Transnational Banking Supervision, Distance-to-Distress and Credit Risk: the SSM Case

ABSTRACT

We assess the impact of adopting a transnational supervisor on the distance-to-distress and credit risk of large and complex banks, exploring the establishment of the Single Supervisory Mechanism (SSM) in 2014 as a quasi-natural experiment. Using a differences-in-differences approach, we compare SSM banks vis-à-vis banks with a similar size and complexity operating in European countries outside the SSM. Our results suggest that adopting a transnational supervisor increases the distance-to-distress, particularly for banks operating in countries with larger banking sectors, higher market concentration and greater supervisory discretion. We also show that SSM banks reduced loan loss reserves and NPLs significantly more than non-SSM banks, but only among the most capitalized banks – which is consistent with the notion that well-capitalized banks are better able to weather haircuts induced by credit risk reduction initiatives. Interestingly, we find that SSM banks from countries with greater supervisory discretion saw their NPLs increase in the first years of the SSM, which could reflect the elimination of national idiosyncrasies in credit risk accounting. In general, the evidence presented in our paper suggests that transnational supervision bears a superior ability to increase the distance-to-distress, reduce credit risk, and harmonize supervisory practices among large and complex banks.

KEYWORDS:

• Banking
• supervision
• distance-to-distress
• credit risk

JEL CLASSIFICATION:

• G20
• G21
• G28
• G32

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

³ The sample includes banks from 29 countries: 17 SSM countries (Austria, Belgium, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Luxembourg, Malta, Netherlands, Portugal, Slovak Republic, Slovenia, and Spain) and 12 non-SSM countries (Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Liechtenstein, Norway, Poland, Romania, Sweden, Switzerland, and United Kingdom).

⁴ Untabulated results show that the improvement in ROA of SSM banks steams from an increase in the generation of fees and commissions that more than cover the higher operating expenses. While bank performance is not the main topic of this paper, we highlight three aspects possibly underlying such results. Firstly, SSM banks’ superior profitability in the post-Banking Union period may reflect the fact that profitability and business model sustainability was adopted as a critical supervisory priority in the SSM since its onset (ECB 2016). Secondly, the higher operating costs of SSM banks could reflect compliance costs stemming from tighter supervisory requirements (Ayadi et al. 2016); on the other hand, in the current context of staff and branch reduction, such cost add-ons may reflect the efforts to digitalize business processes and one-shot expenses with voluntary retirement schemes.

Additional information

Funding

This research has been financed by European Union and Portuguese public funds through the FCT (Fundação para a Ciência e a Tecnologia, I.P.) and the European Social Funds (Operational Program Norte 2020) under projects number UIDB/04105/2020 (CEF.UP) and UIDB/00731/2020 (CPBS).