Remarks by Mary-Elizabeth McMunn Director of Credit Institutions Supervision at Federation of International Banks in Ireland annual conference

Good afternoon.¹

I would like to thank your Chair Fiona Gallagher and the Federation of International Banks in Ireland (FIBI) for the invitation to speak here today.  

It comes a month after our own Financial System Conference², where many of you shared your perspectives with us and with the wider public on pressing topics for the financial services industry. To exchange views in these fora is an important part of the regulatory relationship, and I look forward to the panel session also. 

Supervision of the international banking and investment firm sectors, is a key part of my diverse portfolio.  I see many of you represented here today.  My teams adopt a risk-based, proportionate and outcomes-focused approach to supervising your sectors, working in many cases with the ECB though the Single Supervisory Mechanism, and with peer regulators of other entities in your groups. 

In my remarks today I will focus on the Central Bank’s view of the external context, some topical issues for your sectors and mention some of our regulatory expectations in the current environment.

At a time when the world economy is slowing, global financial conditions have tightened and where global markets remain vulnerable to further shocks, my core message to you is that heightened uncertainty necessitates heightened vigilance. It is a time to show strategic leadership at a local level, appropriate to the risks you face in the Irish entity and where relevant across your European franchise, and it is also a time to harness the benefits of having access to global networks and intelligence, global infrastructure and data, and exposure to global best practices in risk management within your groups. 

In my supervisory experience, I have seen international groups and their subsidiaries truly reap the benefit of being part of a global group, including in particular in times of change. This goes beyond investment, and goes to influencing at and within the group, not just for the benefit of the Irish and European operations but in terms of wider standard-setting for the global entity. This experience is not universal though, and I have in the past also seen passive approaches which do not live up to our expectations about substantive presence and decision-making in the Irish regulated entity. The complex operating and external environment presents unique challenges, which merit highlighting the unique opportunities that being part of a global group brings.  

An Uncertain and Complex Macro-Economic Environment 

First I will comment on the Central Bank’s view of that external environment. The European banking sector as a whole has emerged from the pandemic in a robust position and has coped well with the fallout from the tragic events from the invasion of Ukraine. However, while the direct impact on banks has been contained, the indirect effects on the broader macroeconomic environment have been all too evident in the form of higher inflation, the energy crisis, the end of a long era of low interest rates, and supply chain constraints. These are key factors contributing to the deterioration in financial stability conditions across the euro area, including in Ireland, as outlined in the ECB’s³  and indeed our own  Financial Stability Review.⁴

The situation we are facing today is quite different from the one we faced during the pandemic. During Covid-19, monetary, fiscal and regulatory policy were supportive in tackling the challenges of the pandemic. This is a highly uncertain macro-economic environment, there is a collective need to be watchful of risks crystallising and that brings home the continued importance of retaining resilience in the system. 

As leaders of firms, optimism is important, particularly in the context of driving your business forward and achieving sustainable results.  However, it is essential to continue to test your assumptions, considering what could go wrong, and what you will do if things do go wrong. If the last number of years have taught us anything it is about the importance of consideration of the adverse scenarios that may weigh on your firm’s resilience. There is a need to be cognisant of the risk outlook, in particular the risk of deteriorating credit quality. We expect banks to be proactive in the early recognition and management of credit risk.  

Andrea Enria, the Chair of Supervisory Board of the ECB, noted in a recent speech that the heightened risks of  exogenous shocks to the economy and the banking sector require supervisors to exercise extreme caution and that, when facing events of this kind, in banking supervision or elsewhere, it is generally better to be safe than sorry. 

In managing this environment, it comes down to fundamentals. As noted by Deputy Governor Donnery in recent weeks⁵, and as you will have heard from my teams, firms need to ensure that they have sufficient resources, sustainable business models and effective risk management to mitigate against the risks that they face.  In 2023, these fundamentals are the areas where you can expect supervisors to continue to focus their attention. 

Financial and operational resilience, against this challenged macroeconomic and geopolitical backdrop and a focus on transition risks - not just in relation to climate and environmental risks – but also in relation to digital and expansionary activity across your firms, will be key features of supervisory discussions in 2023. Good governance, including continued progress on diversity at all levels, will be essential.

Changing banking landscape

You will be aware that Ireland’s open and highly-globalised economy is structurally exposed to wider global macroeconomic developments due to its heavy reliance on international trade and foreign direct investment. As noted in the IMF’s 2022 FSAP, the Irish banking sector comprises two segments, retail and international banks, which vary considerably in their business models and market orientation⁶. The provision of banking services to the domestic economy is heavily concentrated in a small number of banks, with the level of concentration expected to increase in the coming years. Conversely, international (non-retail) banks, while located in Ireland, tend to have more limited interaction with the domestic real economy and mainly provide services into the rest of the EU. In recent years, and following the UK’s departure from the EU (Brexit), a number of banks have substantially grown in size. 

Between Q1 2018 and Q3 2022, credit institutions’ aggregate balance sheets grew by €371 billion or 66 per cent, with the majority of that growth coming from cross-border assets held by third country subsidiaries .  We now also have a banking system that is operating truly global business models, across the majority of European jurisdictions.  

Whilst the large systematically important banks are supervised under the joint supervisory mechanism, as the host regulators for a number of European subsidiaries⁷ of globally systemic international banks (GSIBs), our responsibilities as host regulators for internationally facing firms is very important to us.  I welcome that the IMF noted the improvements in banking supervision since the 2016 FSAP in their Financial Sector Stability Assessment last July.  We also consider that our authorisation regime is part of the story of the growth of the Ireland as a global financial services centre. 

