Interview with Il Sole 24 Ore

Interview with Ignazio Angeloni, Member of the Supervisory Board of the European Central Bank, published on 15 July 2016 and conducted by Alessandro Merli

The vote on Brexit had a strong negative impact on European bank shares with possible repercussions on financial stability in the euro area. What is your assessment of the situation?

There is no doubt that the British referendum represents a considerable shock on the European economy, whose impact we now begin to see but will develop further in the coming months. An element that plays a considerable role in this case is the “uncertainly effect”: we do not know how the relations between the UK and the European Union will develop in the future, and financial markets do not like uncertainty. This helps explain why bank stocks have been hit relatively hard: a very important component of this uncertainty concerns the way in which the UK, which hosts the most important financial centre in Europe, will position itself relative to the European single market for banking and financial services. By the way, in the first two weeks after the vote, the impact on euro area bank shares appears stronger than on UK bank shares, but they are not so different if one takes into account the exchange rate movement. It is true that in both cases the fall in the bank index is bigger than the general index.

Italian bank shares were hit particularly badly and many now consider Italian banks the weak link of the euro zone. The SSM has made several evaluations of their health over the past year and a half. What is their state now?

We are following very closely the situation of all banks under our supervisory responsibility, including of course the Italian ones. There isn’t a specific or country-wide problem with Italy. Certain banks in Italy are burdened by a high level of non-performing loans. Markets are sensitive to that and this shows up in a higher volatility of Italian bank shares. The problem of the NPLs can be managed, but should not be underestimated. Besides NPLs, we are focusing on a number of other relevant aspects in the context of our annual SREP exercise, which will lead in due time to the quantification of the prudential requirements for next year. On all these issues, we are working in close collaboration with the Italian authorities, first and foremost the Banca d’Italia in its capacity as national supervisor and member of the SSM. The collaboration is very good.

There is talk of a possible use of public funds in Italy to recapitalise some banks. Do you think this is appropriate? Do you think the coming publication of the stress test results could be the right time to make an announcement about it, in conformity with EU rules?

I do not wish to speculate on specific press reports. The Italian government has announced that contacts are ongoing with the European Commission on measures designed to support some Italian banks, which have suffered recently also as a result of the turmoil triggered by Brexit. The Commission has responsibility of evaluating and authorising measures that may be relevant from a competition and state-aid perspective. As I have recently stated in public, I think that forms of public support, to be used in exceptional circumstances and in a controlled way, are part of any well-designed banking framework. The legal framework of the EU (composed by the CRR/CRD, plus the BRRD and the State-aid rules issued by the Commission in 2013) contains explicit provisions to this effect. It is a matter of applying existing rules.

Should bail-in rules be revised or suspended?

The sharing of risks by certain classes of creditors is a good component of the system, as are the safeguards we have just discussed. It produces the right incentives and it’s part of the rules approved by all. There needs to be, of course, adequate information on financial instruments investors are buying.

What is your expectation for the solution of the MPS case, which was one of the four Italian banks which failed your comprehensive assessment? MPS is now capitalised well above regulatory thresholds and is making money, but is still considered on the brink. What needs to be done?

I do not wish to comment on the situation of individual banks. As I have just mentioned, in the context of our annual SREP exercise and in the regular supervisory work conducted by the supervisory teams we focus on all relevant risk factors. We do this for all banks, including of course MPS. Our analyses and conclusions are communicated to the banks.

On the question of communication and transparency, after the flood of data on publication of the comprehensive assessment, the ECB has been mostly silent and often the markets have had to deal with information coming from other sources, unverified by the ECB. Don't you think the SSM should provide more clarity, to avoid confusion in the markets, through more timely communication and transparency?

Transparency is of course an important issue. But the ECB, as banking supervisor, deals generally with confidential information. Banks provide to the supervisor qualitative and quantitative information regarding their balance sheet and other aspects of their activity. This information cannot, as a rule, be disclosed. There are European rules regarding professional secrecy of supervisors. Exchanges of information between supervisors and other authorities can take place; this is for example what happens now in the context of the stress tests, in which we collaborate closely with the European Banking Authority. The stress tests are now being finalised and the results will be published at the end of this month.

In addition, there are European disclosure rules regarding the issuers of financial instruments, including banks. According to such rules, market-sensitive information should be communicated as soon as possible by the banks themselves to the public. Compliance with these rules is enforced by the national market authorities. This is the reason why the national market authorities (in Italy, CONSOB) have in certain situations required banks to publish information that comes from supervisory process, like for example the SREP. In this area, it would be useful to promote more coordination among national market authorities within the banking union, to ensure that banks in different countries follow the same disclosure practices. Asymmetries of information hamper the well-functioning of the market. Finally, there is a further aspect relating to the transparency of supervisory methodologies and practices. For example, the SSM has published a synthesis of its supervisory manual, and has also more recently disclosed a “guide” to the SREP. Further information on the activity of the SSM is contained in our annual report, as well as in speeches and interviews of the Chair, the Vice Chair and other members of the Supervisory Board.

