Interview with Talouselämä

Interview with Danièle Nouy, Chair of the Supervisory Board of the ECB, conducted by Emilia Kullas of Talouselämä and published on 19 May 2017

As the first head of European banking supervision, you supervise the 125 largest banks in the euro area. You are now midway through your term, what have been the lessons learnt so far?

It has all been extremely interesting. We started from scratch in 2014. I was head of banking supervision in France, with over a thousand people working for me. Then I moved to Frankfurt and we were only five people at the start. We were a tiny start-up but inside a powerful incubator – the ECB – which makes a big difference. By the end of that year, we had nearly 1,000 highly talented and motivated people working for European banking supervision.

It has been a pretty exciting job and a pretty challenging one too.

I was familiar with different national supervisory authorities, and I used to think that the different banking systems were more similar, that we were very much the same and supervised in a fairly uniform way. It came as a big surprise to me to see how much banks differ across countries and, in certain respects, how far we are from having a fully harmonised community. There are up to 19 different ways of interpreting some aspects of the legislation that informs our work. One example is the differing rules in place in euro area Member States for assessing the suitability of banks’ senior management. Because the legislation covering this is in the form of a directive rather than a regulation, national legislators interpreted it differently and transposed it in their own way. Moreover, we have identified 167 options and national discretions in the Capital Requirements Regulation and Directive (CRR/CRD IV) and we have done a lot of work to remove most of them and to apply a standard and consistent approach instead.

I think supervisors are now working well together and doing a good job. European banking supervision and banking union is much better than what we had before. We are certainly better and stronger together.

How likely is it that a new banking crisis will hit Europe?

We cannot say that there will be no new crisis, but European banks are now much better prepared for it than before. Banks are stronger, their balance sheets are more robust – for example since 2012, the average level of high quality capital at banks has increased from 9% to 13.7%; and we have a single supervisory mechanism and a resolution system.

The oldest bank in the world, the Italian Monte dei Paschi di Siena, had to resort to help from the state to fill a gap of over €8 billion on its balance sheet. Italy and Germany have still not cleaned up their banking systems. What can a supervisory authority do about this?

In all euro area countries, there are three categories of banks: banks that are doing pretty well; banks that are not doing so well but are committed – and bravely so – to tackling their problems; and then others that are somewhat in denial and will have to change to improve. We have recently seen examples of banks that have sold non-performing assets and have gone to the market to seek additional capital.

Do certain lines of business worry you?

A sector that always needs to be scrutinised and supervised closely is real estate. Real estate has been a trigger for a number of crises in the past. I am not especially concerned at the moment, but it is an area of risk to which I always pay attention. In Scandinavia, for example, real estate prices are rising and the debt burden of households is increasing. This has to be followed carefully. If I have learned anything in my 40 years of banking supervision, it is that problems do not vanish by themselves, they will just keep growing if they are not tackled.

As for banks' non-performing loans, it is certainly time to address them. We have taken a number of steps, starting with the identification of non-performing loans (NPLs) in the comprehensive assessment in 2014, when, for the first time, the same definition for NPLs was applied across the euro area. A high-level group on NPLs chaired by Sharon Donnery, the deputy governor of the Central Bank of Ireland, has done much work to set out clearly the kinds of steps banks need to take in order to address loans that risk remaining unpaid.

In particular, banks need to have credible plans for addressing NPLs. Supervisors need to check that banks’ strategies and plans on NPLs are sufficiently ambitious on the one hand and, on the other, that they are realistic as to what can be achieved. The treatment must not be worse than the disease. We now see a split between banks that are able and willing to solve the NPL issue as a matter of priority, and banks that will struggle with legacy problems in future years and, as a result, will not be able to play their role in funding the economy.

What role will bank mergers play in this?

Well, there is far from a lack of supply of banking services in Europe. I don’t believe that large banks are necessarily better than small banks, but the European banking sector would benefit from a certain amount of consolidation. We have all kinds of banks in the euro area: cooperative banks, listed commercial banks, mutual banks... And this diversity is a benefit: there is room for different approaches. What matters is that each bank in its own sector should have a sustainable business model.

The average cost-to-income ratio for euro area banks is 65%, so to earn one euro those banks have to spend 65 cents. This is far too high. For Finnish banks the ratio is 46%, which makes Finnish banks markedly more efficient than their average European competitors.

Since the financial crisis, banks have been clamouring about overly tight regulation in the euro area. Is excessive regulation strangling banks' business opportunities?

