEP Bocconi.

 

1. The longest decision ever

The preparation for the digital euro moves on. In November 2023 the ECB launched a new and final 3-year program of exploration of the technical features. Barring a postponment, at the end of this phase a decision on the actual launch will be made.

Before any consideration of substance, one should commend the opennes with which the central bank is conducting its work. The ECB keeps the public regularly informed. Stakeholders are being consulted. Outside experts are in a position to understand what is going on and form their views. In preparing for a possible digital euro, the ECB is abiding to high standards of transparency.

As mentioned, the final decision about launching a digital euro has not been made yet. The preparation process started in 2020 with a 3-year “investigation phase”. The current “preparation phase” should end in 2026. During this time the central bank is “browsing the daisy”, suspended between a “yes” or “no” decision. If, after a “go” decision, some more time passes before the digital euro enters our pockets, its gestation will have taken more time than the euro itself (1992-1999), let alone the euro banknotes (1999-2002) and the ECB banking supervision (2012-2014). That’s not necessarily bad, given the uncertainties involved.

While the process unfolds, however, the rest of the world is moving fast in two related domains: payment technology and geo-politics. Developments in both areas influence what happens around the world with regard to the possible introduction of central bank digital currencies (CBDCs).

The digital payment industry moves fast. Tech giants on both sides of the Pacific (China and even more California) relentlessly introduce more advanced digital payment applications, leveraging on the synergies with handheld devices. A recent example is Tap-to-Pay, the new P2P solution by Apple (Forbes, 2024b). P2P functionalities already exist on PayPal, Revolut and other platforms, but Tap-to-Pay does more: it promises to invade B2P, sending Point-of-Sale technology into retirement. Prepare for a time in which a portable phone will be all a shop manager needs to do business, including comply with accounting and tax obligations. More innovation will come after AI takes hold and combines with payments. Central banks which in the meantime have decided to become suppliers of their own retail digital payment products will find themselves in a fast moving, fiercely competitive business environment, in which they are unlikely to have the upper hand but are relegated to a “follower” position, constantly catching up. Not an enviable situation.

Geo-politics is also moving. After the Russian invasion of the Ukraine and amid the new expansionism of China, international relations and the global security situation have worsened. Monetary and financial arrangements, including the international use of currencies, are affected. Cyber threats affecting the financial sector are rampant. The traditional role of the US dollar as main reserve and vehicle currency may come under threat as a number of “non aligned” countries look for alternatives. CBDCs are increasingly becoming battleground of international currency competition. As discussed more extensively below, China appears to be using its digital currency, the e-CNY, as a lever to increase the attractiveness of the yuan as an international transaction and reserve currency among neighbouring countries and beyond, undermining the established roles of the US dollar and the euro.

Amid this complex set of factors, the purpose of this paper is twofold. First, in Section 2, we revisit the main arguments in favor and against the adoption of a digital euro, focusing on the design choice chosen by the ECB, namely, a retail instrument available to the generality of citizens, producers and retailers. The conclusion here is that uncertainties regarding the underlying motivation for this type of instrument remain; they have been limited by the preparatory work but not fully dispelled. In Section 3 the focus is broadened to developments outside the eurozone. One takeaway from this overview is that there is an extreme variety of views and orientations regarding the rationale of CBDCs, their purpose and design, and more fundamentally the advisability of introducing one and in what form. Another one is that, whereas in Europe and in developing countries the goal of creating a new secure retail payment means prevails, in the United States that of improving the efficiency of wholesale and international payments is gaining ground. Section 4 concludes with some tentative indications for future work on the digital euro.

 

2. Revisiting the arguments

This section briefly revisits the arguments in favour and against the prospective introduction of a retail digital euro, along the lines of an earlier paper (Angeloni, 2023a), considering whether those arguments are still valid in light as preparatory work progresses. The discussion is divided into six headings: Market reception; Effects on bank intermediation; Consequences for monetary policy; Consequences for financial stability; Financial inclusion; Privacy.

 

Market reception

The simplest and most down-to-earth question that must be answered as one ponders the possible launch of a retail-based digital euro is: Do people need it? The answer to this question determines whether the digital euro has a chance of succeed in the marketplace or instead risks being a flop.

The critical fact here is that the ECB would offer a new payment instrument to a large base of customers, in competition with private providers of similar products. Traditionally, central banks offer their products and services on a monopolistic basis (for example, when they print banknotes), or to specific subjects they regulate and supervise, as deposit and settlement services offered to commercial banks. The digital euro puts the ECB in a wholly new situation, where it is not protected by monopolist power and market rejection is possible. Today users have countless digital payment options, largely similar to one another, all efficient, safe and cheap. If rejected by the market, the digital euro would involve reputational and other costs for the central bank. A related consideration is that the central bank has regulatory powers in the payments industry, which generates a conflict of interest. The central bank may be tempted to use those powers to prop up its own product, distorting competition and hampering innovation. China’s example, discussed below, where the government promotes the digital yuan as an alternative to Alipay and Tencent, is not directly applicable but not irrelevant either.

Market analyses conducted by the ECB (for example, Kantar Public, 2022) have not aswered that question definitively. People say that they like efficient and safe digital payment, but consider the existing options quite satisfactory. The extra safety consisting in the digital euro being a central bank liability is not regarded as important. Moreover, people are attached to physical cash because it has unique characteristics: tangibility and absolute privacy. All these considerations together raise the question of whether there is a market niche for the digital euro. More analyses would be needed to clarify this question.

 

Effect on bank intermediation

The main question surrounding the introduction of the digital euro regards its impact on bank intermediation. If the new instrument is sufficiently attractive, a shift will take place away from other instruments. It is unlikely that this will impact the demand for paper currency in a significant way, because cash has specific characteristics the digital euro is unlikely to reproduce. More likely is a decline in the demand for bank deposits. This is particularly the case because the ECB has decided to outsource all front-end functions relating to the digital eiro to banks: onboarding and offboarding, KYC and AML checks, and all services associated with deposits – online banking, payment cards, apps, etc. There will be strong synergies between opening a bank deposit and a digital euro deposit – same process, same information, same forms to fill. From a user perspective, there will be no difference between opening a digital euro account or a normal deposit.

The digital euro therefore is likely to imply a decline in the balance sheet of the bank and an increase in the balance sheet of the ECB, of a size hard to quantify ex-ante. Aware of the risks involved in a disintermediation of banks, the ECB plans to set strict limits on digital euro balances. In its latest progress report (ECB, 2024), it announced work on a methodology to quantify these limits. The nature and the extent of these limits is one of the important open issues that will determine how the prospective digital euro may look like and the impact it may have on the financial sector.

