Methods & approach
The testing of first hypothesis, variation in the EU’s institutional capacity to foster the ‘Single Rulebook approach’, will involve a Principal-Agent analysis of the ‘hub-and-spokes’ relations in the three jurisdictions. The EBA and ECB Principals have been tasked with adopting the ‘Single Rulebook approach’ across their jurisdiction, but they heavily rely on the NCAs’ (the Agents’) willingness to collect and transmit the information necessary to carry out this task. Thus, the nature of the EU’s convergence-building activism may depend on the Principals’ control mechanisms over local supervisors and their ability to manipulate their incentives.
The testing of the second hypothesis will involve the application of constructivist approaches to examine convergence in ideas about effective supervision. Variations in the EU’s institutional capacity to foster the ‘Single Rulebook approach’ can be explained through the application of a transnational policy network analysis of the ‘hub-and-spokes’ relations in the three respective jurisdictions. The EBA and ECB are tasked with adopting the ‘Single Rulebook approach’ across their jurisdictions, but operate in an interdependent environment (resource and know-how constraint), in which the NCAs may have very different understandings of what counts as appropriate bank supervision. Thus, the nature of the EU’s / Banking Union’s convergence-building activism will depend on the scope of governance networks between them, the intensity of their interactions and the two hubs’ ability to strategically use the ‘Single Rulebook’ concept to reshape NCAs’ interests.
The testing of the third hypothesis will involve a combination of rationalist and constructivist approaches arguing that the supranational bodies (EBA and ECB) strategically use ideas about appropriate regulation and supervision in order to bring about greater convergence in national supervisory practice.
Hypotheses and methods
The three hypotheses tested to address the central research question — ‘Under what institutional conditions does the EU manifest capacity to foster convergence in banking supervision?’ — stem from distinct analytical approaches in the political science discipline, involving distinct methodologies. These are not competing hypotheses per se. Rather they apply more or less in each of the three supervisory jurisdictions examined.
The first hypothesis understands convergence pressures in supervisory practice in terms of legal provisions (ex ante controls) and their application in practice, ex post and hybrid controls. The first hypothesis is tested in the three institutional settings through an application of a Principal-Agent analysis (a form of rational choice institutionalism and used in legal, economics and political science studies). The EBA and ECB are, respectively, the Principals, while NCAs are the agents (in three distinct P-A relations). According to H1, the independent variable is the preference of the supranational body to assert supervisory convergence, reflecting an underlying interest of bureaucratic expansion and control. In testing this hypothesis, the contribution of legal studies is central: we need to understand the implications of the legal texts adopted by the EU Member States (SSM regulation) and the hard and soft law texts adopted by the ECB and EBA (the ECB’s SSM framework regulation and supervisory manual / EBA’s binding technical standards) and the nature of legal recourse open to NCAs. Furthermore, semi-structured interviews with elite policy makers in the ECB, EBA and NCAs will be crucial to detect the degree to which control can be asserted in the three jurisdictions.
The second hypothesis understands the pressures encouraging convergence in supervisory practice in terms of appropriate ideas about best practice. The second hypothesis is tested in the three hub-and-spokes institutional settings through an application of a transnational policy network approach. The central supervisory body is tasked with adopting the ‘Single Rulebook approach’ across its jurisdiction, but operates in an interdependent environment (resource and know-how constraint), in which NCAs may exhibit different supervisory preferences that reflect different institutional frameworks and supervisory cultures. According to H2, the independent variable then is the scope and intensity of the governance networks in each of the three hub-and-spokes relations. For example, in the supervision of the euro area’s largest headquartered banks, we would predict the greatest scope and intensity of governance networks given that the ECB runs Joint Supervisory Teams (JSTs) in coordination with NCAs and must chair colleges of supervisors for a number of cross-border banks with a presence outside of the euro area. The contribution of both legal studies and financial economics is crucial in testing this hypothesis given that it will be necessary to understand different supervisory practices (to the extent that these are public) which are based on both different legal texts and economic models.
Methodologically, a mixed methods analysis will be undertaken with the aim of understanding the ideational and socialising effects of the three overlapping transnational networks.
