The long march: ECB struggles with supervisory convergence

Anti-money laundering supervision and emergency liquidity assistance still run at national level

  • Latvian bank ABLV was deemed likely to fail by the European Central Bank on February 23, after the US Treasury found evidence of large-scale money laundering.
  • MEPs, regulators and industry experts say the case is an embarrassment to the banking union, and shows powers such as anti-money laundering supervision need to be taken away from member states and become subject to European oversight.
  • Differences between Latvia and Spain on the use of emergency liquidity assistance also suggest the ECB needs to be given greater power.
  • But there is no consensus on whether to expand powers at a eurozone or European Union-wide level, and member states will strongly protect their role where they perceive vital national interests are at stake.

Advocates of closer European integration have long seen the impending departure of one of its foremost critics – the UK – as an opportunity to transfer more power to European Union institutions, but when it comes to financial regulation, there is an extra complication. The creation of the banking union – currently comprising the 19 eurozone members, but open to any other EU country that chooses to join – has resulted in two different levels of integration.

Banks based in the banking union are now under the supervision of the European Central Bank (ECB) and the Single Resolution Board (SRB). Those based in the rest of the EU are still under national supervisory and resolution authorities, but subject to the European Commission’s regulations and their interpretation by the European supervisory agencies (ESAs).

The recent collapse of Latvia’s third-largest bank, ABLV, has added impetus to the argument for greater centralisation of powers among regulators, lobbyists and members of the European Parliament (MEPs).

The failure of ABLV and other banks in the eurozone has flagged up two particular gaps in the ECB’s supervisory role: the oversight of anti-money laundering (AML) powers, which currently sits with national regulators; and the emergency liquidity assistance (ELA) facility for banks that face a funding squeeze. While liquidity is supplied by the European Central Bank, the decision to grant it is still taken by the national central banks.

“Of course, it makes sense for AML and emergency liquidity assistance to be centralised. It’s bonkers that all these are currently national decisions,” says a regulation expert at a US bank in London.

In addition to these supervisory issues, there are questions around harmonisation of the way bank failure is tackled and the limitations of the SRB (see box: Back seat drivers).

But any talk of further centralisation prompts heated debate over whether those powers should be adopted at a eurozone or EU-wide level. This will feed into the EU’s ongoing review  of the role and powers of ESAs in driving greater supervisory convergence. And observers warn the UK is not the only European country keen to defend its sovereignty on matters regarded as fundamental national interests.

It is not acceptable the ECB holds supervisory powers, either directly or indirectly, but has very little clue what the national authorities find
Sven Giegold, Green MEP

The ABLV case is a stark reminder that money laundering is not necessarily just a question of law enforcement; it can become a prudential concern if the consequences for a bank’s viability are severe. ABLV was deemed as failing or likely to fail (FOLTF) by the ECB on 23 February, soon after being accused by the US Treasury’s financial crimes enforcement network of money laundering linked to Russian deposits.

Market participants with an eye on the saga say this has undermined confidence in the ECB, as well as Latvian supervisors. In response to criticism, Daniele Nouy, chair of the ECB’s Single Supervisory Mechanism (SSM) pointed out that AML is currently within the remit of national authorities.

In a public hearing with the European Parliament’s economic and monetary affairs committee (Econ) on March 26, she admitted the ABLV affair was “embarrassing” for the ECB and called for EU-level authorities to be given AML powers.

On March 27, the ECB itself took a step in that direction when it revoked the licence of Estonia’s Versobank, saying it had failed to tackle money laundering. But this action was still largely at the behest of the Estonian supervisor, Finantsinspektsioon, and it leaves the ECB with a relatively blunt instrument – the extreme option of revoking a bank’s licence altogether. The SSM clearly needs to be able to request remedial governance measures as a way to repair AML breaches before they call into question a bank’s survival.

