Good governance is key for banks to take the right decisions. It is therefore one of the major pillars that ensures their safety and soundness and the stability of the financial system of the European Union, which are overarching goals of the Single Supervisory Mechanism (SSM), thereby contributing to the trust of the wider public in the banking sector.
Both the global financial crisis and idiosyncratic bank failures have shown that deficiencies in internal governance and risk culture can often be seen as early warning signals or even a root cause of difficulties ahead. These deficiencies may then translate into poor decision-making, often resulting in imbalances between risk- taking and control. If severe, such deficiencies can materialise over time as risks to capital, also undermining banks’ operational resilience. Therefore, sound governance and risk culture contribute to promoting a more sustainable business model over the full business cycle. This is especially important in an environment in which banks face economic, financial, competitive, and geopolitical headwinds.
Governance and risk culture are essential features of any well-functioning organisation, having an impact on its structure, culture, and people. Shaping the organisation of a bank and its management body, defining its values, norms, expected behaviours and collective mindset are key to ensuring the soundness of its business operations, strategic planning, and decision-making. Better strategic steering capabilities in particular help to address the challenges stemming from the constantly evolving environment in which banks operate.
Since the global financial crisis, governance and risk culture have risen to the top of the agenda of regulators and supervisors around the world. Standards and supervisory guidance have been provided at international level by the Basel Committee on Banking Supervision (BCBS). At Union level, these standards and guidance are reflected in the Capital Requirements Directive (CRD), which is in turn transposed into the national legislation of individual Member States. The guidelines adopted by the European Banking Authority (EBA) provide guidance concerning the internal governance arrangements, processes, and mechanisms that institutions must have in place under the CRD. In addition to the legal framework, important guidance has been published by the Financial Stability Board (FSB) and the Group of Thirty (G30).
Against this background, a significant amount of work has also been carried out in relation to governance and risk culture since the inception of the SSM. Internal governance and risk management is also one of the pillars of the Supervisory Review and Evaluation Process (SREP) carried out on an annual basis. As part of on-going supervision, bank-specific assessments of targeted governance areas have also been performed by supervisors on the basis of idiosyncratic features of individual banks. In addition, on-site inspections have been conducted to perform deeper assessments related to governance and controls. Furthermore, fit and proper supervision plays a strong role in ensuring that management body members and key function holders are suitable to perform their duties.
Despite this increased supervisory attention and the improvements already made by some institutions, the European Central Bank (ECB) has concluded that the progress made to date has not generally been sufficient. Therefore, banks need to continue enhancing their implementation of governance standards, while the ECB will continue to intensify its scrutiny in order to take timely action to bring about concrete improvements in this area and to escalate non-remediated supervisory findings whenever relevant.
The main purpose of this ECB Guide on governance and risk culture is to set out key ECB supervisory expectations when assessing the governance and risk culture of supervised entities based on the ECB’s interpretation of the current regulatory framework.8 The Guide does not lay down legally binding requirements and it does not replace the relevant legal requirements in either Union or national law, nor should it be construed as introducing new rules or requirements compared to current Union and national law.
The information in this Guide builds on the SSM supervisory statement on governance and risk appetite of 2016, which it supersedes as of the date of its publication, and makes use of additional evidence collected through the supervisory activities described above. It also provides examples of some observed good practices, thereby connecting the dots between the applicable regulatory framework and the supervisory work done over the years. While not being exhaustive, it aims to guide banks towards a more effective internal governance and risk culture, taking into consideration their governance arrangements, culture and behavioural patterns. The Guide should be read in conjunction with other ECB Banking Supervision publications, such as the Guide to fit and proper assessments, Good practices for climate related and environmental risk management, the Guide on effective risk data aggregation and risk reporting, and the ECB Guide on options and discretions available in Union law.
Good governance and risk culture are equally important for all banks, whatever their size, and the various elements of this Guide are also relevant for smaller institutions. Taking into account the principle of proportionality (in line with Article 74(2) CRD), banks’ governance arrangements, processes and mechanisms are to be comprehensive and proportionate to the nature, scale and complexity of the risks inherent in the business model and the institution’s activities. It is to be noted that in pursuing its supervisory approach, ECB Banking Supervision acknowledges national specificities as well as the different governance structures existing across the euro area.
Our interactions with the banking industry over the past years have been important to better understand the challenges banks are facing and to explain the ECB’s high expectations in this area. This Guide aims to continue this effective and helpful dialogue between supervisors and supervised banks, working towards a common goal of improving internal governance and risk culture.
This Guide is also intended for the internal use of the various supervisory teams, with the aim of ensuring a common and consistent approach. The ECB also recommends that national competent authorities (NCAs) align with the expectations and practices set out in this Guide when assessing the governance of less significant institutions.9 Finally, this Guide is intended as a practical tool and is not a substitute for the analysis of individual situations and the exercise of supervisory judgement.
ECB Banking Supervision will continue to develop its supervisory approach towards addressing governance and risk culture-related risks over time, taking into account regulatory developments as well as evolving practices in the industry and in the supervisory community. Therefore, the expectations set out in this Guide may be adapted over time. This Guide is applicable as of the date of its publication.
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