“We are better prepared for the next storm”
Interview with Danièle Nouy, Chair of the Supervisory Board of the ECB, Supervision Newsletter, 14 November 2018
Danièle Nouy, who ends her five-year term as Chair of the ECB Supervisory Board at the end of the year, says European banking supervision is better prepared to face the next crisis and banks have become more resilient since the Lehman collapse. Still, she urges Europe to do more for banking union and the banking sector for consolidation and profitability.
Ten years after Lehman, five years as head of ECB Banking Supervision, four years after the creation of the Single Supervisory Mechanism (SSM). Where are we with regard to better, safer banks in Europe?
Banks have certainly become safer and sounder over the past ten years. They hold more capital than before the crisis, and the capital they hold is of a higher quality. The CET1 capital ratio of a constant sample of significant institutions had reached 13.8% at the end of the second quarter of 2018; and that’s after the banks had “spent” part of their capital buffers to clean up their balance sheets. Banks have also improved their funding and liquidity situation, thanks to new rules such as the liquidity coverage ratio and the net stable funding ratio.
So, banks are better equipped to deal with shocks that might hit them in the future. Some of them still have to deal with legacy issues, but they are making progress. Non-performing loans have decreased by around 30% over the last four years, from around €1 trillion in 2014 to €680 billion.
All this has made the banking sector more resilient. But we must continue in our efforts to make sure that banks will not have to face the next crisis while still carrying the legacy of the previous one. It would be naive to assume that there will never again be another crisis, so we need to be prepared. And we are prepared. A new European framework for managing crises and dealing with failed banks has been established. This allows us to deal with potential crises in an effective and coordinated fashion, in cooperation with the Single Resolution Board and the European Commission.
What do you consider to be the greatest achievements of European supervision so far and where do you still see room for improvement?
The first thing that comes to mind is how quickly European banking supervision has been built up. The decision to set it up was taken in June 2012 and just two years later it was fully operational. Within a very short time we had hired people from across Europe, devised the core methodology and set up the necessary processes. In my view, this was indeed a great achievement.
Over the past four years we have established fair and consistent supervision across the euro area. By doing so, we have contributed to significantly reducing risks in the banking sector. I have already mentioned our work on non-performing loans and could add many more things: our targeted review of internal models, our work on governance and our stress tests, to name just a few.
But it does not stop there, of course. We have levelled the playing field for banks, and not just because we apply the same high standards of supervision across the euro area. We have also contributed to harmonising the relevant legal frameworks. However, as supervisors, we have limited powers in that domain; it’s up to legislators to further harmonise the rules. And they still have work to do: European banking supervision needs European rules.
Sometimes supervisors seem to be of two minds: telling banks to find ways to be profitable, but not to take on too much risk; to consolidate, but not to become too big to fail. What are the key considerations for supervisors when looking at banks?
Overall, banks need safe and sound business models to serve European companies, small and medium-sized enterprises and households. And that means sustainable, therefore profitable, business models. A number of European banks do not earn the cost of their capital; that is not sustainable over the longer run. If banks don’t make profits, they are not able to build the capital buffers they need; this, in turn, might prompt them to take on too much risk.
So in the end, it’s a question of balance. Banks must be profitable, and banks cannot make profits without taking risks. Indeed, taking risks is in the very nature of banking. The important thing is for banks to be able to properly identify, manage and mitigate those risks. “Too much risk” is risk that exceeds a bank’s capacity to manage and cover it. So this is what we as supervisors pay particular attention to: how does a bank manage its risks?
Regarding the consolidation of the European banking sector, a larger market in which banks are able to consolidate across borders would help to get the banking sector back in shape. At the same time, a healthy cross-border banking market can help to decentralise risks across the banking sector, thereby reducing the chance of a systemic failure. In this respect, regulation has also been improved, of course. Legislators have set up rules, including “gone-concern capital” surcharges for systemic banks, minimum requirement for own funds and eligible liabilities (MREL) and total loss-absorbing capacity (TLAC). On top of that, there are now procedures that should allow even large banks to fail in a more orderly fashion.
You have stressed many times that the objective of banking supervision is not to “save” all banks and that there will always be banks that will fail. What is ECB Banking Supervision’s own approach to risk management – its risk appetite, so to speak?
Our aim is a resilient and well-functioning banking market. And for a market to work well, failure must be possible. If failure was not a threat, competition would end, the dynamism of the markets would be lost and progress would grind to a halt. A zero-failure policy is neither feasible nor desirable. So if push comes to shove, we stand ready to accept the inevitable and declare a bank “failing or likely to fail”.
We cannot and will not prevent bank failures at all costs. What we do, instead, is reduce the risk of failure and mitigate its impact. To this end, we supervise banks in an independent, forward-looking and risk-based manner. At the same time, we work closely with the Single Resolution Board to prepare for potential bank failures. We also require banks to draw up meaningful and reasonable recovery and resolution plans.