Absolutely not. Regulation used to be much too lax before the crisis. It is by no means too tight right now and it is not hampering the business of healthy banks. Only financially sound, well-capitalised banks are able to fund the economy through the economic cycle – also in times of crisis. As we experienced in the financial crises of the last decade, poor lending practices, as well as lax regulation and supervision can end up creating very damaging and very costly bubbles. At the same time, the level of regulation and capital we have now is enough. The Basel Committee on Banking Supervision, which is finalising the rules for banks on regulatory capital, has been mandated to address outliers, but also specifically not to significantly increase the level of capital banks are required to hold.

US President Donald Trump has said he intends to unravel banking regulation. What would be the impact on European banks?

We have to wait and see but I don’t think this is going to happen. I don’t believe the United States will become lax in regulating and supervising banks. The criticisms I have heard in the United States about the post-crisis Dodd-Frank legislation relate to its complexity and call for more simplicity. But addressing complexity doesn’t necessarily mean the regulatory treatment will be less strict.

How will Brexit affect London City's status as the financial centre of Europe?

That we do not yet know, but the good relations and cooperation between banking supervisors in European banking supervision and the Prudential Regulation Authority (PRA) in the United Kingdom will continue to be important: Brexit is not only about banks coming from London to the continent, but also how the banks we supervise will operate in the United Kingdom. Also important is that we are ready to supervise the banks that relocate to the euro area so that they continue to have a passport to provide services to their customers.

We have two major pitfalls to avoid. Supervision must not be allowed to become fragmented, and there must be no supervisory gaps. UK banks can continue their activities in the EU in three ways: they can set up subsidiaries in an EU member state, register as broker dealers or investment service providers, or – like their US counterparts – they can register as third-country bank branches.

This is where the fragmentation issue for supervision begins. Broker dealers/investment service providers and third-country branches are supervised by the national supervisory authorities in each country, on the basis of different national regulation. This is because European directives can be transposed into national law in different ways. Moreover, for banking-like activities, the PRA supervises the large, systemic broker dealer exactly like banks, which is not possible under the current Single Supervisory Mechanism regulation. If not fixed through the current revision of the CRR/CRD IV, these elements could trigger a race to the bottom, as the London-based banks may decide to relocate in the country offering the least onerous opportunity among the 19 different euro area countries.

There are proposals now with the European Commission on whether, for the purposes of better supervisory oversight, these different forms of establishment can be captured through a holding company structure called an intermediate parent undertaking.

So in theory, a crisis could be brewing under the very eyes of the supervisors e.g. at an investment service provider, and it would not be detected early enough?

Well these issues have been identified and solutions will be found. We expect banks that relocate in the euro area to conduct genuine banking business in the euro area, meaning that we will not provide licences to empty shells; and we are neutral on which countries relocating banks would choose as their EU base.

One key part of the banking union is still missing, the single deposit guarantee scheme. Finnish banks are not enthusiastic about sharing risks among all parties. What is your response to the reluctant Finns?

The single deposit guarantee scheme is coming, I am convinced of that, and it will be very useful. It is understandable that building solidarity takes time, but a banking union requires commitment from all parties. The single deposit guarantee scheme will reduce risks in the euro area.

How are financial start-ups changing the activities of banks?

This is not merely a question of start-ups, the whole world has changed. My granddaughter who is in her twenties wants to have all her banking services through her mobile phone, unlike myself! Banks must monitor their IT systems for the sake of both cyber security and their own competitiveness. Financial start-ups are both a threat and an opportunity for banks.

A few years ago, hedge funds were regarded as a competitive threat to banks; in particular their wealth management activities. In fact, that did not happen; on the contrary, hedge funds relied a lot on banking services and ended up being a source of profits for banks in their “prime brokerage activities”.

Interest rates have been at a historical low for a long time. How are banks faring with such a low level of interest rates?

Well, a long period of low levels of interest rates can trigger increased risk appetite in some sectors – for example in leverage finance – so that’s why we took a close look at leverage finance operations in our banks. This is in line with work done by our supervisory colleagues in the United States and the United Kingdom. It is the task of banks to take risks; the task of the supervisor is to see that banks are reasonable in what risks they take, and that they have good risk management practices and risk mitigants, and the capital they hold is commensurate with the risks they take.

Emmanuel Macron won the French presidential election and investors let out a sigh of relief. How do you see the future of the euro?

Bright. We need the euro. We are stronger together.