Interview with HRT

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Zeljko Kardum on 19 February 2021 and broadcast on 24 February 2021

25 February 2021

As of 1 October 2020 the ECB is in charge of direct supervision of the significant institutions in the Republic of Croatia and the common procedures for all supervised entities, as well as oversight of the less significant institutions. What does this mean? And which banks are less significant institutions?

Yes, the banking union was established attributing, in the euro area, the supervision of banks to the ECB in 2014. It opened up also the possibility for other Member States to join the banking union through so-called close cooperation, which means that also a country not in the euro area, as is the case for Croatia today, can join the banking union and have the supervision of its banks – its significant banks – under the direct responsibility of the European Central Bank. Significant banks are basically those banks which are particularly big in size, for instance more than €30 billion in assets, or which are relevant for the Member State where they are – which are particularly big with respect to the local economy or which have significant cross-border business. So, since October, eight Croatian banks have come under the direct responsibility of the ECB and the other banks, the so-called less significant institutions, they remain under the direct day-to-day supervision of the Croatian National Bank under the global oversight of the European Central Bank.

Why is that? Don’t you trust the supervision of the Croatian National Bank or are you replacing it in supervision?

The concept of the banking union was to bring together under a common umbrella, under common European supervision, all the relevant banks and to get more integrated supervision – to have the best practices and to have common processes to supervise banks across Europe. We are a single market; we are a common monetary area, and the decision was taken as a lesson from the issues which emerged in the last crisis – in the great financial crisis – to get to more integrated, stronger supervision. It’s not an issue of actually taking the supervision from the Croatian National Bank. It’s the Croatian National Bank joining the so-called Single Supervisory Mechanism. So all the European banks come under the same umbrella, and there is a member of the Croatian National Bank, the Deputy Governor Martina Drvar, who is a member of our Supervisory Board and takes responsibility for all the significant institutions across the banking union.

So it’s not a matter of trust or non-trust?

No, absolutely not. The point is that staff of the Croatian National Bank are now deeply involved in day-to-day supervision, not only of the subsidiaries of European banks in Croatia, but also of the parent companies, of the whole group, and of other banks as well across the European Union. That’s a major step towards a greater integration of supervision as a support to a better integration of the banking sector, of course.

So what would be the future role of the Croatian National Bank? It will carry out supervision and then send these findings to you?

Well, it doesn’t work exactly like that. I mean, first of all, as I mentioned, the Deputy Governor of the Croatian National Bank sits on our Supervisory Board, which is the decision-making body of the ECB on supervisory matters. For all banks, not only for Croatian banks, also for Italian, French, German, Belgian banks and the like. Second, the supervision of the significant institutions is conducted through what we call, in jargon, “Joint Supervisory Teams”. We keep together a coordinator here in Frankfurt, a local coordinator, for instance, in Zagreb, and other members of the team in different countries where the bank is present, and these teams jointly supervise day-by-day the banks. So there is a strong participation from the Croatian staff members now also in the supervision of the parent companies of Croatian banks in Italy, in Austria and elsewhere.

So, if I understand correctly, almost all Croatian banks have their parents in the euro area and you are already supervising them. So how will the cooperation between the ECB and the Croatian National Bank be, how can it help the Croatian side of supervision? For instance, can the Croatian National Bank ask the ECB for information about the parent bank if they discover something at the local level?

Well, it is much better than that. They don’t need to ask for this information because they will be part of the supervisory team that gets all the information on the group. So you have the subsidiary of UniCredit, for instance, in Zagreb.

In Croatia, yes.

Exactly, and this means that the members of the Croatian National Bank, as part of the Joint Supervisory Team, will participate in the day-to-day supervision of the UniCredit group, having all the access to all the information concerning the group. So there is a really integrated supervision of the group as a whole in which the members of the Croatian National Bank will participate. So to some extent I could put it like that. They will not be the only authority responsible for the supervision of the entity in Croatia, but they will participate in the supervision of the entity in Croatia and the parent institutions at the European level. So it’s a much broader scope, and I think this would support much more integrated supervision.

The ECB concluded the comprehensive assessment of five Croatian banks in July last year. What was the reason for this assessment? What are the findings, or were they marked as significant?