 

Consequences for monetary policy

The digital euro was never intended as a monetary policy instrument, but may have unintended effects on the way monetary policy impacts the economy. As just mentioned, the likely shift away from bank deposits would shrink the balance sheet of banks. Bank liquidity would decrease, with a contractionary effect on lending: banks would tend to restrict credit to households and businesses. The amounts are uncertain and could be macroeconomically relevant. The central bank may compensate the liquidity squeeze by offering more refinancing operations. However, banks usually do not regard central bank funding as a perfect substitute for deposit funding, which is traditionally more stable.

It is sometimes argued that a digital euro is needed to preserve the role of central bank money as a “monetary anchor” in an increasingly digitalized financial sector. This idea is misleading, however, because it overlooks that the existing monetary control processes are already entirely digital. Bank liquidity, the crucial variable for the transmission of monetary policy, takes the form of electronic deposits at the central bank. Open market operations affecting bank liquidity are digitalized, as are the ensuing settlement operatins. Cash, physical or digital, plays no role in the conduct of monetary policy.

 

Consequences for financial stability

Depositors may not appreciate the difference between commercial bank and central bank money in normal conditions, but that distinction becomes crucial in a banking crisis, when they perceive their bank may fail. In the EU bank deposits are guaranteed up to 100.000 euros: beyond that, deposits are at least partially at risk. The digital euro would offer depositors a convenient, instant and costless channel to “run” their bank, shifting from bank deposits to a riskless liquid asset. This would risk exacerbating a banking crisis. This risk is compounded by the fact that the eurozone lacks an area-wide deposit insurance scheme.

The practical relevance of this problem depends on the design of the digital euro. If holding limits were sufficiently strict, the danger would be reduced in the aggregate. The impact on each individial bank, however, may be significant, depending on its funding structure. Moreover, one shoud not overlook the risk that in a banking crisis the ECB may come under pressure to relax the limits, to shelter citizen from the losses. A banking crisis is always a painful and politically sensitive event; in certain scenarios, the idea of using the digital euro to shelter savers from losses may become politically attractive. Far from resolving the crisis, the relaxation of the limits would aggravate it and make it systemic.

 

Financial inclusion

A rationale often mentioned is that CBDCs can foster financial inclusion – the access of “unbanked” citizens to the financial sector. However, in the case of the eurozone such effect is unlikely to be important. Citizens that choose to remain outside the traditional banking channel and use cash instead do so because they are technologically unsophisticated or because they are wary of the formalities and complexities involved in operning a bank account. A digital euro involving the same steps and contacts with a bank is unlikely to change the attitude of those citizens.

A related issue is that of foreign workers’ remittances. Cross border workers often face extraordinary delays and costs in transfering money to their families at home. An increasing number of eurozone workers are immigrants. Facilitating money transfers for those workers would be a valuable service from an economic and social perspective. An active role of the public sector, central banks particularly, would be justified. Dedicated schemes for immigrant workers would require accords among the central banks of the countries involved. Alternatively, private initiative by banks and other providers of international money transfers could be facilitated and subsidized.

 

Privacy

As mentioned already, citizens consider privacy an important feature of payment means and regard cash as the ideal instrument for this purpose. Accordingly, the ECB is considering technical features that can deliver “cash-like” privacy. In its latest progress report, it states in particular its intention to “.. use state-of-the-art measures, including pseudonymisation, hashing and data encryption, to ensure it would not be able to directly link digital euro transactions to specific users.” (ECB, 2024).

While this may sooth some concerns, it is unlikely to solve the problem fully. Digital transactions can always be traced and will never be equivalent of exchanges of cash, at least in the eyes of users. Offline functionality, foreseen by the ECB, helps but it is of little relevance: today’s prepaid cards are not extensively used. Moreover, privacy is a blessing in certain respects but a curse in others. Money launderers, drug dealers and all-purpose criminals are very interested in efficient and confidential payment means. Traditionally they used to fill briefcases with cash; today they increasingly use digital alternatives, including crypto-assets. A digital euro with guaranteed privacy would not escape their attention. Another source of reputational risks for the central bank.

 

3. Looking beyond the eurozone borders

The eventual decision on launching a digital euro, the way it will be designed and what purpose it will be supposed to serve, are likely depend to a significant extent on what happens elsewhere in the world. The complexity and risks involved are such that a “do it alone” choice is hardly advisable. Especially among the highly integrated and interdependent Western bloc, cross-border coherence can make country-specific choices more credible and robust. “Interoperability” among different CBDCs is an important oft-quoted requirement. Moreover, what happens outside the Western bloc is also important: in particular, China is exerting first-mover influence on the Unites States and other countries as well.

At present, however, what happens around the world is far from clear. Most central banks are conducting studies but few have made definite decisions. The future is open for the digital euro as well: on the one hand, the passage of time and the cost and investment sunk in the project increase the probability that “something” will be done eventually. On the other, one cannot ignore the persistence of arguments and views to the contrary, especially with regard to a retail CBDC.

What follows is a high-level selective overview of initiatives and debates outside the eurozone. It focuses on initiatives, decisions and official statements that are relatively recent and can signal future trends at national or international level.

 

China

China deserves first mention for two reasons. It was the first country to launch an CBDC project in 2017, and to start experimenting with it three years later. The second reason is that what happens in China can influence opinions and orientations in the United States. The choices made by China can have an important indirect global influence.

The e-CNY experimented by the People’s Bank of China (PBoC) is a retail instrument. It was made available initially in four cities in 2020 and later extended to several regions, although not yet to the whole country (Atlantic Council, 2024). There are different types of e-CNY available, from the simplest ones and most limited in size and functionality, to the more extensive ones, subject to stringent disclosure requirements. The Chinese government is proactively promoting the instrument, granting for example discounts and concessions to holders. Private providers like Alipay and Tencent, already massively present in the country, have integrated the e-CNY, facilitating its circulation.

In spite of strong official promotional activity, the digital yuan has had a slow start. Data – unfortunately very scanty – suggest that the uptake so far is limited, because of strong competition from very efficient private applications. There are reportedly 260 million e-CNY wallets open, around 18% of the population (Atlantic Council, 2024). As of mid-2023, some 950 million transactions had cumulatively taken place. Over a 4-year horizon, this amounts to an average of 2 transaction per wallet per year, a negligible number. Over the last year for which data are available, the average number of transactions per second was about 20, against some 120,000 reported by Alipay alone. The outstanding stock of e-CNYs in 2023 was just about 0.13% of the currency in circulation.