Banco Popular, Veneto Banca, Banca Popolare di Vicenza: do you consider these to be failures of ECB Banking Supervision? Why weren’t their problems identified in the 2014 comprehensive assessment, when a solution might have been cheaper?
Well, those banks were identified right from the start as being very weak. When we took over supervision, we thoroughly assessed their weaknesses, and we asked them to take measures to get back on a sustainable path. But they did not take the measures that were needed, or they did too little, too late. So their situation deteriorated further. As a result, declaring them failing or likely to fail was, ultimately, the only possible outcome.
The calls for truly pan-European banks are growing louder, not least to contain the influence of global investment banks. How, in your view, would this be achieved?
As I’ve said, there are still a number of banks in Europe that are not earning enough to cover their cost of capital. That might work for some time, but not forever – it is just not sustainable. There are numerous reasons for this lack of profitability. Excess capacity in Europe in the supply of banking services is one of them. Some consolidation, at the national or European level, is one option to improve profitability.
Thanks to the banking union, there are now more opportunities for banks to merge. The pool of potential partners has expanded, so we will probably see more cross-border mergers in the future. This would not only help make the sector leaner; it would also help deepen European financial integration.
But it is not the responsibility of supervisors to decide which mergers are desirable and which are not. That is the role of bankers and market participants. Our role, rather, is to challenge the expectations of the merging banks; to make sure that the business model of the new entity is based on solid foundations and a credible scenario; and, when necessary, to put certain conditions in place when delivering the authorisation. In this regard, the fact that banks are now supervised in the same manner across the entire euro area is very useful. Obviously, having less fragmentation and a more harmonised legal framework would also facilitate the development of European cross-border banking groups.
Working in the framework of a union with 19 national authorities, each with its own history, experience, knowledge and expertise, what do you see as the biggest advantages and the greatest challenges?
There are many challenges, of course. They range from the lack of a harmonised legal framework to working with different languages and cultures. It requires a lot of commitment and effort to bring together supervisors from 19 countries and 26 national authorities. But it is fascinating to see how people from all over Europe can work together, and how they can improve supervision by identifying and using the best supervisory practices as well as by learning from each other and promoting a common European culture.
There are also many advantages to working together in this way, and it is definitely worth the effort. A European team of supervisors can achieve much more than a purely national one. Different perspectives help supervisors find better solutions. And they help counter national biases, which often get in the way of good supervision. European banking supervision permits the same tough and fair supervision for all banks across the euro area. Ultimately, we are stronger together and both the banks and the supervisors will be better prepared for the next storm.
What ingredients are still needed to complete the banking union? And in your view, what does a strong banking union mean for Europe?
To begin with the second question, the logic is quite clear. A strong banking union means safer and sounder banks, better able to reliably support European companies and households. This is a significant contribution to a healthy economy.
That is the reward, but to reap these benefits we first need to complete the banking union. I’ve already mentioned the need to turn the rulebook for banks into a truly European one. A fragmented regulatory framework cannot support a true banking union. Similarly, we see a lot of ring-fencing fragmenting the market. So, there are still some fences to be pulled down. I’m thinking of obstacles to the use of cross-border waivers for capital, liquidity and large exposures, for instance.
In addition, there is a need for solidarity, as represented by a European deposit insurance scheme. The SSM has significantly reduced risk levels in euro area banks, so the time has come to take that step. At the same time, we also need to establish a European backstop to the Single Resolution Fund.
What is your biggest worry with regard to reforming Europe’s institutional framework?
Ambition and speed are of the essence. My biggest worry is that Europe may do too little, too late to complete the banking union. The memory of the crisis is fading, national interests may take over and the will to embark on European reforms may be weakening. That could easily lead to trouble in the future. European legislators were very brave and very right when they decided to cross the river and move from national to European banking supervision. However, now that we’re halfway across the river, we cannot stop. The middle of a river is not a good place to be when the next storm comes. We have to make it to the other side. Moving ahead is likely to result in lower costs in times of crisis and greater benefits in good times.
And finally, where do you see European banking supervision five years from now?
European banking supervision has come a long way since it was established in 2014. From scratch, we have established a well-functioning supervisory machine. But after just four years, there are of course things which we could still improve. We need to improve the way we take decisions – real delegation of power, embedded in the SSM framework – would help a lot. And we need to further simplify processes, not least to avoid the duplication of work between national supervisors and the ECB. We need to foster the exchange of information and experiences between the national supervisors and the ECB. And more generally, we need to become fully aware that in the euro area bank supervisors now have a European mandate, regardless of whether they work in Paris, Frankfurt, Brussels or Madrid.