If a bank is classified as significant and comes under the supervision of the ECB and this is, of course, also the case for all the banks under close cooperation in Croatia and in Bulgaria, which is the other country that joined close cooperation at the same time, in October last year – there is a comprehensive assessment. The comprehensive assessment, basically, is a check of the banks which is performed using the methodologies that we use on all other banks in the banking union. It is composed of two elements. The first one is an asset quality review, so the review of a sample of assets, trying to understand the quality of these assets and see whether, from a prudential point of view, they’ve been classified correctly; and the stress test, so trying to have a scenario and trying to see how the banks would perform under an adverse scenario as well. The main outcome of this exercise is to check whether these banks would have a potential capital shortfall, and if there is a capital shortfall identified, then the banks need to fill this hole before joining the banking union.

That’s the overall concept which has been applied to all the banks since the start of the banking union. The Croatian banks are well capitalised, so there wasn’t any capital shortfall identified and so no remedial measures in terms of capital need to be taken as a result of this exercise.

According to this AQR (asset quality review) test, you find what the weaknesses of the system are. What segments should increase in quality and safety measures or procedures?

As I mentioned, the comprehensive assessment is not really meant to identify all the possible weaknesses in the end, but to check the balance sheet and make an assessment of whether the capital is sufficient, whether there is sufficient loss absorbing capacity at the bank. And then we start the ordinary supervision, which of course will focus – is already focusing right now – on all the other aspects: the sustainability of the business model, the governance of the bank, and different types of risks that can affect them. So of course, in these types of exercises there will always be, throughout time, weaknesses that we will ask the banks to remedy, and for this year, 2021, it will be the first year that Croatian banks will go through what we call the “supervisory review and evaluation process”, so an ordinary check of the health of the banks that will end up with some recommendations of points to be improved.

But did you find, comparing to the other banks, that there are some weaknesses in the system, particularly in Croatia, that can be improved, or in what segment of the system? What should be improved? Where should they invest more?

Croatian banks are very well capitalised, more capitalised than banks in other countries, on average. I think Croatia is the third most capitalised banking sector across the banking union at the moment, so it has a very strong capital position, and that’s a plus. Profitability of the Croatian banks is also better than average, maybe not as good as we would like it to be, but better than average. There is, however, a general issue for euro area banks which is their profitability, cost efficiency, digital transformation and the like, which is something which is very key for Croatian banks, as for other banks across the euro area, and we are monitoring this quite carefully. I had a conversation with Croatian banks on Wednesday this week and this topic featured prominently in the discussion.

Then there is the issue of asset quality, of course. Asset quality is probably the area where Croatian banks, notwithstanding the major progress that has been made in the last years after the crisis, that’s the area in which maybe the levels are not yet where we would like them to be. The average NPL ratio is approximately double the euro area average, although, as I said, there has been significant progress there. But of course, attention to asset quality, especially now with the COVID-19 crisis, will be a greater area of attention for us as supervisors.

Governance is another area in which not only Croatian banks, but in general European banks, have significant shortcomings, and we have put a lot of pressure to strengthen the governance of banks, because that’s the key ingredient for their resilience.

So when will you perform the next AQR, what will be the main emphasis of it?

AQRs are not regular exercises. We do them when we take responsibility for banks and in specific cases. For the rest we go for regular on-site inspections, which can cover certain parts of the portfolios or certain aspects. What we do regularly is a stress test, the other component of the comprehensive assessment. And there is a stress test of the European banking sector, which is coordinated by the European Banking Authority, which has just started and which will cover also Croatian banks. We will, of course, follow the Croatian banks in this exercise, and the results will be ready around July. That will be an opportunity for us also to see how resilient the banks are in the face of the pandemic challenges.

So what you would like to say is that you are monitoring us and that you will monitor the impact of the COVID-19 crisis?

We are definitely monitoring the impact of the COVID-19 crisis. In 2020 our supervisory review process was entirely focused on the ability of the banks to manage the risks that were created by the pandemic, and we are very focused on continuous monitoring. In particular, we defined the priorities for 2021 as focused on credit risk, which is the main challenge. We have a lot of government support measures, moratoria, which are not enabling banks and supervisors to see exactly how the credit quality of customers is developing, so that will be a first important area of attention. So provisioning policies, classification of loans, and the other one is the sustainability of business models – the low profitability, low cost efficiency, investment in digitalisation, and ability to control costs and the like.

Can you tell us what are the main challenges for Croatian banks that can be attributed to the, let’s say, local specificities?