The modest domestic uptake of the digital yuan is confirmed by other sporadic sources. An interesting “test drive” conducted by a journalist in Guangzhou (the fourth-largest Chinese city, otherwise know as Canton), in restaurants, hotels and other places of public accommodation, concluded that the e-CNY was little used and even known, except in public transportation and other government-owned facilities (Quinn, 2024).

 

Other Asian countries

While domestic penetration of the digital yuan remains limited, China is promoting its international use of among Far- and Middle-Eastern countries. eBridge, a China-led multiple country platform started in 2021 in collaboration with the BIS, has associated the Hong-Kong Monetary authority and the Bank of Thailand and the central bank of the United Arab Emirates. eBridge works as a multi-central bank platform among participating central banks and commercial banks, on a distributed ledger allowing fast cross-border payments and settlement among the participating entities. Recently, Saudi Arabia has joined; an important extension. It should be noted, however, that the attitude of individual countries toward CBDCs varies. The Bank of Thailand, for example, while a member of eBridge has recently stated that it has no intention for the moment to issue a retail CBDC (Bank of Thailand, 2024).

The tense geo-political situation followed following Russia’s invasion of the Ukraine has increased the interest in initiatives like eBridge (Atlantic Council, 2024), and in general in payment platforms that allow to avoid mainstream financial channels dominated by the US dollar (Ku, 2024).

A survey conducted by the International Monetary Fund on work conducted by Middle-East and Central Asian countries revealed that most of them are exploring the possibility of launching a CBDC (IMF, 2024), whereas a smaller number of countries expressed no interest. In most cases, the involvement is driven by domestic considerations: financial inclusion, enhancing financial and technological literacy, and promoting efficiency and competition.

Japan has explored the potential of an electronic yen, most recently launching a pilot and an opinion survey. The activism of China likely contributed to Japan’s interest. Recently, however, a statement by the central bank governor suggests caution (Ueda, 2024). The governor mentions a scarce awareness by the population and emphasizes the benefits of physical cash (tangibility, proximity of the transacting parties, privacy), calling for more experimentation involving the public.

The Reserve Bank of India has launched pilots of tokenized CBDC instruments for bank wholesale and retail transactions in 2022. While the government has adopted measures to help the success of the initiative, its prospects are still unclear.

 

Russia

Given the geo-political relevance of CBDCs, some attention to what happens in Russia is due. Putin’s Federation has not been active on CBDCs at first, but this is changing. In early 2024, the central bank governor informed on ongoing initiatives to launch a national CBDC (Ledger Insights, 2024). The Duma has passed legislation and first trials have started in 2023. Some 25.000 transactions have taken place since then, mostly P2P transfers, a very small number, which may be due in part to the recent start of the trial. A “second wave” involving large banks will be started after the central bank has fixed a number of bugs. Technical features of the digital rouble are quite sophisticated, including dynamic QR codes, smart contracts and programmable money. The goal of building something that is state of the art and attractive internationally is quite evident.

 

United States

The Federal Reserve started explorations years ago, but is still sitting on the fence, neither supporting nor excluding the idea. Staff analyses tend to be sceptical, rather emphasizing the risks (Carapella et al., 2024). Christopher Waller, a Board member, famously dubbed the CBDC “a solution in search of a problem” (Waller, 2021). Subsequent statement by Fed policymakers moderated the tone a bit, but in substance were on the same line, emphasizing rather the advantages of FedNow, a different type of Fed-sponsored instant money transfer. In a recent statement, another Board member, Michelle Bowman, concluded: “From my perspective, there could be some promise for wholesale CBDCs in the future for settlement of certain financial market transactions and processing international payments. When it comes to some of the broader design and policy issues, particularly those around consumer privacy and impacts on the banking system, it is difficult to imagine a world where the tradeoffs between benefits and unintended consequences could justify a direct access CBDC for uses beyond interbank and wholesale transactions.” (Bowman, 2023)

Outside the Fed, discussions tend to be dominated by geo-strategic competition with China. In 2002, the Hoover Institution, a Republican-leaning think tank, assembled a high-profile team of experts to examine challenges that digital payments in China pose for the US. The report takes the view that the e-CNY will effectively promote China’s financial system and currency, making them more attractive and undercutting the position of the US dollar. The report calls for the US government and the Fed to be more active in developing a strategy on digital payments.

Politics in Washingtin moves in a different direction. Conservative circles criticise the Fed for the opposite reason, namely keeping the digital dollar option open. The republicans majority in the House of Representatives recently promoted an amendment to the Federal Reserve Act banning the creation of a digital dollar (Forbes, 2024a). Trump himself has called it “very dangerous”. Political maneuvering is in flux, partly directed against the independence of the Fed. Chairman Powell has repeatedly stated that the Fed will not go ahead if not explicitly mandated by the legislature. In a recent testimony he was quite vocal against a retail CBDC: “People don’t need to worry about a central bank digital currency, nothing like that is remotely close to happening anytime soon”, adding that “… the last thing the Federal Reserve would want would be to have individual accounts for all Americans.” (Reuters, 2024).

 

United Kingdom

The Bank of England has been preparing for a digital sterling since 2021, with the UK Treasury. The model is much along the lines of the ECB, namely, a retail instrument available to citizens and companies. The central bank seems quite open to the prospect, although a definitive decision has not been made (Cunliffe, 2023). Bank of England communication conveys a rather favourable picture, mentioning possible benefits for innovation, consumer choice, and privacy of information. Legislators will need to issue primary law before any launch is decided. Recently, the UK Parliament’s Treasury Committee Chair has stated that the instrument will not be launched before 2030, and holding balances will be limited.

 

Switzerland

The Swiss National Bank’s most recent digital payment initiative, Helvetia III, launched in December 2023, is a pilot aimed at offering to commercial banks central bank deposits in tokenized form. Offering full integration between central bank money and the Swiss exchange for tokenized financial assets, SDX, the project makes commercial bank transactions more efficient. The scheme is strictly reserved to commercial banks and based on central bank settlement.

On the option of a retail CBDC, The chairman of the Swiss National Bank, has recently stated that “The SNB currently sees no need in Switzerland for such digital central bank money for the general public, also known as retail CBDC. Consumers and businesses already have access to a wide range of efficient and innovative payment instruments offered by the private sector. Retail CBDC could fundamentally alter the current monetary system and the role of central banks and commercial banks, with far-reaching consequences for the financial system. From a Swiss perspective, the risks of retail CBDC currently outweigh its potential benefits.”(Jordan, 2024)

 

The African continent

The African continent provides a fertile ground for CBDCs and digital payments in general. It lacks, in many countries, a developed banking infrastructure with traditional channels – branch networks, ATMs, etc. On the other hand, handheld telephony is quite widespread and digital transformation, while still backwards, is progressing fast (World Bank, 2024). Money laundering and terrorist financing are a risk in some places. This calls for close monitoring and control, something a CBDC can potentially facilitate.

