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Small is beautiful?

12 May 2014
Richard Kemmish

Six months to go before the ECB becomes Europe’s big bank regulator. Am I the only one to have a little trepidation about that?

Consistent banking regulation across borders sounds like a good idea (along with motherhood and apple pie).  And when its pan-European funds to the rescue if the regulators get it wrong, it is clear that it would be unacceptable to let cosy national arrangements obfuscate problems that will be bailed out by all of us.  

On the other hand it is less of a good idea when a banking market is more fragmented – a recent report by the ECB highlighted this as a significant trend since the crisis. Why should German banks serving German clients and funded by German investors be supervised by a Spaniard, for example?

Also, getting to my parochial area, can you speak in a meaningful way of a harmonised approach to regulating covered bonds when covered bonds themselves are so unharmonised, in particular in the field of regulation? Structural differences are fine, we can assume that the new regulator will be able to understand those but what about stress tests? Does our regulator from Madrid really have a valid view on the volatility of house prices in Munich?   Or even what the right variable to stress is? Asset value or liquidity ladder? Swap counterparties or back-up servicers?  

All of which assumes that the regulator actually undertakes stress tests of covered bonds. And that they do so to the same standard and for the same reasons. Do they do so to ‘tick a box’? to protect a systemically important asset class?  Or to second guess a rating agency?

Then there is the all important role of the regulator in allocating covered bond issuing licenses (or more importantly in revoking the issuing licence of a bank in trouble). As Bernd Volk recently highlighted this is key but different countries have very different approaches to licensing. And the decision to revoke is potentially the coup de grace for a troubled bank.

This all wouldn’t be quite so bad if it wasn’t for the fact that it will be inconsistent between issuers. Not all banks will now be supervised by the ECB, just the most systemically important ones. Whereas most covered bonds will come from the (roughly) 130 ECB regulated banks there are a sizeable minority of bonds that come from the other (even more roughly) 5,870 banks in Europe that will continue to be nationally regulated.

Would you rather a German covered bond regulated by the Bafin? Or one regulated by the ECB? And would you give the same answer in Spain? Or Finland? With the role of regulation, and its close cousin, implied government support, so key to the identity of our market its both an important question for an investor and not at all obvious.

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