Well, as I said, the challenges for Croatian banks are not very dissimilar to the ones every other bank in the banking union is now facing, so the pandemic and, if you want, the structural transformation which is necessary for the banking sector. As I mentioned before, I would say that asset quality is the issue which requires particular attention. We developed policies to deal fast with non-performing loans, which were to some extent aligned with what the Croatian National Bank had already applied in Croatia. So actually, there was a very close alignment of these policies, so I don’t expect major changes for Croatian banks. But it’s an area of tension, which is also due to the maybe relatively slow process in judiciary proceedings: that when a customer gets into default, the difficulty in repossessing collateral and the like, which is typical, not only in Croatia, but also in other countries like my own country, Italy, or Portugal, or Greece, in which the proceedings are quite slow, and then lead to a build-up of asset quality problems at banks.

Well, the markets are valuing EU banks much lower than the US banks, so bank stocks are cheaper than ever, at least on paper, with the industry’s estimated price-to-book ratio at its lowest on record. Actually, they are cheaper than during the global financial crisis. What is the reason behind that? How much is the downside already priced in those stocks?

I think that we need to differentiate. I think that when the great financial crisis started, the low valuation of European banks was driven by a perceived opaqueness of their balance sheets, so there wasn’t any clear understanding of the quality of their assets. This depended also on the fact that we didn’t have common European metrics on what is a non-performing loan and the like. So we made a lot of progress in that respect. We have common definitions of asset quality, common legislation, and we have now also common supervision. I think this issue of the quality of assets and opaqueness of bank balance sheets is not there anymore. What is now explaining the low levels of European banks’ market valuations is more, in my view, the lack of profitability. The current prices reflect the expected profits in the coming months and years, and these are expected to be low, much lower than their US peers. This depends, as I mentioned, on the high levels of cost. Maybe European banks have not invested enough in new digital technologies; maybe there is excess capacity in the sector – not enough banks have exited the sector after the last crisis, which means that there is room maybe for more consolidation. So it’s more structural inefficiency that needs to be dealt with. But if I may add a positive message here, I think that the pandemic to some extent provided a catalyst for banks to bite the bullet and tackle all these issues, and I think that now they are addressing these issues in a more decisive way.

So there is a paradox. European banks, or bank stocks, are the cheapest on record, but still can't find any buyers. How can this affect the future capital adequacy, which is what you are supervising?

Of course, we are not happy when banks are not profitable, not because we want to support the wealth of shareholders, but because if the valuations of banks are low it will be more difficult for a bank in case of a shock to raise fresh capital in the market. After all, profits are the first line of defence. The more profitable the bank is, the more it can take losses and provisions in case of a shock. So having better profitability, better stock valuations is also an objective for supervisors, and that’s why we’re putting a lot of pressure on European banks to address these structural inefficiencies that I mentioned before.

And to be more attractive for the market, is that right?

Also. That’s not the direct objective, but indeed, if European banks are good, attractive investment propositions, that’s good also from a supervisory perspective.

Do you agree that the accumulation of NPLs during the pandemic is much lower than initially expected? What was the contribution of the various fiscal measures, moratoria, labour policies to this? For example, unemployment figures haven’t been that bad.

You are spot on here. It’s true that we have not seen the impact of the pandemic crisis materialising in bank balance sheets yet. Actually in 2020, the NPL ratio has continued decreasing, but we expect that this will not last. There will be a moment in which, of course, the harshest recession on record in this time will materialise also in terms of default of banks’ counterparts and deterioration of asset quality. At the moment, of course, the massive and unprecedented support measures which have been deployed by governments, and also the support by the ECB, by the central banks in general, has maintained the economy in a pretty solid status, but when these measures will start being withdrawn, of course, we will see the asset quality problems materialise. So we are pushing banks to start looking through these measures, assessing the real quality of their counterparts, to provision appropriately and be fast in dealing with distressed customers.

So you still see the danger of these NPLs after this coronavirus crisis?

Indeed. I’m sure they will grow. It’s very difficult to quantify precisely how much they will grow, because there is still a lot of uncertainty with reference to the exit from the pandemic, and there is much uncertainty as to the withdrawal of the public support measures, but it’s a fact that there are sectors which will be heavily affected by the pandemic, and that probably will not come back as strong as they were before the crisis, so the materialisation of these issues on the bank balance sheets will happen.

So a hard rain is going to fall. So you’re supervising banks, but not fintech companies. How important is the health of fintechs for the whole system, because fintech now takes up to 33% of revenue share in financial services? Is this a fair game, given that fintech companies are less regulated than banks?

