Interview with Hospodárske noviny

Interview with Danièle Nouy, Chair of the Supervisory Board of the European Central Bank (ECB), conducted by Jozef Ryník, 11 March 2016

Since the beginning of this year the health of European banks has become a hot topic. Are lending houses resilient enough to occasional market turmoil?

Yes, because we have a different European banking system now, compared with the one we had before the crisis and the one we had in 2012. There is much more capital in the banks and it is better-quality capital. We are also better equipped with the new regulatory framework. First of all, banking union is a big improvement: to have European supervision without national bias is very helpful. We are also better equipped to address difficult situations thanks to the Single Resolution Board (SRB) becoming operational at the beginning of this year. So we are in much better shape.

You have just mentioned that banks have better-quality capital. Can you elaborate on this quality?

First of all, common tangible equity is the best quality. We have also improved the common methodology for the supervisory review and evaluation process (SREP) for pillar 2 capital requirements. We are now able to ask for more capital in a consistent and fair fashion from all supervised banks in the euro area.

So are European banks now more resilient to a possible debt crisis?

Regarding credit risk, there are still some legacy assets. In some countries, there are high levels of non-performing loans (NPLs). But at the very least, these NPLs have been identified using a common definition provided by the European Banking Authority (EBA) and are reasonably well covered by provisions. It is not an easy issue and it takes time to address it properly. You need adequate legal frameworks, the option to repossess collateral – which has not always been possible in some countries – and judges to take decisions when they are needed. We have put in place a high-level group, which is reviewing this issue. It is chaired by one of the Deputy Governors of the Central Bank of Ireland, because Ireland has done a good job in working with the banks to address NPL levels.

In countries such as Italy, banks are still burdened with high volumes of bad loans. Where do you see the solution to this problem?

With this kind of problem, you need to use all the solutions, all the tools that you have. Some bad loans can be solved within the balance sheets of the banks; others can be solved by selling the NPLs to asset managers. Or in the framework that Italy has just put in place, a state guarantee of the good parts of these loans is available under certain conditions. It is not considered state aid.

You once stated that monetary policy measures are like medicine and that they may have side effects such that the patient cannot take it forever. How long can banks survive the era of low interest rates without damaging their profits?

I think there is some merit in that statement in that it obliges all banks to reassess their business models to make sure they are sustainable. In this respect, banks still have margins for improvement. For example, the cost-to-income ratio of some banks is still pretty high. This does not explain everything, but it is a good indicator. For example, if banks were to make progress in internet banking, their cost-to-income ratios would be lower. Banks still have room for improving their profitability. In certain countries, there may be too many banks, so there is room for some consolidation. Banks could also rely more on fees instead of interest income to improve their profitability. Each bank needs to assess the sustainability of its business model to make sure it can stay well capitalised.

Bankers tend to say that they could be more efficient, but their competitors, such as fintech companies and peer-to-peer lenders, are not regulated or supervised at all, thus making it hard to compete with them. What do you think of these arguments?

Yes, there are indeed competitors like shadow banks and fintech companies, but banks could successfully compete with them, for example by improving their internet banking offerings. Many people today carry out their banking operations using their phones or tablets. So banks have to be better at responding to this. Obviously, the non-bank companies that are offering banking services should be supervised, but not by bank supervisors because, by their very nature, they are not banks. The European Commission is trying to hold a review on shadow banking and we very much support this. That said, I believe that there will always be a need for good banking services, just as there will always be customers willing to pay for them. For example, for corporates, it would be good to have better access to markets. This is why efforts are being made to have a “market union”, just as there is a banking union. But it will not happen overnight. Europe is different from the United States. Banking intermediation for corporates will remain important for quite some time – as will banking services. I do not believe that non-bank companies will be significant providers of these services. Moreover, those non-bank companies often deliver their banking services through supervised banks.

You mentioned some differences between the US and European banking sector. What else is different?

As a matter of fact, there is no single European banking system; banks differ from country to country. There is a lot of diversity here in Europe, which is a good thing. Market intermediation for funding corporates is more important in the United States. Companies receive around 70% of funding through the market and just 30% via banks. In Europe, it is the other way around, which makes a big difference. Also, following the crisis, the implementation of new regulation was faster in the United States, because there was less phasing-in of new regulations. There are pros and cons. A long phase-in period makes implementation easier for the banks and the economy. But it also means that it takes more time to reach a steady state and emerge from the crisis.

You recently said that the financial sector has ventured into riskier territory in its search for yield. What kind of territory did you mean?

Like a number of our colleagues in other supervisory authorities, we have carried out a study about leverage finance and found that some major banks have increased their proportion of leverage funding. So far this has been done reasonably. But it requires monitoring to ensure that banks stay in such a reasonable situation. We will publish some recommendations for banks on how to manage leverage finance.

Can you give some examples of dangerous leverage finance?

One example concerns big market operations that fund large projects by using more debt than in the past. It could for instance be in real estate, but is not limited to this. This is something we follow closely. We do not want to have an excessive concentration of risk in commercial real estate or riskier mortgages. One of our priorities is to focus on risk concentration in these fields. A number of our colleagues in national supervisory authorities, including the Central Bank of Slovakia, have already taken macroprudential measures to make sure that risk is kept under control. For example, recommendations on the maturity of mortgages, or loan-to-value and loan-to-income ratios for mortgages. We do not want to see additional NPLs.

The Single Resolution Mechanism became fully operational this year. What can banks expect from you as the watchdog this year?

The first thing to be said is that we work closely together with the SRB. We exchange a lot of information. The main focus for this year is to finalise the recovery and resolution plans for the banks. Another important task for the SRB is to define the Minimum Requirements of Own Funds and Eligible Liabilities (MREL) for all banks.

Will the 2016 stress test be any different from last year’s?

The scenarios are of course different from last year’s stress test. It will not be a stress test with fail or pass levels but, as all the information will be published, it will be up to the market to decide for all banks what percentage of common tangible equity can be considered sufficient under the adverse scenario. Also, there is no asset quality review this time before the stress tests. The results will be published in the third quarter.

Why were Greek banks not included in the upcoming stress tests? Do you consider them healthy enough?

The Greek banks have not only already gone through stress tests, they also underwent a fully fledged asset quality review last year; so it makes no sense to test them again. We think that the work has been done, and done well. In fact, they also went through a tougher real-life stress test than what they would have been tested for by supervisors. Moreover, they went through recapitalisation in December, so they are sound and solid now.

Many bankers, especially from major banks with branches in several EU countries, complain that bank regulations have not yet been harmonised. What can they expect from the banking union this year?

We do, of course, believe that there is a need for more harmonised regulation. In fact, in order to have more harmonisation, we also need to have more regulations and fewer directives. For example, on recovery and resolution, investors are not always able to distinguish whether what is happening is the result of national laws or European rules. It would be better if we could say that the same rule applied to everyone. But even under regulations, there can be national options. I hope there will be ever fewer national options because, in order to ensure a level playing field and consistency, we definitely need harmonised regulations. That said, bankers are not being fair when they complain about differences in harmonisation, as most of the time the differences exist because they asked for special treatment.

Banking union was also created to help ailing banks overcome problems. But can the union work without fiscal union and without common deposit protection?

I have absolutely no doubt that it can work without fiscal union, as it is already doing so. We can also work without the third pillar of banking union, which is the deposit guarantee scheme. It is not ideal, but we are managing without it. I am very optimistic that this third pillar will come sooner rather than later.