A recent survey shows that out of 54 African countries, only 4 possess payment system infrastructures that could potentially support a CBDC. 14 countries have made official expressions of interest towards issuing the instrument, and are involved in research and technical exploration of such possibility, whole the others have not expressed an interest (Ozili, 2023).

Two digital payment instruments launched in recent years in Africa have attracted global attention: M-Pesa and the e-Naira. M-Pesa, the largest digital payment instrument in Africa, counts over 30 million users in ten countries. Introduced in 2007 in Kenya, it allows to deposit, withdraw and pay through text messages sent via smartphone, using retail stores as banking agents.

M-Pesa is not a CBDC – the funds are not on the central bank balance sheet – but a money transfer technology relying on a branchless network of quasi-banks. Research has shown that M-Pesa had a positive economic effect, by removing constraints to consumption and reducing poverty (Suri and Jack, 2016).

By contrast, eNaira is a CBDC. Launched in 2021 in Nigeria, the largest African country, it operates via a distributed ledger. Nigeria’s population is relatively highly sophysticated digitally: a large fraction of the population has mobile phones but no bank account, and there is a thriving high-tech sector. The main stated purpose of the eNaira was to provide financial services to the unbanked, leveraging on the high level of digitalization. Another reason is to combat corruption and tax evasion, since eNaira transactions are traceable.

In spite of careful preparation and official measures to prop up the instrument, the e-Naira was a flop. Uptake is limited, with 1 million wallets according to recent information (Nigerian population is 200 mn). The few wallets are rarely used, and the volume of transactions represents a negligible share of the money supply. By contrast, over one-half of the Nigerian population is trading in cryptocurrencies, confirming that technology is not a barrier. (this and some other information on CBDCs mentioned here is drawn from a coauthored forthcoming book: Angeloni and Gros, 2025).

 

Latin America and the Caribbean

Most Latin American countries, including “island” Caribbean economies, have expressed interests in CBDC and are conducting analyses. Crypto-activity is extensive in the area, and digital expertise is widespread. Actual experiences vary, however. In Brazil, an efficient digital payment infrastructure, Pix, was introduced in 2019. While sponsored by the central bank, Pix is not a CBDC but a digital money transfer based on bank balance sheets. The system allows for instant, convenient, safe and low-cost payment functionality; as such, it caters for the main needs of retail users and reduce the potential scope of a CBDC.

A case that attracted worldwide attention years ago is that of the Bahamas. With its tropical climate, tax-exempt system and lax financial supervision, the Commonwealth of the Bahamas attracts tourists and hazardous financiers alike — most prominently FTX, the infamous crypto exchange that went bankrupt in 2022. In 2019, it was the first country to introduce a CBDC, called the “sand dollar”. Its main stated aim was to help financial inclusion and facilitating monetary transactions across a collection of islands subject to frequent disruption because of hurricanes. In spite of its fame, the experiment was not successful. As of recently, the sand dollar balances represented a minor share of central bank money in circulation and transactions were negligible.

Other cases of Latin American countries exploring the potential introduction of CBDCs (none of which have made decisions yet) are reported in a recent survey by the International Monetary Fund (IMF, 2023).

 

4. Conclusions

For several years now, the ECB has been engaged in preparatory works for the introduction of a central bank digital currency, the digital euro. This work has advanced our understanding of the complex issues involved and has contributed to a line of research actively pursued in many parts of the world.

After revisiting the pros and cons, this paper concludes that, all in all, the rationale of introducing an ECB-sponsored digital euro for citizens, retailers and producers, is not solidly established. Today’s highly dynamic, innovative and efficient digital payment ecosystem does not require such instrument, which would unavoidably duplicate existing applications and probably struggle matching private innovation.

The paper also offers a short survey of international experiences regarding CBDCs and alternative digital solutions. What strikes in this overview is the extreme diversity of orientations. Developong countries are interested in promoting financial inclusion and literacy, bypassing their lack of developed physical banking networks. Emerging countries either take different directions altogether (Brazil), or experiment with pilot CBDCs (India). China stands out in being fully committed to a digital yuan, clearly – though not explicitly – motivated by internal control and geopolitical expansion. In spite of extensive public intervention, however, the e-CNY has not attracted so far much favor among the population, amid fierce competition from private competitors like Alipay and Tencent.

The US Federal Reserve seems oriented towards exploring wholesale central bank-based digital solutions to improve the efficiency of the international payments system. A retail-based CBDC seems for the time bing ruled out. Switzerland, a country whose financial sector has a small but significant international role, has undertaken moves in the same direction.

Whereas the ECB has so far placed its bets on a retail CBDC, in our view would be well advised paying attention to other options as well. The need of improving the functionality of the international payment system is long-standing and solidly established. CBDCs can help in this regard. The ECB should actively join the Fed and other central banks in studying a wholesale, interoperable multi currency version of CBDC capable of making the international large-value payment system more efficient and safer. More generally, it is important that in conducing its preparatory work the ECB coordinates with other Western central banks. In a highly interdependent global monetary and financial system, a situation in which the main central banks take markedly different decisions on CBDCs is hardly advisable.

 

References

Angeloni, I. (2023a). Digital euro: when in doubt, abstain (but be prepared). Report submitted to the European parliament, April.

Angeloni, I., and Gros, D. (2025). Money in Crisis, Cambridge University Press, forthcoming.

Atlantic Council (2024). Central Bank Digital Currency Tracker.

Bank of Thailand (2024). Pilot Program Retail CBDC Conclusion Report, March.

Bowman, M.W. (2023). Considerations for a Central Bank Digital Currency (Georgetown University, Washington DC, 18 April 18.

Carapella, F., Chang, J.W., Infante, D., Leistra, M., Lubis, A., and Vardoulakis, A.P. (2024). Financial Stability Implications of CBDC. Finance and economics discussion paper 2024-21, April.

Cunliffe, J. (2023). The digital Pound. Speech at UK Finance, 7 February.

ECB (2024). ECB publishes first progress report on digital euro preparation phase, June.

Forbes (2024a). The House Bans The Fed From Building A CBDC Like The Digital Yuan, May.

Forbes (2024b). Apple Tap To Cash Excites, But The Real Payments Innovation Lies Elsewhere, June.

International Monetary Fund (2023). Interest in Central Bank Digital Currencies Picks Up in Latin America and the Caribbean, While Crypto Use Varies. Country Focus, June.

