Towards a more efficient EU prudential framework: the role of supervision

Speech by Mr Fernando Restoy, Chair, Financial Stability Institute, at the CEPS-ECMI task force on EU regulatory and supervisory structures, 16 September 2025.

General considerations 

Thanks for the invitation to participate in this meeting of the Task Force. I welcome the ongoing reflection which is taking place at different levels within the European Union on how to improve the current financial policy framework by enhancing not only its effectiveness to achieve its primary objectives but also its efficiency, i.e. its ability to minimise distortions and unwarranted costs for the industry.

As agreed with Karel Lanoo, my role here is to discuss issues related to banks' prudential supervision. But I expect this task force to pay due attention to the interaction between the different components of financial sector policies: namely regulation, supervision and resolution. I will refer to that interaction in my remarks.

Recent developments worldwide provide strong arguments to revise the current supervisory framework in major jurisdictions. That is the consequence of three main observations:

• First, the banking turmoil revealed some shortcomings in the current prudential framework, which include flaws in the control of liquidity, interest rate, business model and governance risks.
• Second, the most relevant flaws cannot always be effectively addressed by tighter regulation, such as higher capital or liquidity requirements. More importantly, it could be argued that we might be approaching a situation in which regulations' social returns are decreasing while the private costs of regulatory compliance are increasing.
• And third, there is clear political drive towards alleviating, when possible, the compliance costs for the industry as a way to enhance its contribution to growth and prosperity.

If you put all those elements together, there seems to be a case to consider an improved supervisory framework that could meet two objectives. The first is to be effective enough to correct the flaws in the current framework that cannot or should not be addressed by tougher regulation. The second is to be efficient enough to support efforts to alleviate banks' compliance burden.

Simultaneously achieving the desired effectiveness and efficiency of policy frameworks is always challenging. This is certainly the case when it comes to prudential regulation. Arguably, much of the complexity of the Basel III regulatory framework is related to the need to improve the risk sensitivity of the requirements, which is considered essential to align banks' risk management incentives with regulatory objectives. Therefore, improving efficiency by fostering simplification may well result in less risk sensitivity, leading to a somewhat less effective regulatory framework to preserve banks' safety and soundness.

Yet that trade-off could be alleviated by transferring some of the risk sensitivity from regulation to supervision. Take the example of the debate on how to improve liquidity risk controls. One option is to revise the current regulation, for example by requiring more granular and frequent reporting and tightening the calibration of the liquidity coverage ratio (LCR) by making the underlying stress scenario more severe and further limiting assets' eligibility to be classified as high-quality liquid assets (HQLA). That would, of course, improve liquidity controls but would also impose tighter constraints on banks' liquidity transformation business across the board. A different option would be to take more tailored and stringent action for banks with an objectively estimated weak liquidity position, derived from different quantitative and qualitative indicators. That approach would not, in comparison with the first one, add complexity or compliance costs for the bulk of supervised institutions, but only for those banks for which liquidity risk is considered material.

There therefore seems to be scope to strengthen both the effectiveness and the efficiency of the current prudential framework by relying more on well-defined supervisory policies. I believe European authorities are moving in that direction.

The progress so far

With outstanding foresight, the ECB launched an external review of its supervisory framework already in 2022.¹ Interestingly, while the report was finalised in March 2023, almost coinciding with the banking turmoil, its assessment and recommendations largely anticipate the lessons later extracted from that episode by national and international authorities.  

As you might all know, the report praised the fact that the Single Supervisory Mechanism was able to establish itself, in record time, as an effective authority able to adopt consistent supervisory approaches throughout the banking union. At the same time, it stressed a few areas for improvement. The report contained 17 concrete recommendations in the five following areas:

1. Adopt a more focused and risk-sensitive approach. Adapt supervisory actions and analysis to each entity's specific situation, business model and risk profile, and avoid rigid box-ticking approaches.
2. Better integrate all types of supervisory findings within a comprehensive assessment. In particular, rather than communicating directly with firms, consider submitting the outcome of on-site inspections to joint supervisory teams for them to integrate with their own assessment and the ongoing dialogue with the banks.
3. Better balance quantitative and qualitative supervisory measures in favour of the latter, and improve the definition, prioritisation and monitoring of corrective qualitative actions.
4. Simplify the determination of Pillar 2 capital add-ons and make them address specific risks which are not sufficiently covered by Pillar 1 requirements.
5. Shorten and streamline the annual Supervisory Review and Evaluation Process (SREP).

We in the expert group believe that those recommendations would help enhance both the effectiveness and the efficiency of the supervisory framework. In that context, I appreciate the overall endorsement of the recommendations by the ECB Supervisory Board and welcome the progress made so far to progressively implement most of them.²  

Further issues

In general, the industry has openly endorsed the bulk of those recommendations.³  In particular, it seems to support the proposal to better prioritise supervisory reviews on material issues. And it recognises the need to take into account firm-specific business factors and to avoid excessive reliance on capital to address supervisory concerns.

Yet banks are also concerned about matters like excessive discretion by supervisory authorities, insufficient transparency on supervisory criteria and methodologies, and the issuance of overly prescriptive horizontal supervisory guidance that can make supervision take the role that normally belongs to regulation.        

