Interview with Nihon Keizai Shimbun (Nikkei)

Interview with Danièle Nouy, Chair of the Supervisory Board of the Single Supervisory Mechanism,
8 October 2015

There are several issues with the zero risk weighting of government bonds. Should new rules be introduced and should the current system be reconsidered? What is your opinion?

I think it is very simple. We learnt from the crisis that there is no such thing as zero credit risk for assets – so we have to address this issue regarding sovereigns. We have to have capital requirements based on risk weights for sovereign exposures. And it has to be done ideally through international regulation. But if it is not going fast enough at the international level it would probably make sense for Europe to review it by itself.

For me, it is not only an issue of capital requirements for the sovereigns, because most of the sovereigns are good-quality assets. So, even if one imposes risk weights on sovereign exposures, this will not result in big capital requirements for sovereigns. It is also a matter of large exposure risk. So, large exposure limits should be applied. There is a European rule regarding large exposures which says that no single borrower can account for more than 25% of a bank’s net own funds. So let us apply this rule to sovereign bonds too. In fact, there is no reason to apply a different one. Obviously, it is more challenging and hence will take a bit more time than abolishing the zero risk weighting; so there should be a phasing-out period. All in all, this is one of the lessons from the crisis.

How about interest rate risk?

I must say I am less concerned by this element because the banks have the possibility to hedge their interest rate risks. But sometimes they got into problems because of their hedges. So, indeed, this is not an issue to be dismissed and we are supervising it.

Won’t it be very difficult to enforce this 25% exposure limit?

Of course, there is a tradition for banks to carry almost exclusively the sovereign exposures of their own country: for French banks to carry French sovereign exposure, for German banks to carry German sovereign exposure and for Italian banks to carry Italian sovereign exposure. Now that we have a single currency and a banking union it would make sense to have a diversification of risk also in terms of sovereign exposures. But it cannot happen immediately. It has to be gradual. In my view this is probably the moment to start moving.

The new Basel framework, also known as Basel III, will be fully implemented by 2019. Should this also be the time to enforce the large exposure rule or should that be done later?

It is always good to make all the needed changes at the same time, to then have the benefit of a stable environment. I am pretty sure that once there is a Basel framework for sovereign exposures, it will be fully transposed at the European level too.

Back to the interest rate risk: in Basel they want to discuss by 2016 some kind of consensus regarding the introduction of capital charges to cover interest rate fluctuations. What would you suggest?

I am not saying that I am unwilling to address the interest rate risk. I am saying that compared to sovereign exposures, interest rate risks are somewhat less of a concern. If I had to prioritise, then I would say that credit risk and large exposure limits are a larger concern for me. But yes, indeed, even at the danger of repeating myself: interest rate risk cannot be dismissed. Therefore we are supporting the framework to establish a capital regime for interest rate risk which is currently being developed by the Basel committee.

Should other countries also review the zero risk weighting of government bonds?

Well, every country should be aware and recognise that this is a risk. In Europe, we learnt the painful way from the euro area crisis that there was no such thing as risk-free assets. But it might as well be useful for other countries to learn from our example. It is much better to have risk weights for sovereign debt in all countries.

Aren’t you afraid that abolishing the zero risk weighting of government bonds may lead to a credit crunch or other negative results?

I would say to the contrary. It might be a temptation during a crisis to buy more and more sovereign risk because you trust your own sovereign the most. However, this may be exactly the time when corporations and individuals need your credit the most. So I don’t think it will be disadvantageous in this respect because the important task of the bank is to fund economies more so than to fund their own sovereign.

We also learnt from the crisis that there was not enough capital in the banks. So we have to draw lessons from this situation. Personally I am totally convinced that only well-capitalised banks are able to fund the real economy throughout the cycle.

So you are well prepared for the next debt crisis if you have better capitalised banks in Europe?

We are better equipped now with the new banking regulation because banks are forced to hold more better-quality capital. Also we have more resolution tools – that is something quite new. The Single Resolution Mechanism will fully take up its work in January 2016. So it is much more comfortable and efficient for supervisors knowing that the resolution tools are in place.

Another question regarding the new rules for government bonds. Maybe you have two problems: one is the dependence on rating agencies and the second one is the fact that central banks would be accumulating risk as they buy government bonds during times of quantitative easing. What do you think about these two issues?

The second part is very easy for me to answer. We conduct supervision on the principle of total separation from monetary policy. Therefore I cannot comment on monetary policy.

The rating agencies are a more complicated question. Nevertheless, there are other possible solutions. I remember that when I was working on Basel II we were suggesting the use of ratings provided by external trade agencies from different OECD countries. They produce ratings of countries themselves and could well be part of an overall solution. It would be a possibility to work with them. And one thing is certain: we should not rely too much on rating agencies. This is another lesson of the crisis.

How can you coordinate the task of supervision at the international level as the global economy is becoming more interlinked and the influences from regions outside Europe are growing?

That is true; the world has become a village. This has a lot of advantages, but also some drawbacks, which we have to deal with. For banks to be active in other parts of the world is a source of risk diversification, which is always a good thing. However, as supervisors we have to be able to address that.

How do you describe the current banking system in Europe? Could you share some thoughts about the next stress test?

Regarding the European banking system we have different situations in the different countries. As a whole, the European banking system is doing much better since we conducted the comprehensive assessment in the course of 2014. This is partly thanks to the recovery of the global and European economy. The improvement is slow, too slow for our taste, but nevertheless the economic situation is improving.

The 2014 comprehensive assessment, a type of health check of Europe’s largest 130 banks, has been quite important for us, because it demonstrated that we are able to analyse the banks in depth. We are currently conducting a comprehensive assessment for the Greek banks and we will conduct a stress test together with the European Banking Authority in 2016.

Which aspect do you regard as being critical in Europe’s banking system?

The biggest problem is the economy. The return to growth is lacking in speed. The Greek situation is a good example. Greek banks did relatively well during the 2014 comprehensive assessment, having been restructured and recapitalised earlier on. Nevertheless they have faced problems recently because of the political situation in their country. The Greek banks were weakened by that political situation, despite the restructuring and recapitalisation following the earlier comprehensive assessment. Certainly, the Greek banks have been weakened, for example, by rising non-performing exposures. The problems of the Greek banks came from the outside. Now we hope that Greece can return to the path of growth. Greece needs stability and a growing economy now.

What is your opinion on further European integration?

Personally I think we need more Europe not less; the faster the better. The move towards banking union in the middle of the crisis was a good one, especially for supervision. The common deposit guarantee will happen as well, I am sure about that.

What is the best banking system in Europe in your opinion? The universal banking model (banks that combine retail, wholesale and investment banking services) or the separation of commercial and investment banking?

There is no single good response. I don’t think there is such a thing as “the best banking system”. You have to take the environment into account. In Europe about three quarters of funding in the economy is done by the banks, while the other quarter is funded by the market. In the US the numbers are exactly the opposite. So obviously the response to the question would be different for every country. In Europe we need universal banks; I don’t think we can do without them.