International Monetary Fund (2024). Central Bank Digital Currencies in the Middle East and Central Asia, DP n. 4, April.

Jordan, T. (2024). Towards the future monetary system; Introductory remarks at the SNB conference, 8 April.

Kantar Public (2022). Study on New Digital Payment Methods, March.

Ku, L. (2024). Could China-led wholesale CBDC fuel de-dollarization? Euromoney, June.

Duffie, D., and Elizabeth Economy eds. (2022). Digital Currencies: The US, China, And The World At A Crossroads. The Hoover Institution, March.

Reuters (2024). Powell says Fed not “remotely close” to a central bank digital currency, 7 March.

World Bank (2024). Digital Transformation Drives Development in Africa, January.

Ozili, P. (2023). “A Survey of Central Bank Digital Currency Adoption in African Countries”, in “The Fourth Industrial Revolution in Africa: Exploring the Development Implications of Smart Technologies in Africa”, David Mhlanga ed., Springer.

Quinn, C. (2024). I just gave China’s digital yuan a test drive — how did the world’s biggest CBDC perform? DL News, March.

Suri, T., and Jack, W. (2016). The long run poverty and gender impact of mobile money. Science 354, 1288-1292.

Ueda, K. (2024.) What to know about central bank digital currency, remarks at the Fintech Summit FIN/SUM 2024, Tokyo, 5 March.

Waller, C. (2021). CBDC: A Solution in Search of a Problem? Speech at the American Enterprise Institute, August.

Footnotes

Footnotes
↑1 Senior policy fellow, SAFE (Frankfurt) and non-resident fellow, IEP Bocconi.

Non-performing loans: an old problem in a new situation

by

Authors

Ignazio Angeloni

 

One year has passed since the Covid-19 pandemic was discovered and recognized as such. The world economy plunged into a major recession; some areas have recovered, some are in the process of doing so while others are still deep into it. Policymakers have responded promptly with measures to protect the economy; in particular, massive support has been provided to the banking sector in the form of credit moratoria and guarantees. These measures have helped spared people, firms and banks the brunt of the crisis but have also suspended the normal functioning of the market mechanisms. As a result, the full consequences of the crisis are not visible yet. As one ECB supervisor put it to me recently, referring to eurozone banks: “we stopped the car; when we will have to start it again, we don’t k now what we will find under the hood”.

Virus and lockdowns impact the banks through multiple channels. The first to manifests itself is an increase in the demand for credit, as households and firms experiencing revenue shortfalls draw on their credit lines, often with the support of public guarantees. The increase in the amount of guaranteed credit is revenue-positive for the banks; this explains, for example, why 2020 was a surprisingly good year for small banks in the US[1]Wall Street Journal: “The best year ever: 2020 was surprisingly good to small banks”, 14 December … Continue reading. This positive effect is dampened, and may even be reversed, by the reduction of lending margins which follows from a more accommodative monetary policy. Over time, however, both of these impacts are likely to be dwarfed by the deterioration of credit quality resulting from the recession. This effect becomes evident with a considerable time lag, after the public support measures are lifted.

In the eurozone, an increase in the demand of credit was observed in early 2020. The growth rate of bank loans to non-financial firms, close to 3 percent in the pre-Covid period, rose to 5 percent in the first quarter and reached a plateau around 7 percent in the summer months[2] See ECB Economic Bulletin, various issues.
https://www.ecb.europa.eu/pub/pdf/ecbu/ecb~b6a4a59998.eb_annex202101.pdf.. Intermediation margins shrunk somewhat, due to the decline of lending rates on certain components of the loan portfolio, mainly overdrafts. By contrast, no deterioration of credit quality has been observed so far in the supervisory statistical reports. The (gross) NPL ratio for the euro area as a whole, slightly over 3 percent at the end of 2019, continued to decline, reaching 2.8 percent in September 2020[3] ECB supervisory statistics,
https://www.bankingsupervision.europa.eu/banking/statistics/html/index.en.html.. However, recent surveys by the ECB suggest that this benign phase may be ending and the post-Covid “wave” of NPLs may now start[4]A. Enria, “European banks in the post-Covid world”, speech given at the Morgan Stanley European Financials Conference, 16 march … Continue reading.

Eventually, NPLs are expected to rise sharply in the eurozone. An estimate based on an adverse scenario, published by the ECB, puts the peak at 1.4 trillion euros[5]A. Enria, “An evolving supervisory response to the pandemic”, Speech given at the European Banking Federation, October 2020; … Continue reading, which would imply a CET1 ratio depletion of up to 5.7 percent. It is interesting to compare this estimate with the NPL increase observed after the great financial crisis (GFC). Between 2007, the last pre-crisis year, and 2013, the peak year, the NPL ratio in the euro area rose by roughly 6 percentage points, while NPLs in nominal terms increased by over 600 bn. euros. If one makes the milder assumption that NPL may rise up to 1 tn. euros, the increase relative to today’s level would be comparable in magnitude to that occurred after the GFC. Under the aforementioned adverse scenario, it would be significantly greater.

While magnitudes may be comparable, the context in which the NPLs increase occurs this time is completely different. In the GFC, the epicenter of the crisis were the banks themselves – their excessive risk taking in the earlier period and later the delays in recognizing the problem and dealing with it. Now, the banks are “victims” of an exogenous and unpredicted shock, which they are in fact contributing to mitigate. As Augustin Carstens, general manager of the BIS, put it at an early stage, banks this time are part of the solution, not of the problem[6]A. Carstens, “Bold steps to pump coronavirus rescue funds down the last mile”, Financial Times, 29
March 2020.. And they have in fact already started doing so, by keeping credit channels open. Supervisory and regulatory measures to deal with the problem should accordingly be different.

Broadly speaking, four were the main areas of response of eurozone supervisors and regulators after the GFC, in dealing with NPLs:

  1. Supervisory action by the ECB. ECB action was organized in a specific action plan, which included guidelines, regular and ad-hoc reviews and inspections, as well as guidelines and Pillar II requirements applied to capital and provisions;
  2. Pillar I provisioning requirements. These requirements, embodied in EU law in 2019, are often referred to as “calendar provisioning”;
  3. Accounting rules. They relate to the way in which NPLs are quantified for accounting purposes, and were introduced in the EU as part of the new IFRS9 framework;
  4. Asset management companies (AMCs). Various proposals were made to establish AMCs either at national or at area-wide level, to help banks remove NPLs from their balance sheets. These proposals were extensively discussed but never implemented.