Those concerns are of course legitimate. Thus, discretion by supervisory authorities should be properly bound by coherent methodologies and consistency checks. Moreover, it is important for supervisory actions to be as predictable as possible, and in this transparency is key. Finally, the scope for issuing horizontal guidelines should be duly confined to supervisory issues and, when sufficiently relevant, be subject to an appropriate cost-benefit analysis.

That said, we should recognise that there might be tension across sensible objectives when they are considered individually. For instance, the need to tailor actions to firm-specific situations may require sufficient room for discretion and somewhat constrain the transparency of supervisory criteria. Similarly, higher transparency could require some degree of codification of supervisory criteria that could become closer to actual regulatory requirements.

In general, it is hard to imagine an effective supervisory framework which does not adequately rely on a fair amount of reasonably constrained judgment. Constraints could take the form of the ex ante determination of areas of application, a flexible suite of tests and indicators on which to base actions and a suitable governance process seeking consistency across institutions but without rigidly establishing, whether implicitly or explicitly, binding industry benchmarks. 

In addition, the use of judgment should not lead to excessive variability of supervisory criteria. To the extent possible, banks should have sufficient clarity on what is expected from them in terms of capital, liquidity and management actions over long enough horizons to facilitate planning.

Finally, banks need to have opportunities to discuss and challenge supervisory decisions. The current SREP contains different instances for a supervisory dialogue and includes a "right to be heard" provision. Ultimately banks have access to an Administrative Board of Review (ABOR). Yet the limited activity of the ABOR in a context in which non-negligible litigation exists may suggest that enhancing the ABOR's role could help achieve more efficiency in dispute resolution. 

Some more structural challenges

Before I conclude, let me cover a few more structural challenges for the prudential framework in which supervision plays a key role.

The first is capital determination. The current arrangements to establish banks' loss absorbency requirements are markedly complex in the banking union. That role is shared by regulators (which establish Pillar 1 minimum requirements and some buffers), supervisors (which define Pillar 2 add-ons like Pillar 2 requirements (P2R) and Pillar 2 guidance (P2G)), national and European macroprudential authorities (which establish or top up buffers like the countercyclical capital buffer (CCyB) and G-SIB and D-SIB surcharges) and resolution authorities (which set the minimum requirement for own funds and eligible liabilities (MREL)).

The plurality of actors with direct responsibility over a single policy instrument (capital requirements) makes it highly challenging for that instrument to simultaneously achieve all microprudential, macroprudential and resolution objectives. I hope that the ongoing discussions at the European and the global level on possibly simplifying the so-called capital stack could help address this important challenge. Meanwhile, I believe that within the banking union it is essential to articulate a well-functioning coordination mechanism involving all authorities that have now a bearing on how much capital banks are required or expected to have.

In order to facilitate that coordination, the expert group report suggested establishing a regular collective assessment of how much capital the banking sector would need in order to address the relevant risks and to facilitate the continuation of credit flows to the real economy in adverse but plausible forward-looking scenarios. That should help frame the decisions on capital requirements by both microprudential and macroprudential authorities in a more coherent setup.

A second important challenge is to further upgrade the technological infrastructure of the supervisory function. The ECB is continuously working to refine its information platform (IMAS) and to embrace new machine learning / artificial intelligence technologies to develop suptech applications. That is a very positive development that can support efforts to enhance the supervisory function while mitigating some of the costs faced by firms.

As an example, I believe one of the main challenges for supervisory action as we move forward is to significantly modernise supervisory data collection. The current regime under which banks report data by filling out and sending detailed templates to supervisors and other authorities on a regular or ad hoc basis is vastly inefficient for the firms and the authorities. My view, inspired by what some authorities are already experimenting with, is that we need to put in place technological facilities that would allow the supervisor to have (controlled) access to subsets of banks' granular data and use them to derive the indicators used for different purposes. That would certainly help address the usual claim by banks that they have to bear disproportionate reporting costs without weakening the information set supervisors rely on to assess banks' situation. This is a more ambitious version of the European System of Central Banks' Integrated Reporting Framework (IReF) project, which still envisions a "push" approach to reporting. Having a "pull" approach, in which supervisors have on-demand access to data, can enhance supervisory oversight without the usual burden on banks.   

And, finally, people. The whole claim that better supervision can facilitate more efficient regulation rests on the assumption that supervisory agencies are sufficiently endowed to perform more focused and risk-based supervision. That may imply adjustments in the supervisory culture but also adequate human resources. In particular, the supervisor would need sufficiently qualified supervisory staff able to perform their now more challenging function, leveraging new technologies.    

I'm afraid that without enhanced supervisory capacity a more effective supervisory function that could support more efficient regulation can hardly be achieved. Consequently, without adequate resources to upgrade the supervisory function, it may be challenging to avoid (as a second best) the need for increasingly detailed and comprehensive regulatory requirements to adequately preserve financial stability in a rapidly changing environment. It is therefore a serious matter.

Many thanks.

¹  S Dahlgren, R Himino, F Restoy and C Rogers (2023): Assessment of the European Central Bank's Supervisory Review and Evaluation Process Report by the Expert Group to the Chair of the Supervisory Board of the ECB, April.

²  S Connery, "As simple as possible, but not simpler", The Supervision Blog, ECB, September 2025.

³  See M Portilla, K Rismanchi, G Kobayashi and D Folcher, Improving supervisory effectiveness – addressing concerning trends in bank supervision, Institute for International Finance, September 2025.