Although banking supervision has now been unified under the SSM, authority over banks resides also elsewhere, in particular the DG Competition of the European Commission. Their position seems at times not at all coordinated with those of the SSM and this creates confusion in the markets. Is there no dialogue between the two bodies?

Different institutions have different responsibilities, and should collaborate when these responsibilities interact or when synergies can be exploited. In particular, the SSM is responsible for prudential supervision, which means ensuring, within the existing regulatory framework, that banks are safe and sound and that the banking system is stable. The SRM focuses on resolution, both ex-ante (ensuring that banks have sufficient loss-absorbing capacity) and ex-post (intervening in concrete cases of resolution). The competition arm of the EU Commission is responsible for enforcing the rules regarding market competition and state-aid control. There are cases when collaboration and coordination can be very useful. The SSM and the SRM have recently agreed on a memorandum of Understanding that regulates the collaboration and the exchange of information between the two institutions.

The markets are also waiting for the results of your study on NPLs, which are a crucial issue for Italian banks. The manner in which its start was communicated created a lot of uncertainty and turmoil. What should be expected from it now?

The reactions triggered by this initiative at the beginning of this year were exaggerated. Monitoring NPLs, especially when they are excessive, is part of the normal duties of a banking supervisor. This includes collecting the necessary information, identifying best practices, and if necessary setting guidelines. Given the importance of this issue for a number of banks that we supervise, we have set up a dedicated working team, which includes staff from the ECB and the national authorities. The main relevant results will be published soon. We know well that re-absorbing NPLs, especially when the level is high, cannot be done rapidly, and we know that there is a trade-off between speed and value that can be extracted. Our goal is to help the banks use all margins of manoeuver they have to solve the problem, as quickly as possible.

The figures circulating in the markets about Italian NPLs and the one provided by the Bank of Italy (lastly by Governor Ignazio Visco at the ABI conference) differ widely. What is the SSM position on that?

Again, I should not speculate on rumours or press reports. On NPLs as well as on all other aspects, in our work we use the same statistical figures and share the same information that is also at the disposal of the national supervisory authorities. Also for this reason we have created “joint supervisory teams”, where national and ECB supervisors work together. It is essential that supervisory decisions are based on solid and commonly shared information.

There is a perception in Italy that there is an excessive focus on the NPL, and not enough on other issues, like derivatives, which affect other banking systems and have a bigger potential for disruption. A recent report from the IMF pointed out that Deutsche Bank is “the most important net contributor to systemic risks”.

I don’t think that perception is grounded. Our supervisory activity is complete and covers all aspects of bank risks, including credit risks, market risks, operational risks, risks to capital and liquidity, and so on. All these aspects are considered and assessed to the best of our knowledge, both in the SREP and more specifically in the stress test, as well as in the regular contacts between the supervisory teams and the banks.

Let me mention in particular two aspects that are relevant for market risk. First, we have launched a broad ranging review of internal risk models. These models are used by the major banks to measure their risks in various areas, and to calculate risk weights, including for market and operational risks. Different modelling approaches can give rise to different prudential requirements, and if models are not appropriate an underestimation of such requirements can arise. Banks that take on large market exposures are often characterised by lower average risk weights on their exposures. This is why it is important to supervise these models. But this takes time, given the large number of banks we supervise and the multiple models that they use. I should also mention that talk of derivatives in general is misleading: there are derivative positions that help hedge risk and others that increase risk. Second, we are also paying increasing attention to the leverage of credit institutions, as a complement of risk weighted exposures. Leverage measures are not weighted for risk hence they are not subject to the potential bias I have mentioned. In Europe, the leverage requirement will enter into force in 2018, but banks must already disclose their leverage today. Disclosure is important because it fosters market discipline; banks are reluctant to maintain a high leverage if they have to disclose it, even if no outright prohibition exists yet. On our side, we monitor leverage and ensure that all banks calculate it correctly.

In Italy, the creation of the Atlante fund has solved the problem of the recapitalisation of 2 banks, but has fallen short of what is necessary to clean up the banking system. What is your assessment of the role of Atlante so far, and do you think it should be supplemented by more resources or by a creation of an Atlante2, as it is currently been discussed?

I have discussed this in some detail in a recent hearing at the Italian Senate. Atlante was a good initiative, and it has already contributed to stability by intervening in the recapitalisation of two banks. By doing so, it has used up a large part of its resources. Its present size is not sufficient to address all cases where an intervention on NPLs or in support of bank capital may be needed. Prospects of replenishing its resources, especially from private investors outside of the Italian banking sector, would be welcome. I also think that a presence of international investors would be a good signal.

Could you explain the methodology of the coming SREP and how it differs from previous exercises?

