“We need to seize the opportunities to adjust to changes in banking”

Interview with Ignazio Angeloni, Member of the Supervisory Board of the ECB, Supervision Newsletter (Autumn 2017), 15 November 2017

Ignazio Angeloni, Member of the Supervisory Board (ECB representative), discusses how the banking landscape has changed since the financial crisis and considers whether integration has progressed, cross-border consolidation will happen and the banks are addressing fundamental challenges to stay ahead of the curve.

The European banking landscape is changing. How far has integration in the euro area advanced? Is there a conflict with ongoing banking consolidation, leading to fewer banks and a smaller banking sector?

For a few years after the euro was introduced, we saw major progress in financial and banking integration. After 2008, however, the financial crisis led to a retrenchment, as cross-border activities were perceived as more risky in turbulent market conditions. One of the objectives of the banking union is precisely to re-create favourable conditions for banking integration.

A consolidation process is ongoing in the euro area, especially among smaller institutions. It is taking place mainly within national boundaries. Over time, there may be scope for cross-border mergers among major banks, a development that would give rise to entities capable of competing effectively at a global level. But mergers can foster a sounder and more competitive banking sector only if there are well-proven synergies and sound business models in place. Our objective is a stable and efficient banking sector, contributing to sustainable economic growth. And all stakeholders need to seize the opportunities to adjust to the changing landscape.

What are the biggest obstacles to true competition in the European banking sector? Will banking consolidation – especially across borders – happen?

We do not yet have a harmonised business environment to underpin European banking activity – even in the euro area, where we share a common currency. For as long as banks face different legal and judicial norms in different jurisdictions, a truly single banking market will remain elusive.

In supervision, we are working hard to ensure a level playing field for all banks. The main obstacle at present is the insufficient harmonisation of the legislative framework. It would help if legislators could make as much use as possible of regulations, which, unlike directives, can be applied directly to banking institutions in the same way in all 19 countries. It would also help if the elements of flexibility in the legislation were entrusted to the supervisor, which could then apply them in a harmonised way. In this regard, the ongoing review of the European legislative framework, the first such review since the banking union was established, provides a unique opportunity that should not be missed.

The establishment of a euro area supervisor and resolution authorities were decisive steps but we need to progress further, both in the direction of making banks sounder and safer – which is our mandate – and in completing the banking union architecture. The single resolution mechanism needs strengthening and requires a credible backstop. A European deposit insurance scheme is overdue. An agreement on both fronts would be very welcome.

It’s also true that the link between banks and their sovereigns distorts cross-border competition. Removing this link was a fundamental rationale for the banking union, but is a goal that has not yet been achieved.

The banking union is still incomplete. We need to move on and the period ahead, with new governments in place in a number of countries, offers an opportunity to do so.

We have recently seen forced sales of banks or assets of banks under ECB supervision. Bail-in, as envisioned in the recovery and resolution rules – the Bank Recovery and Resolution Directive (BRRD) – was not used in all cases. What needs to improve to achieve the vision of no more bail-outs?

The first experiences of bank resolution in the banking union have been positive in several respects. The new crisis management framework worked well, with good collaboration and cooperation between the authorities involved. Also, contagion risks arising from the bank failures did not materialise.

However, further reflection is needed on the lessons that should be drawn for the future. The European Commission has made it clear that the measures taken are compliant with European rules, but some observers have expressed concerns that national liquidation involving state aid for significant banks constitutes a precedent for circumventing the rules in the future. This perception needs to be taken seriously and, once again, the current legislative review offers an opportunity.

Non-performing loans – in particular legacy NPLs – still weigh down many European banks. How and when will this improve?

Problems with bad loans have been years in the making. Currently there is a stock of €795 billion in bad loans on the balance sheets of significant banks; this cannot be dealt with overnight, but that does not mean that the banks should not make their best effort to address NPLs as ambitiously as possible. The NPL ratio for significant banks in the euro area fell to about 5.5% in the second quarter of 2017, from more than 7% in the same quarter two years earlier. This is an average, which masks large divergence across countries and banks. Banks are making progress, but many of them could do more. The opportunity is now, when economic conditions in the euro area are favourable. Working through problem loans is much easier when the economy is strong.

