Banking supervision primarily seeks to safeguard the stability of the financial system, in order to prevent the banking sector from suffering significant shocks or even collapsing, given its significant role in the economy. To do this, the supervisor focuses on the solvency and conduct of supervised entities.
This framework establishes the reasonable scope of banking supervision with a dual aim:
- To minimise the effects of individual crises; this does not mean that there will not be any poorly managed or inefficient banks, as responsibility for their proper functioning lies directly and exclusively with the management teams.
With this in mind, the supervisory function entails designing and applying systems to analyse banks so as to help forestall potential crises and ensure that they are less frequent, smaller and less costly. - But achieving financial stability requires more than just minimising individual crises and preventing one or more crises from triggering a chain of defaults throughout the system. It calls for ensuring the smooth operation of payment systems and establishing proper protection against contagion risks. As a result, minimising so-called "systemic risk" is without doubt a primary concern (and supervisory task), to which the greatest efforts are devoted.
A bank recovery and resolution regulation (Directive 2014/59/EU) was passed at European level in 2014, which established new approaches, tools and authorities to help achieve these objectives.
However, as banks become more efficient in the face of competitive forces, banking supervision cannot be interventionist, and instead needs to be respectful of market mechanisms and the autonomy of directors and managers in business matters.
In view of its legal mandate, the Banco de España's supervision, which it currently exercises under the Single Supervisory Mechanism, is designed to verify compliance with the specific banking legislation under its remit. This includes, along with the legislation relating to banks’ financial situation and solvency, the regulations on customer protection and transparency vis-à-vis the market.
In this setting, it is important to bear in mind other legislation whose scope encompasses not just banks, but also other entities whose supervision falls to other competent authorities, such as:
- The tax authorities, which have powers in relation to tax rules.
- The National Securities Market Commission (CNMV), which has powers relating to the operating rules of securities markets.
- The Directorate General of Insurance and Pension Funds (DGSFP), which is responsible for the rules concerning insurance contracts and pension funds.
- The Executive Service of the Commission for the Prevention of Money Laundering and Monetary Offences (SEBPLAC), which has powers in these areas.
Limits to supervision
Given the objectives outlined above, the supervisory functions are defined within certain boundaries, which sets them apart from the sometimes parallel functions carried out elsewhere, such as:
- The management and administration of the banks. A bank's directors and management are responsible for its progress, successes and failures, whereas the supervisor carries out the analyses and verifications needed to obtain a reasonable understanding of its solvency and situation. To do this, the supervisor uses the procedures most appropriate to each bank’s situation, taking into account its size, complexity, risk profile and the possibility of its potential difficulties or defaults spreading to the financial system.
This does not involve, nor could it involve, carrying out an exhaustive review of the operations carried out by the bank. That task is only entrusted, in exceptional and particularly serious circumstances, to administrators when they are legally appointed under supervision and resolution legislation. - Internal audit and risk control. Internal auditors review the different areas of the bank, ensuring that the internal controls established by the directors and managers, including the internal rules and procedures in force, are correctly applied. The supervisor relies on the work carried out by the internal auditors, among others, and, like them, performs checks, but never takes part in the management of banks.
- External statutory audit. The external auditor has to check and report whether the annual accounts give a true and fair view of the equity, financial position and financial performance of the company under audit. It sets out its opinion in a report, which is filed at the Mercantile Registry, to ensure that it receives adequate exposure and secures the relevant effects vis-à-vis third parties. As part of its ongoing supervision of banks and consolidated groups, the Banco de España also carries out data verification tasks during its on-site inspections. But its work is focused on achieving the objectives outlined above, rather than on reporting its findings to third parties. In fact, under Article 82 of Law 10/2014 of 26 June 2015 and with certain express exceptions, all the information that the Bank holds is confidential and may not be revealed to third parties.
- Investor compensation and deposit guarantee schemes. Financial supervision pursues system stability, which means reducing the likelihood of bank crises, indirectly protecting depositors and creditors. However, the supervisory authorities do not guarantee, in the strict sense, bank customers’ transactions.
To carry out that function, developed countries have arranged guarantee schemes which, in the event of crisis, provide for the repayment of deposits or for compensation for the loss of securities entrusted to banks, in certain conditions.
The Spanish system is basically regulated by Royal Decree 2606/1996 of 20 December 1996 on the Deposit Guarantee Scheme for Credit Institutions. This royal decree provides for compensation to be paid to depositors and holders of securities or financial instruments that have been deposited with banks as part of an investment service. - Resolution systems. These systems are designed to manage situations in which a bank is not viable, by minimising the risks to financial stability and the cost for society as a whole.
The exercise of supervisory powers takes into account the objectives and limits described above. Resources are assigned efficiently and supervisory plans defined considering each bank’s importance and risk profile and the priority that should be afforded to monitoring its solvency.
In addition, the supervisory procedures are based on the principle of prudence and a constructive approach, as their objective is to solve any problems that may arise in order to ensure banks’ solvency and viability and the stability of the system.
This means carrying out activities with discretion, possibly over a long period, and deciding on and taking urgent measures in those cases where the bank faces a progressive deterioration.