Sven Giegold
Sven Giegold

Green MEP Sven Giegold, a member of the economic and monetary affairs committee, is one of those leading the calls for a rethink. He criticises the ECB for doing too little with the powers it already has, including its ability to obtain information from national supervisors. But he recognises there is a need to grant the SSM more powers over money laundering supervision. “Before we debate institutional questions, one has to collect the lower-hanging fruit. That means requiring information gathered by AML authorities to be shared with European-level authorities. It is not acceptable the ECB holds supervisory powers, either directly or indirectly, but has very little clue what the national authorities find. Relying on the US Treasury to find evidence of money laundering is deeply embarrassing for the EU,” Giegold tells

A group of MEPs, including Giegold, attempted to set up an EU-level AML authority as part of the fourth update to the EU’s AML directive, which came into force in June 2017, but failed after opposition criticised moving AML powers away from the national level.

In the absence of an EU-level AML authority, and until there is enough support for such a body, Giegold says the ECB needs to step up its supervisory review-and-evaluation process (Srep), which feeds into Pillar 2 capital charges.


This use of the supervisory prudential function is a bit of an indirect way to solve the problem
Sven Giegold, Green MEP

“This use of the supervisory prudential function is a bit of an indirect way to solve the problem. I would always admit this, but not using it – given we will not get a fully federalised model very soon – is negligent,” he adds.

Srep gives the ECB direct access to a bank’s data and risk-management practices, which are then assessed and reported back to the bank with notes for improvement. Four areas are examined, including capital, liquidity, the bank’s business model, and governance and risk. The business model, governance and risk modules should allow the ECB to assess the potential risk to the bank from financial crime if governance practices are substandard, and subsequently impose Pillar 2 capital add-ons as an incentive for shareholders to force the bank to clean up its act. 

“I think it’s unacceptable that the ECB, with the limited information they do have, do not truly take AML into account in the Srep process. I understand they intend to change that, and I would encourage them to do so sooner rather than later. Banks that have banking models with a higher risk for financial crime should have a much higher Pillar 2 surcharge,” says Giegold.

Separate powers

However, Nicolas Véron, a senior fellow at think-tank Bruegel in Brussels and the Peterson Institute in Washington, questions whether the ECB is the right institution to supervise financial crime as well as prudential regulation. The natural fit for new AML powers would be the European Securities and Markets Authority, Véron believes.

“Generally speaking, I’m convinced by the view that conduct-of-business supervision requires different skills and culture to prudential supervision. The experience of large, complex financial systems where supervision has been undertaken by the same authority hasn’t been that good – the UK’s Financial Services Authority before the crisis comes to mind,” he says.

Switching oversight to Esma would align with the fourth AML directive that applies across the EU, not only in the banking union. And there is a precedent for Esma to act as a supervisor rather than as just a standard-setter, because it is responsible for directly overseeing securities market infrastructure, such as trade repositories and credit-ratings agencies. Greater power over central counterparties could be added to this list by legislation currently being discussed by EU law-making institutions.

Emergency liquidity assistance should be given through a process where the governing council participates and discusses, and in the end decides
Mario Draghi, ECB president

“I think it’s a good idea for a system as large as the EU to have prudential and conduct supervision separated. Esma would be the natural choice for AML powers because it has direct supervisory authority and its focus is on market integrity,” Véron says.

However, he acknowledges AML authorities at national level are deeply embedded in the intelligence and security communities in each member state, with many member states holding on to security related powers very closely. AML should only be transferred to Esma once the EU has developed a more centralised framework for security and intelligence. As a result, he shares Giegold’s conclusion that a full institutional overhaul is likely to be a long time coming.

Contrasting approaches

The questions surrounding ELA currently relate only to the eurozone, where emergency funding is provided by the ECB but is still decided by national central banks. Non-eurozone countries that retain their own monetary policies will also keep control over liquidity provision, although the European Commission or Banking Authority (EBA) could choose to develop guidelines on how ELA should be used across the EU.

Observers have been quick to point out the very different approaches to ELA taken in the cases of ABLV and Banco Popular in Spain. ABLV was given close to €300 million of ELA by the Latvian Central Bank shortly before being declared FOLTF by the ECB. This support was provided despite the US accusation of serious governance failings and the fact that the bank mostly served depositors outside Latvia – and, indeed, outside the EU – so local retail customers were not particularly at risk from the bank’s illiquidity.