In the following sections, these areas are examined from the viewpoint of whether they can help in the new situation. The conclusion is that the two main new regulatory elements which were introduced, points 2 and 3, are no longer suited or at least would require significant adaptation. Asset management companies, at national or at area-wide level, are an interesting avenue to consider but for several reasons are not likely to become part of a realistic policy package in the foreseeable future. Traditional micro-supervisory tools will therefore continue to occupy center stage. The final section expands on this conclusion with some comments on how the ECB can overcome the challenge.  

 

1. Supervisory action

ECB supervision started dealing with NPLs immediately after its inception, in 2014. It did so by launching a dedicated “action plan”, which was started in 2015 and virtually completed, except for routine follow-ups, before Covid struck at the beginning of 2020. Details on the ECB NPL action plan are available from several sources[7]ECB Guidance on Non-Performing Loans, 2017; see https://www.bankingsupervision.europa.eu/ecb/pub/pdf/guidance_on_npl.en.pdf; and I. Angeloni, Beyond the pandemic: reviving Europe’s banking union; … Continue reading. For our purpose here, three aspects need highlighting.  

First, the plan put major emphasis on the need for banks to maintain efficient structures to measure and monitor the state of their exposures and the debtors’ ability to pay. These structures would include ad-hoc internal units able to collect all relevant information, with direct access to top management and decision-making boards. Before the ECB action plan, this was not regarded as a priority by many banks. Often, information on credit quality was not available in a systematic way and therefore boards and management were not always properly informed. As part of the action plan, the ECB requested banks to set up dedicated units in charge of monitoring loan performance, with direct reporting lines to the board, responsible also for proposing solutions for NPL disposal if needed.  

This aspect remains crucial today; in fact, good internal information and governance are going to be particularly important in the post-Covid scenario. While bank exposures are provisionally protected by moratoria and guarantees, banks need to continue to maintain an updated picture of the clients’ ability to pay. This is an aspect the ECB supervision has repeatedly insisted on in 2020. Using the earlier metaphor, maintaining good internal information will lower the probability of bad surprises when the “hood of the car” will be opened. 

Secondly, the ECB action plan was based on the idea that the NPL strategies should be tailored to the specific conditions of each bank. For this purpose, emphasis was placed on a constant dialogue between the teams of examiners and the bank. Their interaction would exploit the best information available on the situation of the bank’s loan portfolio, in order to propose to the bank’s decision makers and to the supervisory authority itself, the strategy most appropriate in each case.  

Third, while tailored to the bank’s specific condition, the NPL strategies should also satisfy criteria common across all supervised banks. Consistent criteria fulfil the banking union’s principle of a single supervisory concept applied to all participating banks. Criteria should be not only consistent, but also transparent. Transparency, a universal principle of good governance, is also a contributor to effectiveness because policies which are well understood tend to be more easily accepted and followed. 

The ECB meant to fulfil the twin requirement of consistency and transparency by announcing “supervisory expectations” regarding NPL provisioning. Banks with a significant NPL problem were asked to set-up provisioning plans within specific time frames, different across loan types. “Supervisory expectation” were not rigid rules but rather starting points of supervisory dialogues, during which specific elements could be taken on board and modifications in the provisioning calendar could be made. NPL strategies would eventually become an input in the annual supervisory reviews (Supervisory Review and Evaluation Process, or SREP[8]See https://www.bankingsupervision.europa.eu/about/ssmexplained/html/srep.en.html ), thereby contributing to the determination of Pillar II requirements. 

This combination of general criteria and bespoke elements helped exert the right amount of supervisory pressure while not losing sight of individual considerations. This approach was successful: the (gross) NPL ratio for the euro area declined between 2013 and 2019 from close to 7 percent to close to 3 percent, with a marked convergence across countries. The plan and the recapitalization processes that followed did not prevent, in that period, a restart of the bank lending process in the eurozone and a recovery of its economy. 

After the pandemic, the SREP was essentially suspended. Pillar II requirements have been kept constant except for a few specific cases. This means that the underlying conditions of the banks’ exposures are no longer reflected in supervisory policies. However, the underlying approach with its blend of rule-based and ad-hoc elements remains valid; in fact, it will be particularly useful during the exit from the pandemic. At that time, bank specific conditions will be particularly important because each bank is impacted differently by the virus and the lockdowns depending on the sectoral and geographical mix of its exposures. The quantum of discretionary decisions by the supervisor is likely to increase. This raises the bar for the ECB, which will need to apply in each case the proper mix of flexibility and determination. Common principles regarding NPL disposal and provisioning plans will remain useful but will require adaptation to individual circumstances. Excessively rigid instruments (like the legal provisioning calendars discussed in the next section) are not going to be helpful. 

 

2. Calendar provisioning

The concept of “supervisory expectation” mentioned in the previous section was initially not universally well understood. While parts of the banking community and some member countries were resisting the ECB’s pressure towards cleaning balance sheets, the European Parliament objected on the legal side, arguing that supervisory expectations invaded the prerogative of legislators by being akin to general rules rather than specific risk-based requirements applied on a case-by-case basis[9]See letter sent to the ECB by the President of the EP on .. 2017 ( See https://www.politico.eu/wpcontent/uploads/2017/10/Letter-to-President-Draghi.pdf). .  

Misunderstandings and criticisms converged in putting in motion a process leading to a legislative package dealing with NPLs, which after a long gestation entered into force in 2019[10]See a Council summary here https://www.consilium.europa.eu/en/press/pressreleases/2019/04/09/council-adopts-reform-of-capital-requirements-for-banks-non-performing-loans/. The full text is here … Continue reading . The law prescribed minimum legal coverage levels for loans (so-called “prudential backstops”), with percentages increasing with the time of non-performance (between 1 and 10 years), distinguishing among different loan categories: secured by immovable collateral, secured by movable collateral, and unsecured. The legal (Pillar I) requirement was intended to coexist with possible additional requirements set by the supervisor as part of Pillar II. 

Unlike the “expectations”, however, the legal requirement lacked any flexibility in responding to bank specific conditions. This may have been unfit to individual banks in some cases. More seriously, it could become inapplicable to the system as a whole in case of system-wide adverse shocks outside the banks’ control – for example: a pandemic like Covid-19.  Not surprisingly, the prudential backstops were de-facto suspended as a result of the entry into force of moratoria and government guarantees[11]The EU “banking package” introduced in 2020 is available here
https://ec.europa.eu/commission/presscorner/detail/en/qanda_20_757. 

Even beyond the short term, the prospect of restoring the “prudential backstop” in its present form after the pandemic is questionable. Provisioning calendars enshrined in law may at times become an alibis discouraging supervisors from proactively applying Pillar II powers for the same purpose. Parameters set by law across the board, as already mentioned, may not fit individual circumstances. More seriously, in presence of certain shocks they become impossible to apply. Rules whose application is impeded by circumstances difficult to foreseen in advance lose credibility, especially when such circumstances occur.  