This will involve:
- The collection of data on supervisory practice in all 27(28) EU Member States;
- The organisation of approximately twenty interviews with a range of supervisory officials from the four case study NCAs, the EBA and the ECB. The same set of questions will be asked of all officials to allow for an empirical analysis to detect the actual impact of the institutional specific network on national supervisory preferences and practice — distinct from international guidelines and EU legislation adopted;
- An empirical analysis of the interview results will attempt to draw out features of the transnational networks
- A diffusion analysis involving quantitative (regressions) and qualitative techniques will be undertaken to explain the spread of specific supervisory practices;
- The organisation of a participant observer — the PhD student on a four to six-month internship in an NCA — will further facilitate an understanding of the features of the transnational network.
A third hypothesis involves the testing of a combination of the rationalist and constructivist approaches outlined above, notably through a strategic constructivist analysis. The ECB’s and EBA’s ability strategically to use ideas (here EU banking rules and ideas about supervisory best practice) to reshape local supervisors’ preferences is another important dimension of the expression of their control mechanisms.
This research project also identifies three intervening factors embedded in the institutional design of the three main hub-and-spokes supervisory jurisdictions which build the EU’s (supranational) capacity by conditioning the hub’s convergence-driving activism. These are:
- the hub’s (EBA / ECB) technocratic mandate in the jurisdiction;
- the division of resources and expertise in the jurisdiction;
- and enforcement credibility in the jurisdiction.
These intervening factors explain the different convergence pressures in the three hub-and-spokes relations.
Methods
Four country (NCA) case studies and three supervisory topics
The proposed research project will also involve comparative case study analysis. While an overview of supervisory practice (and divergence) in all EU 27(28) member states and on a range of supervisory elements will be conducted, detailed research will be focused upon four case study countries (NCAs) and three supervisory topics. Previous research by the applicant PI already allows the identification of a number of country and supervisory topic case studies. However, the latter may change with the collection of data. This study will focus upon two Euro area countries with the largest banking (financial) sectors: German and France. The study will also examine two Euro area countries with banking sectors that are of significant size and importance both to the national economy and to the rest of the Euro area: specifically the Netherlands and Luxembourg. Economy and financial sector size matter because it is assumed that Germany and France will have more influence in EU policy making and, specifically, more influence in the context of both EBA and SSM policy making. Size might also better enable these countries to resist harmonisation pressures. We would expect smaller countries to be more ‘Europeanised’ and thus adapt their legislation to EU provisions quicker because of their greater sensitivity to potential reputation gains. At the same time, these smaller countries with important financial sectors may look to regulatory and supervisory arbitrage in order to maintain their competitiveness. One could also argue that the bigger countries’ preferences are already included in the EU provisions given that it is more likely that they have been able to upload these preferences to the EU level. Thus, it could be easier for them to adapt their legislation and more difficult for some smaller jurisdictions. But the existence of larger countries with longstanding and / or distinct supervisory practices also argues against this assumption. The applicant PI has also selected country cases which were negatively affected by the recent international financial crisis but have, nonetheless, today relatively stable banking sectors no longer subject to significant government support ten years after the crisis. The applicant PI has avoided the selection of cases, notably Italy or Greece, where numerous banks face major difficulties and the government and NCAs are under considerable political pressure to engage in forms of regulatory and supervisory arbitrage to prevent banks from collapse.
Observing differences in national supervision and thus the divergence of treatment of a number of cases by selected countries allows a comparative analysis of convergence. Based on prior research, the applicant PI will focus on the following three cases of supervisory topics: national treatment of NPLs, SREPs and the macro-prudential elements of CRDIV. A number of consideration have resulted in the selection of these three cases. First, they are Options and National Discretions (ONDs), to varying degrees, which have been resistant to convergence pressures from the EBA and the ECB in the SSM (Kudrna and Puntscher Riekmann 2018; ECB 2015). Second, they have been referred to by both the EBA and the ECB and in a range of previous interviews undertaken by the applicant PI with NCA and ECB officials as ONDs of particular significance. However, these topics might be added to or changed subject to subsequent developments.
