Interview with Il Sole 24 Ore

Interview with Danièle Nouy, Chair of the Supervisory Board of the ECB, conducted by Isabella Bufacchi and published on 24 November 2018

Is the European banking system safer today compared with 2014, when the ECB took over banking supervision?

We have delivered in making the European banking system much safer and sounder. It is better able to serve European people and companies and fund the economy. Compared with 2015, or indeed the end of 2014, when the ECB took over banking supervision, banks have more capital and, most importantly, they have better-quality capital. Their tangible common equity, the highest-quality capital, was around 12% in 2015. It is now around 14%, on average. This ratio improved in spite of the fact that some banks used part of their solvency buffers to reduce legacy assets and had to take losses. But it is not only about capital. The liquidity situation has also improved; liquidity is now better controlled and managed. New rules on liquidity ratios, though not yet binding, are already producing results. We have also benefited from new regulations on governance. Europe was lagging behind the United States on this issue. So, we have made a lot of progress but we still need to do more, on “fit and proper” for example. These rules, which aimed at having bankers who are competent and honest, are an old part of the directive, transposed differently in the euro area countries and not up to the challenges of modern banking business.

What more can banks do?

We have done a lot to make banks safer and sounder, but the banks themselves still need to do more to become more profitable. That would allow them to build their buffers to prepare for the next crisis. They are moving in the right direction, but they have not yet done enough.

What can be done to improve profitability in the European banking system?

There are a number of issues. It is clear that banks with high levels of non-performing loans (NPLs) need to reduce them further to be more profitable, but this is not the only factor. In general, there is an overcapacity in the offer of banking services. Too many banks are competing for the same customers. This is not the case everywhere, but in several countries competition is very tough. Many banks are not earning the cost of their capital, and that is not sustainable. Nevertheless, if you look at the data you can see that, in the euro area, two dozen banks have consistently outperformed their peers in terms of profitability, ever since the beginning of European banking supervision. And these two dozen banks come from different countries; their size and financial structures are different; they are listed banks, cooperative or mutual banks; and they have different business models.

What makes these banks successful?

I would say it’s their steering capacity, paired with good execution capacity, meaning that they are able to take the right decisions and implement them. In these banks, the boards properly challenge the senior management, by having discussions, posing questions, asking for a change in course when needed, and not waiting too long to address unprofitable businesses.

Do you favour one business model over another?

Profitability is not about a single size or a single business model. And we do need diversity. In Europe we need all kinds of banks: large, medium-sized and small banks; universal and specialised banks; listed, mutual, public and cooperative banks. But we also need boards and senior management capable of steering their banks. Some banks’ board members and senior management have not completed the review of their business models to assess whether or not they are sustainable in the medium term.

You mentioned NPLs. Where do we stand?

The level of NPLs on banks’ balance sheets is now about €650 billion, compared with €1 trillion when European banking supervision began in 2014. €1 trillion was a scary amount! Now banks are much safer. Italian banks in particular have done a good job in reducing NPLs. The level of NPLs is going down every day. But there is more still work to do.

How would you assess the Italian banking system: is it safer now compared to 2015?

As in several other countries, you have all kinds of banks in Italy, it is an interesting market. The situation is very diverse from bank to bank. The best performer in the 2016 European Banking Authority (EBA) stress tests was Intesa. There are also banks that have managed successful turnarounds, such as Unicredit. And some other banks still have work to do to improve their situation.

You said that there are too many banks in Europe, that it is “overbanked”. What can we do to reduce the number of banks in Europe?

Cross-border mergers and national consolidation should be encouraged, as both are good solutions to reduce overcapacity. But the situation is very different from country to country. We have 3,000 less-significant banks in Europe: 50% of them are in Germany, 25% in Italy and Austria. In some other countries, on the other hand, such as France, after the crisis in the 1990s, the banking system is already pretty concentrated.

Having 19 jurisdictions does not help cross-border mergers, as they are very expensive in Europe.

In part, cross-border consolidation has diminished following the crisis. Banks were more adventurous before the financial crisis; their risk appetites were bigger. Now they have become more cautious. But I agree that regulation also plays a role. We need the euro area to turn into a single jurisdiction, and the sooner we have it, the better. We must harmonise our 19 different legal frameworks and create a truly European market. It would allow banks to more easily reach across borders and draw from a larger pool of potential partners for mergers. Moreover, savers would have more options when investing their money; and companies would be able to tap more sources of funding.

Is EDIS important? Progress is slow, or even non-existent, and there is no road map yet to get there. But do we really need EDIS?