In the 2016 SREP we are introducing some innovations to make the process and the related requirements more flexible and effective. In particular, the Pillar 2 indications that the banks receive from us will be divided in two parts, a Pillar 2 “Requirement” and a Pillar 2 “Guidance”. Banks will need to strictly meet the Pillar 2 Requirement at all times. They will in general be expected to meet the Pillar 2 Guidance as well; however, the Pillar 2 Guidance will not constrain the Maximum Distributable Amount (MDA, an aggregate that includes the resources that banks pay out in the form of dividends, bonuses and remuneration of Additional Tier 1 or AT1 capital). Consequently, the MDA trigger levels will decrease in the 2016 SREP, other things equal. Failure to meet the Guidance will not automatically result in supervisory actions. It may, however, result in a more intense monitoring and specific measures based on the individual situation of the bank. The quantitative impact of the adverse Stress Test will be, together with other elements derived from the SREP analysis, a component helping determine the level of the Pillar 2 Guidance. As such, the adverse Stress Test results will not raise the MDA trigger. As the SSM Chair, Ms Nouy, has stated this week, we expect the overall Pillar 2 measure (comprising both the Requirement and the Guidance) to remain broadly stable, for given risk levels, compared to last year. There will be, of course, adjustments upward or downward in specific cases, depending on the situation of individual banks.

The stress tests are being conducted by EBA. How will this change once the UK is out of the EU? Will the existence of EBA still be justified?

Let me say, first, that over the years the EBA has played a key role in fostering a much-needed convergence in supervisory practices and secondary regulation in the EU. In the last two years, EBA has also been an important partner of the SSM; we have worked together on many things, including recently on the project that the SSM has undertaken to harmonise the Options and Discretions in EU banking law. It is important that the EBA continues to perform this function. Since the onset of the SSM, the cooperation between the ECB and the EBA has been intense and, we believe, very fruitful. In addition, EBA has been an important forum of exchange and coordination between the EU member states that belong to the banking union (19 at present) and those that do not belong to it (9, including the UK). After Brexit, there will still be 8 EU member states in EBA that are not part of the banking union; therefore, this function will remain important. That said, there may be a need to introduce changes in the rules and organisation of EBA after the exit of the UK. The location of the organisation will need to change. All this will be part of the discussions and negotiations that will take place in the coming months.

The SSM now runs single supervision in a banking union that is far from complete. The resolution fund is years away and the EDIS has been postponed sine die. How does this complicate your task?

A central theme on the regulatory agenda at present is the completion of the banking union. The ECB firmly believes that a single deposit insurance scheme is a necessary pillar of a well-functioning banking union. In our view, the Commission´s proposal (EDIS), involving a gradual set-up of the scheme in three phases to be concluded by 2024, is sound, because it properly balances clarity of purpose and gradualism. More generally, the set-up of an area-wide bank safety net using mutualised resources is the logical complement of elevating the responsibility for bank supervision and resolution to the same level, a step that has already happened with the launch of the SSM. This process should proceed in parallel with the gradual reduction of banking risks in the system, a process to which ECB Banking Supervision is actively contributing. A common, credible system for deposit protection will underpin confidence, help stabilise the system and contribute to a level playing field.

Sovereign debt in the portfolio of banks is one of the difficult points. Do you think this needs to be addressed before EDIS, even if this will take several years?

The completion of the banking union, including specifically the establishment of an EDIS, has become part of a broader discussion regarding the timing and sequencing of achieving risk reduction and risk-sharing within the banking union. It has also been linked to changing the prudential treatment of sovereign exposures. In present banking law, bank´s domestic sovereign exposures are treated as riskless; that is, they are exempt both from risk weights and from large exposure limits. The experience of the recent years has shown that, in fact, sovereign exposures are not riskless. The ECB recognises that there are good reasons to consider a modification of the prudential treatment of sovereign exposures. Any regulatory change, however, should be mindful of financial risks in the transition and should take into account the central role that sovereign debt instruments play in the financial sector and in the monetary policy process. Rigid limits should be avoided. Consideration could be given, for example, to flexible approaches consisting in the application of gradually increasing risk weights to exposures concentrated on individual sovereigns, beyond certain thresholds. The goal is not to engineer a decline in the total amount of sovereign bonds held by banks, but a greater portfolio diversification. In any case, an appropriately long phasing-in period should be foreseen to avoid abrupt effects and be able to adjust in response to experience. The Basel Committee on Banking Supervision is conducting a reflection on the issue, which may lead to the establishment of an international standard. Any changes in Europe should, in our view, take place within that framework.

How has the situation of Greek banks changed after the reinstatement of the waiver?

Following the reinstatement of the waiver on 29 June, the Greek banks were able to switch a certain amount of central bank refinancing given in the form of emergency liquidity assistance (ELA) into normal refinancing from monetary policy operations. This was realised thanks to additional collateral that became eligible – i.e. Greek government securities – with the reinstatement of the waiver. A lower cost of refinancing, implied by the aforementioned switch, has a positive effect on banks. Furthermore, the reinstatement of the waiver would have a positive effect on confidence of both depositors and investors from which the Greek banks are also expected to gain.