 

 3. Accounting treatmentof NPLs 

As part of the reforms undertaken globally after the GFC, accounting rules for financial institutions were changed in several respects, with the aim of making financial statements responsive to changing economic conditions. Part of the amendments regarded NPLs. The underlying logic there was to make NPL recognition and provisioning no longer based on incurred (past) losses, but rather corresponding more closely to the moment in which the corresponding risks were undertaken.  

Fig. 1 provides a graphical representation. During normal demand-driven business cycles, risks are perceived to be low in the upswing. In this phase banks tend to undertake more risky lending (left-hand part of the curve), which normally results in NPLs later in time. If provisions are based on incurred losses, they end-up being made when the economy declines (right-hand side of the curve), hence strengthening the recession. It may then be appropriate to anticipate the provisions to match the time when risks originate. Early provisioning dampens growth in booms and stimulates it downswings. Basing provisions on the expected level of NPLs therefore exerts a desirable counter-cyclical effect. 

Figure 1: Demand cycle 

Following this type considerations, and consistent with the general move towards mark-to-market accounting after the crisis, new IRFS9 rules were introduced in EU law in 2016[12] Commission Regulation 2016/2067; see https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32016R2067, effective in 2018 but with a gradual transition which foresaw a full phasing in only in 2023.  

The new approach has two problems. First, it requires banks to formulate accurate expectations of their future losses. This may not be easy, not only because of the inherent uncertainty but because, as already noted, expectations tend to be optimistic in booms and pessimistic in busts[13]See for example J. Abad and J. Suarez, “IFRS 9 and COVID-19: Delay and freeze the transitional arrangements clock“; VoxEU 2 April 2020, see … Continue reading. The second, more serious problem is that the logic just described applies only under the specific demand-driven cycle depicted in fig. 1.  

Fig 2 represents a different economic cycle, more similar to that occurred under Covis-19. The left side of the curve represents the time when the pandemic hits the economy with the related initial lockdowns; say, the first half of 2020. The wave of NPL is not yet manifest in that phase; it will occur later. If provisions are based on expected losses, they tend to worsen the economic cycle when it is already declining due to the pandemic shock. It is better, in this case, to delay the provisioning to a later time when the economy recovers (right side of the curve). Under this type of cyclical pattern, unlike in the previous one, traditional, backward looking NPL provisioning based on incurred losses is counter-cyclical, while that stemming from the new accounting rules is pro-cyclical.  

Figure 2: COVID-19 Cycle 

In 2020, the transitional regime of IFRS9 was further prolonged to take this into account. De-facto, its implementation was suspended. Once again, unexpected circumstances required suspending application of an element of the post-GFC reform program right after it was adopted. 

As for the case of calendar provisioning, whether the IFRS9 rules for NPLs can be revived as such after the pandemic is questionable. The new rules are inherently fragile because of the uncertainty of loss expectations. Even abstracting from that, undesired effects arise in a variety of circumstances, as soon as one departs from the textbook case of demand-driven cycles. Well-functioning accounting rules for NPLs need to be designed in a way to respond appropriately in all circumstances, so as to be robust from a macro-prudential perspective. This is a complex question, requiring further analyses which go well beyond the limited scope of this paper.  

 

4. Asset management companies

The idea of removing NPLs from eurozone banks and relegating them in an area-wide AMC was suggested while the ECB was still in the early phases of its NPL action plan. Though an AMC does not in itself necessarily involve mutualization of bank risks (this depends on how the scheme is designed), the proposal immediately faced opposition from some eurozone members, fearing that the proposal would allow countries with large amounts of legacy assets, preceding the launch of the single supervision, to offload part of the burden onto others.  

In 2018 the Commission, fulfilling a mandate given by the Council, issued a “blueprint” with criteria for member countries willing to set up their own, national AMCs[14] See https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=SWD:2018:72:FIN. The document spelled out conditions for creating such schemes, making suggestions on various aspects including accounting, risk management, transfer pricing, impact on public finances and so on. The blueprint raised interest but as such was not applied, for several reasons. First, no explicit relaxation of state-aid criteria was included in the scheme, thereby limiting its feasibility for countries facing public finance constraints (countries with public finance problems often have also high NPL levels). Second, in the meantime the ECB supervision had advanced in its NPL action plan, and a more active secondary market for NPLs had developed. This allowed several banks in high-NPL countries to conclude important offload operations, alleviating the problem in the countries concerned. In the background, there was also a perception of stigma annexed to national AMCs, whose creation may in itself signal a systemic fragility in the banking sector of the country in question.  

The eurozone-wide AMC proposal was revived in 2020 by the ECB[15]6 A. Enria, “The EU needs its own ‘bad bank’”; Financial Times, 27 October 2020 and echoed by the European Commission as part of its Covid strategy[16]Coronavirus response: Tackling non-performing loans (NPLs) to enable banks to support EU households and businesses”; 16 December 2020. See … Continue reading. The Commission proposal, however, dropped the idea of an area-wide scheme arguing instead in favor of a “network” of cooperation, of unspecified content, among national AMCs.  

These new proposals, while still rather general, are of interest and should be carefully considered. An element in favor of them is that in the situation created by the pandemic the AMC solution is less prone to the criticisms that had plagued the proposal previously. NPLs derived from Covid cannot be regarded as a “legacy” of past errors by bankers or attributed to national supervisors, as had been the case in the past. These NPLs are the result of a common shock which hit all countries and was outside of their control. The underlying logic of the proposal is therefore stronger. 

Yet, there are hurdles in this new proposal as well. First and foremost, the entity of the problem is not known. The wave of Covid-related NPLs has not been observed yet; we do not know when it will develop, how large it will be, how it will be distributed across countries and banks. It seems unlikely that such scheme can be agreed upon, let alone implemented, before this information is available.  

Second, certain obstacles faced by the earlier proposals persist, to some extent. Even before Covid, an NPL problem still existed in certain countries and banks. Distinguishing between new, Covid-related losses and the preceding ones may not be easy in all cases. As a result, the objections raised in the past with reference to “legacy” problems may resurface. In addition, the “stigma” effect may still discourage certain countries from setting-up national schemes. The set-up of national “bad banks” could be regarded as a sign of underperformance in a broader sense, not only in dealing with banks including but also in the way the health situation has been handled or the supports to the economy have been provided.  

 

5. Conclusions

The wave of NPLs expected to develop in the eurozone as a consequence of Covis-19, while perhaps not too different in size from to the one observed after the financial crisis, is different in nature and will therefore require different remedies. Predictions are premature, because the phenomenon has not been observed yet. But it is already possible to make some reasoned conjectures on whether the regulatory tools put in place after the earlier crisis are going to be helpful in the new situation. 