This is both a highly politicised issue and one which may have significant impact upon financial stability. After the financial crisis, the number of NPLs in the EU member states increased significantly. Despite the improvement of the economic situation in most member states, the NPL ratio remained too high throughout much of Europe. For instance, the NPL ratio to balance sheet across the EU reached 5.7% in March 2016, more than 3 times higher than in Japan or the USA (World Bank data). Moreover, the distribution of NPLs is highly unequal among member states; countries such as Greece and Cyprus report more than 40 per cent of NPLs in their balance sheets (EBA 2016a, b). The high level of NPLs is a significant problem for financial institutions, which face difficulties to lend further because of lower profitability, higher capital requirements and increased funding costs. It is also an issue at the macroeconomic level with the limitation of available capital and decrease in credit growth (EBA 2016a, EIB 2014, IMF 2015). In order to give investors and supervisors sufficient information about the quality of assets, the EU has encouraged transparency on NPLs. The EU member states have the obligation to ‘disclose information on loans and debt securities exposures and their credit quality pursuant to Regulation (EC) No 1606/2002 and in Council Directive 86/635/EEC’ (EBA 2013a). However, this obligation was not followed by a common definition of NPLs at the EU level. Even at the level of a single country, sometimes different terms designating non-performing assets have coexisted (d’Huelster, Salomao-Garcia and Leteiler 2014). This research project will analyse the degree of harmonisation of the treatment of NPLs in the Euro area and the possible reasons of the lack of harmonisation. On NPLs, we can observe that the main definition based on 90 days past due is applicable to all member states concerned, but there are differences when it comes to the additional elements of the definition. A qualitative criterion is used in all four member states but the exact provision is developed at the national level. France, the Netherlands and Luxembourg have introduced specific guidelines and legislative measures to handle NPLs, whereas Germany’s banks only rely on EBA and SSM provision as well as MaRisk principle-based guidelines (ECB 2016).
SREP allows a supervisory review of the capital and liquidity situation of the financial institutions in a more continuous way than the evaluation of Pillar I risk limits under Basel III guidelines and takes into account the internal governance and risk management practices of banks (Baglioni 2016, Dragomir 2010). The researcher has chosen SREP as a case study given the importance of this process for the supervision of banks. The objective of SREP is then to review continuously and evaluate the risk profile of supervised institutions and take into account all types of risks and the specificities of each bank. The introduction of SREP by CRDI reinforced the autonomy of NCAs which could make use of different types of evaluation process with more focus on qualitative and/or quantitative elements in their assessment (McPhilemy 2014). This means that the supervision of banks can be highly divergent depending on the countries in which they are located. The objective of the selection of this case study is also to evaluate the differences in the process used by NCAs and the reasons for these divergences. When it comes to the SREP for LSIs, each member state has developed its own methodology. The risk assessment system used in France is mainly based on quantitative criteria which then can be complemented by ‘expert judgement’. In Germany, the Netherlands and Luxembourg, the assessment of risk is mainly qualitative. The supervision of consolidated entities varies depending on countries. All four assess at the consolidated level, while only France supervises at the level of the individual bank entities (Germany and the Netherlands in principle do not do so).
The harmonisation of the macro-prudential elements in the supervision of individual banks (as outlined in the EU’s Capital Requirements Directive, CRDIV) is the third case study to be examined in the proposed research project. The choice of this case is based on the importance of macro-prudential provisions for the stability of both individual banks but also for the banking system as a whole. CRDIV allows significant margin of manoeuvre to national governments and NCAs in the national design of these provisions. More specifically, the application of the capital conservation buffer and the countercyclical capital buffer required under CRDIV varies considerably in the euro area. According to the ECB, systemic risk is the risk that financial instability can cause significant damage to the real economy (Trichet 2009). Systemic risk can be caused by significant macroeconomic shocks, excessive leverage or contagion risk from interdependent institutions (Constancio 2016). The macro-prudential elements of CRDIV were adopted to diminish excessive risk taking by financial institutions and to reduce spill-over effect. Macro-prudential supervision is a preventive approach, which has as its main objective to limit credit expansion and increase the shock absorption capacities of banks (Borio 2003, 2006, 2010; Cartapanis 2011). The proposed research project will analyse the implications of discretion and assess if there are any visible trends towards harmonisation in the implementation of CRDIV macro-prudential tools.