The never-ending story of non-performing loans (NPLs) in the eurozone has now developed into a legal discussion. The ECB started out with „guidance to banks on NPLs“ in March last year and a subsequent „addendum“ presented in October. That NPL guidance has been criticised by the European Parliament and the EU Council for being a means of unlawful policymaking by the ECB. I counter that view and argue that the ECB is acting on a sound legal basis.

---

Quick read

The ECB guidance on NPLs does not infringe the European Parliament’s prerogatives as lawmaker.

1. Whether ECB’s NPL guidance is legal is, at the end of the day, a question of democracy. For this, one has to look not only at its “legal effects” as the EP Legal Service implies, but also on its content and legal basis as well as the number of addressees concerned.
2. The NPL guidance is not legally binding itself but draws on banks’ expectation that the ECB as supervisor will act in accordance with it.
3. The central effect of guidance instruments is that they allow the ECB to pre-exercise discretion granted by the underlying provisions in the substantive law. Supervisory officers in charge therefore do not need to comprehensively exercise their discretion on a case-by-case basis.
4. The informal pre-exercise of discretion, however, has no direct legal effects vis-à-vis supervised banks. It lies within the legal competencies granted to the ECB under Art. 4 (3) SSM Regulation.
5. The fact that the guidance is of “general applicability” in the sense that it concerns a number of addressees in practice does not render it an unlawful means of policymaking, but a regular instrument of rulemaking in banking supervision.

---

Enter the European Parliament (EP), headed by Antonio Tajani. Based on the legal opinion by its legal service, the Parliament challenges the ECB’s mandate to issue said NPL guidance, consisting of a guidance document and an addendum, the underlying motive here supposedly being that it fears an intrusion of the Parliament’s lawmaking powers.

As reported in the FT:

Antonio Tajani told the Financial Times that the European Central Bank was going beyond its competence and trying to make “soft law”.

“Can the police make a law? No. The police needs to verify that the law is applied. The legislative power is in the hands of the parliament”

The European Commission (COM) sided with the Parliament as well (the European Council (EC) also concurred a few weeks later). Reuters reports:

“Binding measures and requirements can only be applied by the supervisor on a case-by-case basis depending on the individual circumstances of the bank,” the commission said.

Thus the EP and COM line of reasoning basically is as follows: laws are made by the legislature and the ECB’s NPL guidance constitutes a law. Therefore it must be illegal.

I will make the argument that the ECB is acting on a sound legal basis and that it lies in the ECB’s remit as lead supervisor of the Eurozone to issue the NPL guidance at hand.

I. Soft law and hard law

To begin with, Tajani’s assertion that the ECB is not allowed to produce „soft law“ has no basis. Lawyers have very diverging concepts of what constitutes „soft law“. It is, however, agreed upon that, unlike „hard law“, it is not formally binding for its addressees in the sense that it would be readily enforceable in courts. Therefore, every organisation and especially one rooted in the European treaties like the ECB, can in general issue “soft law”.

Specifcally, under Art. 4 (3) and Art. 6 (5) lit. a) SSM-Regulation the ECB is handed the legal tools of regulations – certainly hard law by any definition –, guidelines, recommendations and (general) instructions. It follows from this that, contrary to what the EP Legal Service claims on the surface, it is not solely “legal effects” that determine the legality of ECB’s NPL guidance.

II. Distinguishing (legal) rulemaking from (illegal) policymaking: a question of democracy

 As a starting point, the crucial point for a legal analysis is to distinguish – illegal –policymaking from what I will call – legal –rulemaking.

In the EU democracy, the European Council and Council as main actors, as well as COM and EP make the political decisions (policymaking). This is because they are the ones (somewhat) accountable to the democratic public. Supervisory agencies have to apply these.

Since every case is different, these agencies need to be given discretion in order to exercise their supervisory function. What’s more, regulatory agencies can communicate their intention as to when and how they will exert said discretion. To this extent, they issue guidance to the supervised subjects, who can then plan ahead for the individual supervisory measures to come. In this sense, supervisors have the authority to set ex ante rules (rulemaking). Functionally, these lie between the decision-making spheres of laws and and individual case-by-case application.

This certainly goes for the ECB as well, which can explicitly make use of the legal instruments of regulations, guidelines, recommendations and (general) instructions under the SSM-Regulation in order to pre-exercise its discretion. Having said this, the issue at hand is not whether the ECB is allowed to issue guidance concerning NPLs, but how far it is allowed to go in pre-exercising its discretion:

Now does said NPL guidance constitute mere rulemaking or is it already policymaking?

Remember that, in essence, the distinction between policymaking and rulemaking and the according horizontal delimitation of competences between European institutions is a question of democratic legitimacy. As a starting point we should look at the (political) consequences for the concerned regulatory matter.

The problem of NPLs of course is highly salient in political debates. Finding a solution for the problems posed by NPLs is regarded as a pre-condition for any efforts of European risk-sharing, e.g. for a common deposit insurance scheme. The ECB as lead supervisor of the eurozone is in a crucial position to move forward on this front. But the mere fact that an administrative agency is taking measures that touch politically sensitive issues obviously doesn’t confer on it the nature of policymaking, for which the ECB would not be the competent European institution.

From a legal perspective, we can approach this question by looking at three separate dimensions:

• the legal effects (III.),
• the content and legal basis (IV.) of the guidance at hand
• as well as the number of addressees concerned (V.).

As will be shown, the EP Legal Service, in its Legal Opinion, lumps all of these together under the label of “legal effects”. Why “legal effects” should be the solely relevant criterion for delimitating ECBs competences remains, however, unclear – especially given that the ECB certainly has the right to issue (legally binding) regulations under the SSM-Regulation.

