Interview with Het Financieele Dagblad

Interview with Danièle Nouy, Chair of the ECB’s Supervisory Board,
conducted by Giel ten Bosch and Cor de Horde, on 26 April 2016 and published on 30 April 2016

Not a week goes by without news about European banks: an emergency fund in Italy, comments by the IMF on the dismal state of possibly one in seven banks. But Danièle Nouy – who as Chair of the supervisory arm of the European Central Bank (ECB) bears primary responsibility for the supervision of European banks – is optimistic. Her motto is that, although some problems cannot be resolved within a few weeks, what counts is that we are heading in the right direction.

And keeping in the right direction is what Nouy is determined to do. “I come from Brittany, a region where people are said to be stubborn. That is a good quality for a supervisor”.

Are European banks now safer than they were before banking union?

Yes, absolutely. Banks are now safer. Banks’ capital positions have improved significantly. Look at their solvency: that is now 4 percentage points higher than in 2012. And we can also see improvements in their profitability. We are using the best of the different supervisory practices.

Nonetheless, the IMF recently warned that one in seven banks is not viable without changes to its business model, and for the euro area that could be one in three. Were you surprised by that?

Banks are not all in the same situation. Some were harder hit by the crisis than others and are still in the recovery phase. I think that they are moving in the right direction, but the situation is different for banks that were less affected. One cannot compare a Greek bank to a French, German or Dutch bank. Also, not everything is the banks’ fault. Greek banks were struggling with political events that were beyond their control. Supervision of the banks was good, but they suffered some damage due to the political turmoil, which resulted in recapitalisation.

Italy also has many non-performing loans. How is that possible, eight years after the crisis?

The comprehensive assessment showed that some Italian banks had a capital shortfall. Italy is one of the countries that has to deal with bad loans. Not the only country, by the way. And yes, bad loans are a problem within the banking union. Tackling that issue is a long road. When we carried out the comprehensive assessment, we were able to use,for the first time, a common definition of non-performing loans; so they were properly identified and provisionedand this gives us now a sound basis for tackling the issue. The bad loans have various causes, such as the legal system. In Italy, for example, it takes a very long time to lay claim to the collateral of a non-performing loan.

The story goes that it sometimes takes up to ten years.

Maybe not ten, but it can take several years. The Minister of Finance has now said that the legal framework for addressing non performing exposures and repossession of collateral would be amended. I am fairly certain that once that has been done, the situation will significantly improve. The value of a portfolio of non-performing loans can increase quickly after such a legal change. So, we are addressing the issue. But it is not something that can be fixed in a few weeks or months. We now have a working group which is chaired by an Irish colleague. Ireland dealt well with this problem. So, we are using the Irish practice for the banks that we supervise, in countries that have this problem. That group is reviewing the portfolios and defining methodologies for addressing the issue. Banks overloaded with bad loans are not able to issue new loans. That is holding back the economy.

In some cases, subordinated loans issued by banks are held by private individuals, some of whom thought that they were a savings product. That makes the resolution of such a bank politically sensitive. What is your view?

All investors, whether retail or institutional, should fully understand the features of their holdings, and the risks. They should know that the world has changed since 1 January. The rule now is: bail in, and no longer bail out. Only deposits up to €100,000 are fully guaranteed. In all other cases, it depends on the extent of the bank’s losses and on the composition of the liabilities in its balance sheet.

As we have seen in Portugal, Spain and Italy, there are problems with private individuals.

Whether they are retail investors or not, I think it is up to the supervisory bodies that oversee consumer protection to ensure that they are well informed. That is their job.

So it doesn’t matter to the ECB who the investor is? Subordinated is subordinated?

We are not the resolution authority. As supervisors, we have to deal with situations that were not of our making. But the rules are very clear: as of now, bail-in applies. You often hear people welcoming the fact that taxpayers no longer have to come to a bank’s aid. But they forget that these may sometimes be the same people: as investors in subordinated bank debt, or indirectly through life insurance policies that have invested in such debt.

Will taxpayers never need to come to a bank’s assistance again?

I am old and cautious enough to say: never say never. But we have a clear legal framework. It is the investors who have to pay, the same investors who received the returns when things were going well. But there is another option, in the case of a “precautionary recapitalisation”, that may involve some public support, but the conditions are so strict that I wonder whether it is feasible at all. And in the case of a genuine resolution, there is the resolution fund, which can only be drawn on if 8% of total liabilities have been already bailed in. That is a lot of money. Moreover, that fund is funded by the banking sector; it is not public money.

The close links between banks and sovereigns played a major role in the euro crisis. Banks that ran into difficulties had to be saved with taxpayers’ money.

The solidarity arising from a European deposit guarantee scheme will help to deal with this nexus. Having the third pillar of the banking Union - the single deposit guarantee scheme for the euro area would help.

At the same time, countries that encounter problems drag banks with them because of the banks’ balance sheet holdings of sovereign bonds. That entanglement is still in place.

We learned during the financial crisis that sovereign bonds are not risk-free, so capital should be held against them. That is not the case at the moment. If things then go wrong, the bank has a buffer. That cannot be achieved quickly or easily, but it is under discussion and things are moving in the right direction . There were good discussions in the Basel Committee on Banking Supervision and, recently, by the ECOFIN (European Ministers of Finance) in Amsterdam. It’s work in progress – I think we will get an agreement on risk weighted assets for sovereign exposures; and they should not be very demanding because most of them are of reasonably good quality; concentration limits will take more time. I will place no bets on when this will be settled; but if you have a long journey ahead, you need to start as early as possible.

Are Dutch mortgages – which are generally interest-only and in many cases exceed the value of the house – a risk for Dutch banks?

That is not at the top of my list of risks for the moment. I know that real estate in general can be a possible source of weakness for banks. And we are keeping a close eye on it. But in the context of banks in the euro area, there are bigger problems.

Are you concerned about the low interest rates?

They are certainly a cause for concern. The low interest rates affect the profitability of banks whose source of income is interest rate margins. Along with the bad loans, profitability risks head up my list of priorities. And some banks are troubled by both.

Low interest rates are caused by economic conditions and by the ECB’s policy, so banks can’t do anything about them.

They are certainly a challenge for them, yes. But they force banks to become more efficient and to reconsider the sustanaibility of their business model and to look at their costs, which are sometimes too high. Digitalisation, for example, can help to bring down costs.

That means that many jobs are at risk.

New jobs will be created too: in the development of IT-systems and of financial technology. Finding the jobs of the future is of prime importance. The world is changing and we can’t do anything about that. Banks must be ready for the future challenges, and the competition is tough.

Do you discuss the concerns about the low interest rates with ECB President Mario Draghi?

My concerns about profitability risk are publicly known; but I don’t discuss interest rates with the President of the ECB. We do not talk about monetary policy. And believe me, supervisors are not in denial at the ECB. This is a challenge for banks. But it is also an opportunity. Too many banks have not looked at the sustainability of their earnings model for too long. This is a good time to do so. And in some countries they need to take the necessary steps, such as merging with other banks, digitalisation, or something else.