At the ECB, our efforts started with the 2014 Comprehensive Assessment, and were complemented with a three-step approach. First, we published guidance setting out the ECB’s expectations as to how banks should manage their NPLs. Second, we recently released a draft addendum to this NPL guidance which is subject to an ongoing public consultation that will close in December. The rationale behind the draft addendum is to foster more timely provisioning practices for new NPLs (or “NPL flows”), including through quantitative supervisory expectations for minimum levels of provisions, to prevent a renewed increase of such loans in the future. Third, concerning NPL stocks, in the first half of this year we required banks with high levels of NPLs to submit their NPL strategies, including NPL reduction targets. These strategies are being monitored by our staff – and challenged where needed – through normal supervisory engagement. Going forward, we plan to present our considerations to address the existing stock of NPLs by the first quarter of 2018, possibly including appropriate backstops and adequate transitional arrangements.

Many banks in Europe still struggle to be profitable. What do they need to do to pursue sustainable business models?

We attach a lot of importance to business model analysis, although we do not prescribe specific models for banks. Our role is to assess whether the banks’ intended business models are sufficiently resilient over time, especially in adverse conditions.

Notwithstanding the challenging environment, a significant number of banks have systematically outperformed their peers from the point of view of profitability. For these banks, a common characteristic is the ability to keep costs in check. We think many banks still have lots of scope for catching up in this regard. Also, banks need to redouble their efforts to diversify their income sources. And as already mentioned, a number of banks need to be more ambitious in reducing their NPL levels.

The potential normalisation of the interest rate cycle should have a lasting impact on bank profitability. In the meantime, banks should take advantage of the more benign macroeconomic environment to strengthen their balance sheets and to adapt their business models, if needed, to the new and very challenging environment that the banking industry is facing.

Will blockchain technology make banks as we know them obsolete? How will supervisors deal with financial services companies using blockchain?

The rise of digital technology in the banking business is one of the most hotly debated issues among policymakers and industry practitioners, and its implications are not yet fully understood.

The discussion on this issue last week at our ECB Forum on Banking Supervision – our flagship conference on supervisory matters – was a good reflection of the wide array of views held by industry practitioners. On the one hand, there are the “enthusiasts” who have wholeheartedly embraced the new technologies. And on the other, there are the “reluctant believers” who see digitalisation more as a marketing tool to retain customers than as a new paradigm.

A growing number of our “traditional” banks are incorporating a digital dimension into their business models and banking strategies, albeit to different degrees and at different speeds. We are engaging with banks to understand the degree to which this pattern is strategic rather than accidental in nature and (relatedly) whether any inherent risks are arising for individual entities as a result.

Following a recent public consultation, we will soon issue a final policy guidance regarding the authorisation of fintech companies. In the meantime, to our supervised banks our message is this: be ready for harsher competition from outsiders in the coming years, and at the same time push hard to improve and rationalise your internal processes, making use of new technologies to the extent needed. We see many banks responding positively to this stimulus, while also realising that the process entails a degree of trial and error.

Economists and experts gravely underestimated the scale of the last financial crisis. What can supervisors, researchers and analysts do to better predict and pinpoint trouble on the horizon?

The financial crisis was a humbling experience for economists and policymakers in many domains, because it forced a sharp re-think of certain long-held truths. If history is any indication, the next crisis will not look the same as the most recent one, so we should prepare for something altogether different.

The recent cases of bank failure have taught us two lessons in particular. First, risk correlations across different components of a bank’s balance sheet can be heightened in times of crisis; I am thinking in particular of how a loss of confidence in the quality of bank exposures can quickly translate to bank stocks and even deposits. We should be more cognisant of this possibility in the future.

Also, vulnerabilities that eventually led to banks getting into trouble often originated from long-standing and deep-seated governance problems within the bank. This means that supervisors should monitor risks in this domain even more closely and be equipped with the appropriate tools to intervene early on in the process if necessary – well before governance problems translate into weaknesses of the balance sheet.

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