By contrast, the Spanish central bank is reported to have granted Banco Popular, which had a large Spanish deposit base, only €3.8 billion of ELA, backed by €52.5 billion of asset collateral. This was much less than the €9.5 billion reportedly requested by Popular’s management. Popular’s former bondholders maintain the bank may well have been solvent when liquidity support was requested.

Mario Draghi of the European Central Bank
Mario Draghi

The divergence in approaches currently existing between central banks has pushed regulators, central bankers and policymakers to suggest centralising ELA in the eurozone would make the most sense. During an ECB press conference on March 8, ECB governor Mario Draghi made clear he was in favour of centralising ELA, after being asked about the supervision of Latvian banks. He said this is not something that could be implemented immediately, however, because it requires treaty amendments.

ELA should be centralised. Basically, it should be given through a process where the governing council participates and discusses, and in the end decides. This is not possible legally now, so it’s an evolution of the system that at [the] present time I judge unsatisfactory and needs to be changed,” Draghi said.

Currently, national authorities only have to inform the executive board of the ECB about the use of ELA if the amount is envisioned to be greater than €500 million, including an outline of the liquidity implications. If the amount is expected to be more than €2 billion, the ECB can block the decision if it thinks the use of ELA would have significant macroeconomic effects and interfere with the single monetary policy of the eurosystem.

Out of our hands

The failure of ABLV and Banco Popular have raised questions, and led to conspiracy theories about political interference in ELA decisions. One accusation from sources quoted in the Spanish press is that the Spanish central bank withheld ELA to speed up resolution action. Whether there is any truth in such claims or not, some view the current relationship between national politicians and ELA provision as unhealthy.

Panicos Demetriades, ex-governor of the Central Bank of Cyprus, says he would have been delighted if decisions on ELA during the 2012-14 Cyprus banking crisis had been made by the ECB, rather than himself.

Demetriades resigned as governor in 2014, following criticism from then-president Nicos Anastasiades around the handling of the country’s €10 billion International Monetary Fund and ECB bailout. He was also criticised for using €3.8 billion of ELA for Laiki bank in 2012, under Communist Party president Demetris Christofias, which many argued was insolvent and therefore should have been closed down without ELA more promptly. Laiki bank was eventually shuttered in March 2013 under the Anastasiades government.

“I would have been ecstatic if, in Cyprus, all decisions on ELA were made by the ECB rather than me, considering how much negativity surrounded those decisions afterwards. The problem was that, ex ante, all politicians wanted ELA to continue, because they knew if you stop ELA then there is financial meltdown, but ex post, some of them were making all kinds of accusations that I’ve kept the bank afloat by bloating it with ELA, allegedly to protect the outgoing government. They want to have their cake and eat it,” says Demetriades.

I would have been ecstatic if, in Cyprus, all decisions on ELA were made by the ECB rather than me
Panicos Demetriades, formerly of Central Bank of Cyprus

He believes if the ECB had been making decisions rather than the national central bank, it would have been much harder for politicians at national level to complain before or make allegations about political interference afterwards. 

The question is whether national governments, and central bankers in larger eurozone countries, would be willing to give up liquidity assistance powers, especially in relation to banks considered systemically relevant at the national or regional level but not at the eurozone level. Further, regulation experts say national governments in the eurozone are unlikely to be willing to support the mutualisation of liquidity as long as some member states’ banks are arguably more likely to fail than others.

The European regulatory expert at the US bank says centralising ELA makes sense to ensure banks are not given or denied ELA unwarrantedly. But he warns centralising liquidity support at the ECB level will feed into the debate on the mutualisation of banking risk across the eurozone.

He compares this with the debate over the European Deposit Insurance Scheme (Edis), another banking union project that proposes moving depositor insurance from the national to the banking union level.

“It’s very similar to the politics of the Edis. The Germans will want to see more action taken on non-performing loans before there is a single mechanism for liquidity support. So far Edis has gone absolutely nowhere, so moving powers like ELA to the EU level will also take a long time,” says the regulatory expert.