There are certain segments of activity in which the increasing competition from non-bank providers of services has been a deliberate choice of lawmakers at the European level. That is, for instance, the case for payment services. There was a perception that there could have been more innovative, better services to customers by opening up competition to third-party providers, to non-bank providers of payment services, and this is an area in which, indeed, fintech companies are being quite active, and to some extent this has also improved the quality of services for citizens, so that’s a positive I would say. If a fintech company was to offer bank services, or to offer deposit services, lending and the like, well, then they need to take a bank licence, and they need to be supervised as banks. There have been a number of fintech companies which have developed into banks, they’ve asked for a bank licence, and then there is a full level playing field, and they are supervised exactly as any other bank.

The fintech companies usually do not want to be supervised, they just want to take part of the margin or a profit.

It is true that this is an important development that we need to keep under close check. It’s true that now there are different types of companies which start picking different components of the value chain of banks. Some are offering payments, then you have the crowdfunding platforms, which are offering only loans, and then you have new platforms which are channelling deposits from banks to other players. So it’s true that this is eroding a little bit the profit margins for banks. But what is important is that when you take the full monty, let’s say, of the banking services and you raise the risks which are connected with that by offering jointly deposit-taking, payments and lending, well, then you need to be supervised as a bank, and that is the law. But we need to keep track of the developments in these other areas, especially in the field of consumer protection. We look at virtual currencies, virtual currency exchanges. There have been a number of cases in which retail customers have lost a lot of money, so the consumer protection issues for these types of providers need to be taken care of closely.

Croatia and Bulgaria are newcomers to the banking union. How would you rate the first six months of their membership?

Very positively. I would say that, from the supervisory point of view, the first months have been mainly onboarding, as we call it. So for our supervisors, getting to know the Croatian banks better, and the colleagues at the Croatian National Bank have helped us out with that. And for the team at the Croatian National Bank to learn our methodologies, our approaches, and there have been a lot of seminars, workshops and joint work. I feel a lot of excitement and a lot of engagement from both sides, so I want to give very positive feedback for this start.

Maybe to just clarify for our audience, you are not in charge of controlling anti-money laundering, but the duty of the ECB is to cooperate with anti-money laundering authorities, because it can result in insufficient governance and internal control mechanisms, the supervision of which is a task of the ECB. But where do the competencies of the ECB end and those of other authorities begin? Where can we draw the line?

It’s a very important question, thank you. Indeed, you are right; the Treaty explicitly says that the ECB cannot take up responsibilities for anti-money laundering supervision. So we are not the anti-money laundering supervisor. But if a bank is subject to penetration from criminal money, money laundering, it means that the internal controls, the governance of the banks, are not working well. These aspects are very relevant for us, of course. Also, because we have seen banks which have been subject to money laundering scandals, which have defaulted in a matter of days, so eventually, there is also a stability aspect which eventually falls under our responsibility. So what we do is when we do our own examinations, when we do our own on-site inspections, if we identify some issues which could be a signal that there could be a money laundering suspect, we immediately pass this information to the competent national authority responsible for anti-money laundering controls, and we expect the same, actually, the other way around. So if the anti-money laundering authorities identify some issues which could signal problems in governance, internal controls, they should channel this information to us. But let me say that we are in a single market; money laundering, by construction, happens across borders. If you want to clean your money you move it around countries, and I think it’s about time to move to more European approaches also in the supervision of money laundering.

So you are taking care of the procedures, and the anti-money laundering authorities, they are just investigating a particular case or money flow?

Exactly. They look at transactions, they look at who are the originators and the beneficiaries of the money. When there are transactions which are suspicious, they do further investigations. These are not things that we can do. But the overlapping in the area for cooperation is when there are internal controls, governance, these issues need to be robust both for prudential purposes and for anti-money laundering purposes. So that’s the area where we cooperate the most.

But the cooperation is still going on, and we can expect that this cooperation will now bring you closer on the EU level?

Well, we have a Memorandum of Understanding for cooperation and exchange of information with all the national authorities in the banking union, and this has led already since 2019 to numerous exchanges of information in both directions. We exchange also our regular assessments of the banks in terms of internal controls and the like. This cooperation is already ongoing and very effective, but indeed it would be much better also for us to have a counterpart at the European level that deals with anti-money laundering, and this would increase the effectiveness of the controls and the effectiveness of cooperation also between anti-money laundering and prudential tasks.

Can you tell us at the end of this conversation what are the future tasks or the new future tasks for the ECB, and is there any news that you would like to share with the Croatian people that are watching this interview?

We already have enough tasks. Our job is already difficult enough. We’re not seeking additional tasks, I can tell you, but indeed, our focus at the moment is very much on the fallout of the pandemic on the European economy and therefore on the European banking sector, and this will keep us busy for some time I think.