Credible and robust authorisation and supervision are characteristics of an attractive location to do business.  This applies both to new entrants and to existing firms wishing to materially expand, and it is an area where we continue to enhance our processes and our effectiveness. We are clear on our supervisory expectations, ensuring that the growth is well managed by your institutions. 

Desk Mapping Review

We have been clear on our post-Brexit expectations for so called ‘incoming banks’ on-shoring business to Europe. One of the key tenets of those supervisory expectations, and that of the ECB, is that firms’ onshore levels of governance and risk management capabilities, are commensurate, from a prudential perspective, with the risk they originate.  Banks must continue to make progress in ensuring adequate local trading and risk management capabilities. As Andrea Enria outlined in May of this year, we recognise that “banks need clear instructions for appropriately implementing the target operating models previously agreed with their Joint Supervisory Team”, and these are the issues at the core of the so called ‘Desk-Mapping Review’ (the DMR). 

The practice of back-to-back mirror transactions and hedges transferring the risk to parent entities are a very real concern, and this is a significant focus of the DMR. These structures are exposed to heightened operational and counterparty risk. In the event of financial stress or default at the level of the parent entity, the local entity can be left with large unhedged positions and limited staff and infrastructure needed to wind them down smoothly. This, in turn, undermines both the local entity’s recovery capacity during severe stress and, where applicable, its resolvability. Furthermore having risk management resources and infrastructure located offshore can significantly impact a bank’s ability to identify, measure and monitor its risks. 

As part of the SSM, we are in advanced stages of dialogue on the specifics of the DMR with impacted banks, and engaging closely with other relevant authorities. A key measure of success for this work is that banks will have sound risk management arrangements and a local presence that is suitable for the risks they originate in the euro area.   

Climate Change ⁸

I spoke earlier of some of the immediate risks to the financial services sector: geopolitical, economic, and a rapid change in monetary policy. These are risks that are difficult to predict and plan for, but we know are ever present and which we, as regulators and central bankers, and financial market participants alike, have grown accustomed to dealing with. 

Climate and environmental risk on the other hand can feel more intangible, more distant, less certain.  

In November 2020, the ECB published its guide on climate-related and environmental risks, which is applicable for all significant and less significant credit institutions, with due regard to proportionality. The Central Bank has also written to all firms setting out our expectations on climate matters.  

The outcome of ECB’s recent thematic review and stress testing on climate risk, along with our own supervisory work in this area, shows that firms are still far from adequately managing climate and environmental risks. 

There is a clear underestimation of the breadth and magnitude of climate risks. 

We will continue to enhance our processes internally around fitness and probity to ensure that applications are progressed in a timely and efficient manner, but the efficiency of the process is dependent on receiving complete information on candidates who have been through the appropriate due diligence. 

The implementation of the IAF will complement and bolster the F&P regime. The IAF is fundamentally about underpinning good conduct and high quality governance and culture within firms. It is about being clear who is responsible for what and ensuring that reasonable steps are taken to fulfil those responsibilities.

The IAF is a further important addition to our supervisory toolkit.

The framework and our approach to implementation of it, will be firmly grounded in proportionality and what is reasonable.

Closing

Today was an important and welcome opportunity to engage with you and your members. 

We recognise that we collectively are operating in a challenging and dynamic environment.  We will seek to continue to regulate in a way that is balanced and proportionate, efficient and fair.  The need to be adaptable and agile has never been more important, while simultaneously ensuring we continue to maintain our vigilance and focus on risk and resilience.   

At the Financial System Conference, there was a heartening emphasis from across the financial industry on the role your firms and your peers play in society. There are a multitude of risks permeating the financial and physical landscape and it is our collective duty to ensure we deliver on our specific responsibilities – each safeguarding the interests of that society.

Thank you.

[1] With thanks to Patrick Haran, Melissa McCahey and Steven Cull for their support in preparing this speech. 

[2] See Central Bank of Ireland Financial System Conference

[3] Central Bank of Ireland Financial Stability Review II of 2022

[4] European Central Bank Financial Stability Review November 2022

[5] Sharon Donnery ‘Charting the course - leading financial services through complexity and change’ 17 November 2022

[6] International Monetary Fund Financial Sector Stability Assessment: Ireland July 2022

[7] See Table A.4 Credit Institutions – Aggregate Balance Sheet; and Bernard Kennedy, Understanding the surge in resident banks’ cross-border financial assets since 2018, January 2022

[8] The Central Bank is committed to redoubling its efforts to take action in respect of climate change (PDF 120.67KB). We established a Climate Change Unit in 2021 to strategically drive forward our work and to centrally oversee the integration of climate and broader sustainability considerations into our work. As a member of the Network for Greening the Financial System (NGFS), the Central Bank also recognises the need for international cooperation in tackling the climate challenge and endorsed the NGFS ‘Glasgow Declaration’. We are connected and collaborating with our European partners through the SSM, EBA, ESMA, and other European Supervisory Authorities to leverage our collective strengths to tackle this risk.

[9] All firms are encouraged to pay attention to the ECB’s compendium of  Good practices for climate related and environmental risk management (PDF 744.26KB)

[10] Federation of International Banks in Ireland. Supporting Ireland’s Success – The Contribution of International Banking  (PDF 6MB)2021

[11] Gabriel Makhlouf The Central Bank’s Regulatory Philosophy: Regulating for stability and positive outcomes, 2 November 2022