That would suggest the centralisation of ELA will not happen any faster than the wider process of risk reduction and mutualisation in the banking union.

And harmonisation of AML supervision could be even further into the future, since it is likely to need the construction of new European infrastructure on crime-fighting and intelligence. Although ABLV has made the shortcomings of current banking union supervision clear, potential political solutions that can attract majority support in the EU Council and Parliament remain obscure. 

Back-seat drivers

Latvia’s ABLV had a Luxembourg subsidiary. When the ECB deemed this failing or likely to fail (FOLTF), along with the Latvian parent, Luxembourg’s financial regulator, the Commission de Surveillance du Secteur Financier (CSSF), attempted to liquidate the bank. But a Luxembourg insolvency court thought otherwise. In March, it ruled ABLV Luxembourg was solvent and financially sound in all respects, save for liquidity, and appointed two administrators to oversee new investment over six months.

This highlighted a clear gap in the powers of the Single Resolution Board. Specifically, if it concludes a bank is not systemically important for the eurozone and can be liquidated rather than being placed into resolution, the SRB cedes power over the winding-up process to national insolvency courts.

A photo of bafin president elke koenig
Elke Koenig

On March 20, SRB chair Elke Koenig told the European Parliament’s Econ committee the ABLV case “highlighted the importance of harmonising banks’ insolvency laws”. At present, she warned, the SRB has to navigate 19 different national insolvency frameworks if the banking union resolution framework is not invoked.

“The failing or likely to fail assessment does not automatically link to the criteria for insolvency/liquidation. Only by raising national bank insolvency procedures to a common standard can we clarify the line between resolution and insolvency and eliminate wrong incentives,” she added.

James Wigand, a managing director at advisory firm Millstein & Co, previously responsible for overseeing complex financial institutions at the Federal Deposit Insurance Corporation, says the EU should consider moving towards a US model, where state authorities still have the ability to close down state-chartered banks but can be overruled by federal regulators.

He points to examples in the US where, despite the fact a state authority has the ability to close down a bank, they have sought out the FDIC and asked it to apply federal powers, because of limitations in state statutory schemes. This was done to avoid the risk of a state court overturning a state regulator’s decision, similar to the example of ABLV in Luxembourg, he says. 

“I think the EU needs to evolve to a model where the member state authorities maintain the ability to liquidate an institution, but the EU has the capability to take over if the state lacks sufficient powers or the decision is not consistent with EU policy. That kind of backup authority would be useful to member state regulators too,” he adds.

But this is likely to require much wider legislative changes in the EU. The SRB’s rules are themselves governed partly by the Bank Resolution and Recovery Directive (BRRD), which applies across the EU, not just in the banking union. And while BRRD legislation and its implementation guidelines drafted by the EBA to some extent harmonise the powers of EU regulators over resolution, there has been no attempt so far to harmonise bank insolvency laws or allow EU regulators to have a say in bank insolvency proceedings.

“The problem is that moving these powers to the EU is very political, ie, what the federalists want. Taking national insolvency law applied to banks as a key example, this goes really to the heart of what it means to be a state, because it is attached to an individual country’s approach to property law,” says the regulation expert at the US bank. 

In November 2016, the European Commission proposed a directive for a common insolvency framework for corporates in the EU. But national sensitivities are so strong that the proposal is largely limited to facilitating early creditor intervention and out-of-court insolvency deals for small and medium-sized enterprises. The final rules on harmonising corporate insolvency, at least to a set of minimum standards, are currently under debate between the EU Parliament and Council.

The ECB has also been thinking about weaknesses in the resolution framework. Bloomberg News obtained and reported a document dated March 21, which stated the ECB is considering a new tool to provide liquidity to the viable part of a bank’s business in resolution, called emergency resolution liquidity.

The SRB has previously pointed out that it might not have been able to provide sufficient liquidity support to Banco Popular had Santander not offered to buy the bank so quickly after the FOLTF decision in June last year. But once again, extra powers for the ECB would require major legislative changes – and potentially treaty changes that would need unanimous approval of member states.

Editing by Philip Alexander

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