III. Legal effects

Legal effects of the guidance are important when considering the political impact. Something that is not legally binding can generally be assumed to be of less relevance to the participants. The ECB itself does not consider the NPL guidance to be legally binding in the sense that courts would be unconditionally bound by it. As a result, the guidance is not supposed to be readily enforceable on their own. Instead, it only expects financial institutions to either comply or explain why they intend to diverge from the guidance. To put it simply, institutions are not legally bound to comply with the ECB guidance as they are by CRR.

Nevertheless, the EP Legal Service argues at length that the NPL guidance does indeed have legal effects (No 30 ff.). We are, however, not given a proper definition of what constitutes “legal effects”. Chief among the EP Legal Service’s arguments is the “direct link between the non-compliance by banks […] and the outcome of the SREP” (No 45 ff.).

However, for the purpose of discerning “legal effects” by any conceivable definition, this misses the point. The comply-or-explain expectation is not the legal mechanism by which the guidance’s – certainly substantial – effects will be delivered. Rather, the ECB draws on its direct supervisory competences vis-à-vis significant institutions. According to the ECB, the NPL-guidance only concerns institutions directly supervised by herself within the SSM. Its effects therefore are based solely on market participants’ (realistic) assumption that the ECB is going to apply their supervisory competences as proposed in the guidance. Put simply, instead of being legally bound by the guidance, they are motivated by the threat or mere prospect the ECB will actually go forward. At the end of the day that is a mere factual effect. Strangely, the EP also sees this point:

“It is admittedly true that, from a purely formal point of view, there is no automaticity between non-compliance […] and the application of supervisory measures” (No 48).

IV. Content and legal basis

The spotlight then turns to the question of whether the guideline has an appropriate legal basis in the substantive law. As a supervisor and according to several rules in CRD IV, the ECB is provided with discretion as regards impacting banks’ internal risk management. Here, the ECB points to competences in Art. 74, 79 (b) and (c), 88 and 104 of the CRD IV. In this respect, nobody seems to doubt that the ECB is allowed to use these provisions to demand for changes in the banks’ NPL portfolio on an individual basis. What is, however, questioned by the EP – also under the umbrella of legal effects – is her ability to adress all of her directly supervised banks under these competences (see V.).

“none of the provisions […] lays down quantitative requirements generally applicable to banks” (No 41)

Notwithstanding the EP’s rather strong arguments against the validity of Art. 74, 79 (b) and 88 CRD IV (No 52 ff.) as a legal basis, at least Art. 104 (1) CRD IV should equip the ECB with a sound legal basis for the NPL guidance. Again, the EP legal service disagrees (No 41). Powers stemming from Art. 104 (1) CRD IV are supposed to be of a “bank specific nature” (No 55). This, again, touches upon the issue of the number of addressees concerned by the guidance (V.).

Taking the practical consequences as a benchmark for policymaking, the guidance could also constitute policymaking, if it touches upon the “fundamental guidelines of Community policy“ (C-240/90 Germany/COM). However significant one might consider the reduction of NPL stock in bank balance sheets to be for the completion of the banking union, this threshold is arguably far from being met in the case at hand. In any case, the EP Legal Service does put forward this argument.

IV. Number of addressees: the functional difference between pre- and ad-hoc exercise of discretion

The all-decisive criteria in distinguishing policy– from mere rulemaking in the case at hand thus lies in the number of addressees the guidance is looking at.

The mere fact that the guidance is applicable to all banks does not speak for a political dimension. Naturally, every rulemaking-instrument is applicable to all cases in its respective purview.

We therefore have to be conceptually clear on what the precise difference between the pre-exercise of discretion via guidance on the one hand and the ad-hoc exercise of discretion on the other hand is – and whether this gives the NPL guidance something of a „political“ nature. It is exactly what Richard Thaler and Cass Sunstein refer to as „choice architecture“. Pre-exercising guidance “frames” or „nudges“ the supervisory decision ultimately made by the bureaucrats in charge vis-à-vis banks in individual cases (that is, within the ECB Joint Supervisory Teams).

Instead of comprehensively exercising the discretion granted in the Single Rulebook, the supervisory personnel’s discretion is directed and influenced by the the NPL-guidance.

One might make the point that this narrows down the discretion of superivsory officers in individual cases as to what supervisory measures to take. At the same time, the remaining options are clearly provided for in the legal basis. At the end of the day the guidance does not create any new options and should therefore not be considered policymaking.  

First, it is hard to see how the reduction of options originally envisioned by the legislator should be of a political nature.

Second, the guidance reduces bureaucrats’ options only in an informal fashion: Neither the ECB nor its respective Joint Supervisory Teams are legally bound to follow through with what the guidance proposes. To be sure, the guidance might bind the ECB itself by way of the principle of equal treatment. However, this “self-commitment” only works to the institutions’ benefit: they have to challenge an ECB act on this ground – something they will only do if this works to their advantage. By the same token, institutions are not bound by it.

VI. Conclusion

I am having great doubts that the ECB’s guidance on NPLs constitutes illegal policymaking as the European Parliament Legal Service claims. The mere fact that the guidance addresses all banks does not give it a political dimension. Nor does the fact that the supervisory personnel’s room for discretion is (informally) reduced.

On the contrary, the guidance can soundly be based on the ECB’s existing rulemaking competences. This does not imply, however, that EP, Council and COM are prevented from issuing their own, higher-ranking, rules on the treatment of NPLs, and, thereby “overrule” the ECB guidance. All that is necessary is to issue more precise rules by way of amending the substantive law. As concerns the COM, she is indeed set to table a proposal in the coming weeks.

Lukas Koehler graduated from Oxford University (MJur) and is a PhD candidate at Bucerius Law School, Hamburg, and LMU Munich.