Interview with Verslo žinios

Interview with Danièle Nouy, Chair of the Supervisory Board of the ECB,
conducted by Dalius Simėnas on 23 August 2016 and published on 31 August 2016

Today, what is the situation of the Nordic banks whose subsidiaries and branches dominate the Lithuanian banking market?

The banks of the Scandinavian countries – that is, Sweden, Denmark, Norway, which are not in the euro area – operating in Lithuania are not a concern for us. In fact, the quality and profitability of their loan portfolios are above the average of other banks in the euro area which are under our supervision.

Certainly, there are fears that new threats might emerge. The Baltic States are open economies. For reasons that are beyond Lithuania’s control, for example, if exports fall due to difficulties in importing countries, the banks operating in Lithuania might face higher credit risk.

In addition, this is a small highly concentrated market which is dominated by several foreign-owned banks. If the situation in the countries of origin of these banks worsened, we would likely see consequences also for Lithuania, where subsidiaries (or branches) of such banks operate.

Are you receiving any signals that such credit risk has increased in Lithuania?

No, I would not say that. On the other hand, credit risk has a significant impact on banks, therefore we monitor it very closely. Currently, the Supervisory Board of the European Central Bank is taking a close look at portfolios of bad or defaulted loans, which still exist in some banks of the euro area.

You have mentioned potential threats in the countries of origin of the Scandinavian banks which are dominant in Lithuania. For example, it is currently a matter of intense debate and opinions are being voiced that a real estate bubble is developing in Sweden. If a real estate market crisis broke out there, what consequences could Lithuania face?

I receive extensive information about the situation of banks in Europe and other continents. I have had a number of opportunities to study closely the situation of Swedish banks, because they are of considerable importance.

Certainly, such a threat exists. But there is no clarity as to whether this may happen, though the real estate sector must be under adequate control.

I know that Lithuania has introduced restrictions on lending in order to ensure that the amount of a loan would be within a reasonable limit of the overall value of the property. I believe that introduction of such safeguards is highly important.

The Bank of Lithuania and experts have repeatedly expressed their willingness to see not only Scandinavian banks, but also banks of other countries operating in the country. There are concerns that competition is too limited.

I do understand the concerns of smaller countries about the fact that their markets are dominated by a few foreign-owned banks. My goal as Chair of the Supervisory Board of the ECB is to achieve a common euro area banking market in which cross-border banking mergers would take place, and this would create a truly homogeneous banking system within the Single Supervisory Mechanism.

In such a world, the situation would significantly change in smaller countries, such as Lithuania. I hope this is what will happen eventually, I mean that in practice large euro area banks will seek to engage in banking activities throughout the euro area with branches or subsidiaries. I believe that in that case we could talk about the success of the Single Supervisory Mechanism.

What are the greatest barriers that banks face in extending their operations across the euro area?

They are mostly economic reasons as the development of the economy has been sluggish in most countries of the euro area.

Moreover, decreased profitability of banks in the euro area limits opportunities in respect of bank acquisition or merger initiatives. Low profitability is closely linked with low growth and a persistently high level of bad loans in some banks of the euro area.

The low interest rate environment also has an effect, although initially it had positive effects for banks as funding costs declined, more loans were issued, and customer credit also improved due to lower interest rates.

However, it is becoming clear now that the low interest rate environment takes its toll and limits banks’ profits.

Therefore, for the situation to change for the better, we need to see more growth in the euro area.

Presently, bonds of more than half the governments in the euro area are sold at a negative interest rate. Is it a matter of concern for you as regards banks, which are the main funders of the governments?

For me as head of the banking supervisory body, it is vital that banks are sufficiently profitable to secure adequate capital buffers and are thus safe and healthy. To achieve that, they need to make enough profit to generate retain earnings or to search for investors in capital markets, and must show investors that they are attractive and enjoy appropriate return on equity.

At the end of July, you performed an assessment of the condition of European banks, a so-called stress test. Experts ask why the assessment of over 50 large banks excluded the Greek or Portuguese banks which survived the crisis?

Greek banks were excluded from the assessment because their condition was comprehensively assessed six months before the stress test. The Greek banks were assessed in 2014, then the crisis broke out and they were reassessed and recapitalised in 2015; so they no longer needed an additional assessment. We had all the information about them which we needed.

First and foremost, all the major banks, with the exception of the Greek banks for the previously stated reasons, were tested by the ECB, including the Portuguese banks that you mentioned. But as they are not large banks, they were not included in the EBA (European Banking Authority) sample, covering (according to EBA rules) 70% of the SSM banking assets. The stress test was coordinated by the EBA. It covered 51 European banks, including 37 major credit institutions directly supervised by the ECB.

The stress test was passed by all the banks, except for one of the oldest Italian banks, Monte dei Paschi di Siena, whose capital became negative during the test. What is your view on the condition of this bank?

We don’t comment on individual institutions so I would not refer to Monte dei Paschi directly. I would just say that the EBA sample was mostly comprised of large banks that were less hit, or recovered faster from the crisis, than small and medium-sized banks. The first bank stress test implemented in 2014 showed that mostly medium-sized banks failed the stress test.

And we have worked with them to make sure that such banks resolve their problems.

What is your greatest concern in the present-day banking sector of the euro area today?

Certainly, the greatest concern is the low profitability of banks as profitability is needed for banks to remain solvent and healthy.

Investors can no longer expect the same high return on equity as they received before the banking crisis, but they do need their returns to be adequate.

I would also like to ask why the impact of Brexit on the EU banking system was not assessed during the stress test?

The Supervisory Board of the ECB does not decide on potential adverse (macroeconomic) scenarios of EBA stress tests. I believe that this is appropriate; otherwise we as the banking supervisory body might have a potential conflict of interest.

At the same time, I think that it does not matter that much what scenario is being considered. What matters in the case of a stress test adverse scenario is the shrinking of banks’ equity capital during such scenarios.

According to the adverse scenario, the common equity tier 1 (CET1) ratio would decrease by nearly 4%. This means that in the event of a loss of this amount of their equity, banks could continue to operate properly.

We could continuously discuss why one or another element was or was not included in the assessment of the banks’ condition but, as I have already mentioned, the most important outcome is that even after losing 400 basis points of their equity, they are capable of functioning properly and this is good news.

I believe that banks are now more resilient than they were before the crisis. The solvency of banks has increased significantly from 9% to almost 13% of CET1. However, markets are still concerned about the low profitability of banks.

And for a number of banks, increasing profitability requires addressing their bad loans issue.

[Additional question submitted after the interview was conducted]

On 25 August, the Norwegian bank DNB and the Swedish bank Nordea, both operating in the Baltic States, announced their merger. How do you view such a step? It is clear that concentration is increasing and competition is decreasing. Is it good news?

We don’t comment on individual institutions. We supervise 129 banking groups directly – many with very diverse structures. We supervise banks as individual institutions in the context of the European banking environment rather than as national entities. For us, the safety and soundness of the institutions, alongside robust governance and the prudent management of risk are the important elements. The EU Commission is the responsible agency for competition issues.

In general, for us supervisors, in the euro area we do not see any markets with too few banks. I would even say that in some parts of the euro area there is room for consolidation and bank mergers.