The two main regulatory instruments introduced before the pandemic in the eurozone’s Pillar I structure for tackling the NPL problem, namely, the so-called “calendar provisioning” and the new accounting principles based on expected losses, are not suitable to deal with the new situation. Even prospectively, after the pandemic will be overcome, their usefulness in their present form is questionable, because either they are excessively rigid, or excessively sensitive to uncertainty, or both. Conversely, the proposals to create AMCs, at national or supranational level, are valid but cannot be seriously considered before the dimension of the post-Covid NPL problem is known.  

Absent these, traditional micro-supervisory instruments will continue to play a key role. One more time, the responsibility of cleaning eurozone banks from their NPLs will be predominantly fall on ECB supervision. Pillar II powers will have to be applied flexibly, depending on the conditions of individual banks. But when the moment comes, supervisory pressure should be exerted with determination, using all the independent power that the law and the statutes accord to the single supervision. Not an easy task; but the ECB has the instruments and the expertise necessary to carry it out. 

 

Notes

This draft is based on an intervention made on 11 February 2021 at the Global Annual Conference organized by the European Banking Institute in Frankfurt.

Footnotes

Footnotes
↑1 Wall Street Journal: “The best year ever: 2020 was surprisingly good to small banks”, 14 December 2020.
https://www.wsj.com/articles/the-best-year-ever-2020-was-surprisingly-good-to-small-banks11607941800.
↑2 See ECB Economic Bulletin, various issues.
https://www.ecb.europa.eu/pub/pdf/ecbu/ecb~b6a4a59998.eb_annex202101.pdf.
↑3 ECB supervisory statistics,
https://www.bankingsupervision.europa.eu/banking/statistics/html/index.en.html.
↑4 A. Enria, “European banks in the post-Covid world”, speech given at the Morgan Stanley European Financials Conference, 16 march 2021.https://www.bankingsupervision.europa.eu/press/speeches/date/2021/html/ssm.sp210316~55c3332593.en.html.
↑5 A. Enria, “An evolving supervisory response to the pandemic”, Speech given at the European Banking Federation, October 2020; https://www.bankingsupervision.europa.eu/press/speeches/date/2020/html/ssm.sp201001_1~ef618a5a36.en.html.
↑6 A. Carstens, “Bold steps to pump coronavirus rescue funds down the last mile”, Financial Times, 29
March 2020.
↑7 ECB Guidance on Non-Performing Loans, 2017; see
https://www.bankingsupervision.europa.eu/ecb/pub/pdf/guidance_on_npl.en.pdf; and I. Angeloni, Beyond the pandemic: reviving Europe’s banking union; VoxEU. See https://voxeu.org/content/beyondpandemic-reviving-europe-s-banking-union.
↑8 See https://www.bankingsupervision.europa.eu/about/ssmexplained/html/srep.en.html
↑9 See letter sent to the ECB by the President of the EP on .. 2017 ( See https://www.politico.eu/wpcontent/uploads/2017/10/Letter-to-President-Draghi.pdf).
↑10 See a Council summary here https://www.consilium.europa.eu/en/press/pressreleases/2019/04/09/council-adopts-reform-of-capital-requirements-for-banks-non-performing-loans/.
The full text is here https://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32019R0630&from=EN
↑11 The EU “banking package” introduced in 2020 is available here
https://ec.europa.eu/commission/presscorner/detail/en/qanda_20_757
↑12 Commission Regulation 2016/2067; see https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32016R2067
↑13 See for example J. Abad and J. Suarez, “IFRS 9 and COVID-19: Delay and freeze the transitional arrangements clock“; VoxEU 2
April 2020, see https://voxeu.org/article/covid-19-and-expected-loss-provisioning.
↑14 See https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=SWD:2018:72:FIN
↑15 6 A. Enria, “The EU needs its own ‘bad bank’”; Financial Times, 27 October 2020
↑16 Coronavirus response: Tackling non-performing loans (NPLs) to enable banks to support EU households and businesses”; 16
December 2020. See https://ec.europa.eu/commission/presscorner/detail/en/IP_20_2375.

The Single Supervisory Mechanism

by

This article[1]ECB. I am grateful to Cécile Meys for excellent drafting support. The views expressed here are my own and should not be attributed to the ECB. This article draws largely on a speech held in Dublin … Continue reading describes the actions undertaken by the European Union towards the establishment of a Single Supervisory Mechanism (SSM), with a special focus on its rationale, on its priorities to promote the soundness and stability of the banking system across the Euro Area. This work also discusses the need to implement an harmonised regulatory framework in the estimation of bank risk and in the calibration of prudential requirements.
The global financial crisis triggered financial reforms in all major economies, but nowhere was the change as comprehensive and radical as in the euro area. In 2008, as the crisis reached its peak in the United States, the euro area still had national banking regulatory frameworks (for supervision, regulation and crisis management), with only a mild overlay of harmonisation arrangements provided by European directives and supervisory “committees” without binding powers. At the time of writing (December 2015) a euro area-wide banking supervisor has been in charge for more than a year at the European Central Bank (ECB), with the mandate of ensuring banking soundness, stability and a level playing field in the whole euro area. A single bank resolution authority is about to take responsibility for crisis management, supported by a single resolution fund. There is a legal framework for conducting supervision, the Capital Requirements Regulation (CRR), which is directly applicable to all banks in the euro area without the need for national transposition, as well as EU-wide crisis management rules, the Bank Recovery and Resolution Directive (BRRD). The launch of a European deposit guarantee scheme is still being discussed, but in the meantime the rules guiding the operation of the national schemes have largely been harmonised.
The aim of this article is not to describe all the elements of the European Banking Union. It focuses on its supervisory arm, the Single Supervisory Mechanism (SSM). In particular, it elaborates on the establishment of the SSM and the rationale behind it, as well as its priorities during its first year of operation. Special focus is placed on what the SSM has accomplished in the area of regulatory harmonisation to give rise to an effective level playing field, and on the methods it uses to assess bank risks and calibrate the prudential requirements, namely the Supervisory Review and Evaluation Process (SREP). Finally, the article provides an overview of the priorities of the SSM for the immediate future.

Footnotes

Footnotes
↑1 ECB. I am grateful to Cécile Meys for excellent drafting support. The views expressed here are my own and should not be attributed to the ECB. This article draws largely on a speech held in Dublin on 27 November 2015, available at https://www.bankingsupervision.europa.eu/press/speeches/date/2015/html/se151127.en.html.