The sooner we have the European deposit insurance scheme (EDIS), the better. The ring-fencing that occurred at national level after the financial crisis is still in place; it must be removed; but this is unlikely to happen before we have EDIS. The SSM has significantly reduced the risks in the euro area banking systems; everybody recognises this, although some are asking for more risk reduction. I am saying that risks have been reduced and the time has come to start the journey towards EDIS. The ECB position is well known – risk reduction and risk sharing have to move forwards in parallel. We need a road map to move forwards with risk sharing, with measureable and verifiable steps. The weaknesses revealed by the crisis triggered the euro area journey towards a banking union, and its decision to “cross a river”. We have left national supervision behind but we have not yet reached the other side. We are now halfway across the river. This is not a good place to be when the flood comes! We have to make it to the other side.

Some people argue that cross-border M&A creates new banks that are too big to fail, so this creates new problems.

A bank that is too big to fail at the national level is not necessarily too big to fail at the European level, especially when we will have EDIS and a European back-up for the Single Resolution Fund. We need a truly European market, that is closely integrated and comprised of different kinds of banks, including a few European champions to help large European corporates to export to the rest of the world.

You aren’t in favour of M&A to solve problems at specific banks: you once said two ducks don’t make a swan…

Yes, that is a German saying. I like it and I use it because sometimes national politicians seek to solve a banking problem with the merger of the weak banks; but the success of such an operation cannot be taken for granted. It is more likely to result in a bigger, more systemic problem. On this merger issue, let me tell you that, in my view, it is not the job of the supervisors to say what are the “good mergers”. It should be the bankers, the investors, the market participants who decide what are the good, desirable mergers. Our role is to assess the business model, the strength and possible weaknesses of the new bank that is created after a merger. And to mitigate the identified weaknesses, we put some conditions for authorising a merger. For example, we may ask for some clean-up of the balance sheet, or for more capital. Mergers can be dangerous if they are not planned and executed properly.

Italian banks now have another problem – a higher spread. The country risk premium went up sharply, so banks are paying more for their funding and SMEs and households are paying more too.

This higher spread is definitely not welcome. It would be a pity if Italian banks, that have worked very hard to reduce their NPLs and improve their situation, were losing the benefits of these efforts. And it would have an impact on the availability of credit to the economy.

Rising government bond yields caused by a rise in country risk are intensifying the debate on the sovereign exposures of European banks, an unsolved problem as government bonds are not risk-free assets. What is your opinion on this burning issue?

The crisis has indeed taught us that sovereign bonds are not risk-free assets. On this issue, the ECB position follows four principles: (i) the regulatory change should be based on both the quality of the sovereign risk and its diversification, rather than on quantitative restrictions; (ii) it should avoid causing market disruptions; (iii) it should be agreed at a global level, given the potential impact and the need to ensure an international level playing field; and (iv) a transition period is needed.

What about derivatives and Level 2 and Level 3 assets: are these risky exposures under control?

Regulation and supervision of derivatives has indeed been improved. Moreover, banks have reduced their appetite for complex products; they have learnt from their past mistakes and are less involved in such operations. Level 2 and Level 3 assets are not bad products as such; they are just exposures that are more complex to value. Our supervisory work hence focuses on the correct classification of these exposures as well as the soundness of their valuation framework. Our assessment of the valuation risk is based on a combination of on-going monitoring, very detailed “deep dives”, and on-site inspections of the less transparent portfolios, in particular within “campaigns”, where we send inspectors to several banks at the same time to compare peers. Moreover, we will be launching a new data collection exercise fairly soon for large institutions, to check whether we know everything we should know.

When is this new exercise on data collection going to take place?

We are currently testing the templates containing the questions with the involved banks. If there are no big changes, it could be launched in a matter of weeks.

What are the biggest challenges for your successor, the next Chair of the Supervisory Board, Andrea Enria?

Andrea Enria is a very experienced candidate. He has all the qualities needed to be a good Chair of the Supervisory Board of the ECB. The challenges are what we have been discussing in this conversation. Profitability is the big issue for most SSM banks, and we have to keep observing how the banking sector evolves in this respect. We should then continue working on the reduction of NPLs and on fostering the harmonisation of regulations and legal frameworks. We should also do what we can to foster the completion of the banking union, particularly through EDIS. And work has to be enhanced in the fight against money laundering in the European banking system. There is a plan to give the EBA more power to address money laundering risk. I think that all improvements are welcome.

What is the most difficult decision you had to take as Chair of the Supervisory Board, given that ECB Banking Supervision takes 2,500 decisions per year? And do you have any regrets?

The most difficult decisions to take are the decisions that will have painful consequences for the customers of the bank, and in particular the investors and depositors. I have been working in banking supervision for almost 45 years, and every time I have to take decisions that I know will have painful consequences for people, households and corporates, such as when we have to take a failing-or-likely-to-fail decision, believe me, it is not easy.