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ECB Banking Supervision and the issue of Level 3 assets

by Danièle Nouy*

Dear Ladies and Gentlemen,
Your article on 17 March 2017 entitled “MPS, Deutsche Bank and the ECB’s lopsided banking supervision,” wrongly claims that European supervision is unfair in its treatment of banks. As supervisors, we are looking into all types of risks that banks face, including non-performing loans, internal models and Level 3 assets.

Your story compares the supervisory treatment of non-performing loans with that of Level 3 assets on the basis of a very limited and incomplete set of information. It tries to paint a picture of unfair supervision that is tainted by individuals because of their nationality and background. Quite the contrary to what your story claims, inspectors do not receive mandates with foregone conclusions. They are independent experts who vouch for their findings with their signatures in the reports.

It is regrettable that you single out individual inspectors and auditors who are part of a larger European team of supervisors, auditors and senior managers who diligently assure consistency in approach, quality and outcome of supervision.

Since the beginning of the SSM in 2014, we have devoted significant attention in our off-site and on-site inspections to potential valuation issues, whether they are related to non-performing loans or to Level 3 assets. The ECB first examined fair value exposures, including Level 3 assets, in the context of the asset quality review (AQR) in 2014. Of a total book value adjustment of €47.5 billion, €4.6 billion resulted from fair value exposures (including Level 3 assets). The undoubtedly biggest part of the adjustment, €42.9 billion, resulted from the need for additional provisions stemming from the credit portfolio review and a significant amount of the credit risk is related to non-performing loans.

Despite some progress, the stock of non-performing loans across a sample of 122 significant banks still stood at €921 billion in the third quarter of 2016—several times higher than the total stock of Level 3 assets held by euro area banks at the same time.

Regarding the supervisory treatment of Level 3 assets, we conduct rigorous reviews of valuations and pricing models at banks where Level 3 assets represent material exposures. We investigate market risk aspects on a recurring basis. Both are key elements of our internal model review. Risks posed by Level 3 assets are also explicitly captured in the market risk assessment of our annual Supervisory Review and Evaluation Process (SREP) and the number of on-site inspections focused on Level 3 assets has steadily increased.

We trust that your readers appreciate that we are doing our utmost to assure that individual banks are healthy and that the banking system is able to support economic activity—including keeping people’s deposits and investments safe.

Danièle Nouy

*Chair of the Supervisory Board
ECB Banking Supervision

The Chair of the ECB Supervisory Board does not deny a single fact or data that we presented in our investigation, while the impartiality she attributes to the Single Supervisory Mechanism (Ssm) is contradicted by those very same facts and data.

As evidence of that impartiality, Danièle Nouy continues to mention the results of Asset quality reviews that our investigation has shown were conducted with a lopsided approach and in an inadequate methodology. The approach was in fact so inadequate that the Ssm recently decided to start a “thematic review” in order to better assess the real prices - and therefore real risks - of level 2 and 3 assets.

The future tangible results of such development certainly is something that readers of Il Sole 24 Ore - and Europeans citizen in general- will greatly appreciate.
Claudio Gatti