Interview with Il Sole 24 Ore

Interview with Ignazio Angeloni, Member of the Supervisory Board of the ECB, conducted by Isabella Bufacchi and published on 5 January 2019

Why has the ECB now taken early intervention measures with the appointment of temporary administrators to Banca Carige? What is the main objective of this urgent action and what is the time frame?

We took urgent action to stabilise the bank’s governance, which was compromised after the majority of its board members – including the Chairman and Chief Executive Officer – resigned. The temporary administrators have all the necessary tools at their disposal to handle the difficult period which the bank is undergoing following the failure to adopt the capital increase at the last shareholders’ meeting. The appointment of Pietro Modiano and Fabio Innocenzi, in particular, ensures both the necessary knowledge of the bank and continuity with a view to moving quickly and effectively towards recovery. The administrators have been given an initial term of three months, which can be extended.

From the ECB’s perspective, what does the virtuous path look like in order for a bank like Carige to quickly restore compliance with the capital requirements and stabilise governance so as to ensure stability on a sustainable basis. Is a merger (or could it be) also among the solutions on the table for Carige?

The ECB has appointed temporary administrators, but it is no substitute for either the administrators or the shareholders. It is up to the bank’s decision-making bodies to find the best solutions for the bank itself. Carige is of critical importance for the regional economy. In the past, the ECB has suggested considering the possibility of a merger with another institution in order to exploit synergies and better diversify risks. It is the task of the administrators and shareholders to determine the most appropriate course for the path to recovery. For our part, as for all of the banks that we supervise directly, the next step will be to set the capital requirements for Carige to meet in 2019.

Failing this, what risks does the bank face if the capital requirements are not met quickly?

The recent bond issue allowed the bank to meet the capital requirements set for 2018. The 2019 capital requirements are not yet known, but they will be communicated in the course of January. The bank must be placed in a position to produce profits, by drawing up and implementing an effective business plan that provides, among other things, for tight cost control. It has the resources and tools to do so.

How do you see the outlook for 2019? Will it be a hard year for European, and especially Italian, banks?

In 2019 we could see a reversal of the economic cycle. Growth will continue in the euro area, but a number of factors, in part related to global developments, may slow it down. The high liquidity and low rates we have seen for such a long time in the main monetary areas have reduced volatility. However, the central banks are gradually reviewing their stance and this could continue in 2019. Volatility in the financial markets has already increased. In this scenario, European banks – and with them, banking supervision – will need to monitor market risks very closely, while continuing to pursue their task of reducing credit risk.

And do the banks, the SSM and the supervisors have the tools they need to address the return of market risk to banks’ balance sheets?

In ECB Banking Supervision we have always monitored market risks closely (including the risks inherent to complex and non-marketable financial instruments). We check whether banks’ internal controls are effective and impose specific requirements. For example, we carry out targeted inspections to verify whether banks’ risk models are satisfactory, and whether their market exposures are correctly classified on the basis of their degree of risk. Partly as a result of this work, the weight of the most risky financial instruments on the balance sheets of the biggest banks has decreased in recent years. The new cycle could result in risk factors becoming more material and provide more fertile ground for contagion, which the ample liquidity conditions of recent years had discouraged. The macroprudential instrument set is also available to control systemic risks; so far it has not been used widely enough.

What does it involve?

The post-crisis financial reform led to the creation, in all countries, of new instruments to combat systemic risk. One of these, the “counter-cyclical buffer”, provides for banks, especially systemically important ones, to build up capital buffers during the growth cycle so that they can be used when the cycle deteriorates. Unfortunately these instruments, which are entrusted to Member States’ macroprudential authorities but in respect of which the ECB can also intervene through a decision by its Governing Council, have not been used enough in this economic cycle.

Could the absence, or the insufficient size, of the capital buffer, and the lack of sufficient stocks of this ammunition to tackle the reversal of the cycle, undermine investors’ confidence and thus the stock market performance of banks’ shares?

Italian banks have reduced their levels of non-performing loans (NPLs) and increased their NPL provisioning, following the recommendations of European banking supervision and the regulators. As a result, they are winning back some of the market confidence that they had lost. Over the last three years Italian banks have made considerable efforts and, before the spread widened and thanks to renewed investor confidence, they succeeded in completing a number of recapitalisations: not just the two big banks, Intesa and Unicredit, but also the medium-sized banks. I’m referring, of course, to most of Italy’s banks, without ignoring the fact that specific weaknesses still exist in some institutions. Now we need to go further by reducing costs, rationalising business models, including through automation, and increasing profitability. Sometimes in Italy there is talk of the supervisor being biased against Italian banks. On the contrary: lately, in particular, European banking supervision has shown appreciation for the efforts they are making on the road to recovery.

Italian banks have suffered in recent months from the widening of the spread, which has affected their sovereign risk exposure and as a result eroded their capital. How much does the spread weigh on them?

It can only be a negative thing for a banking system that is recapitalising to go backwards and lose capital. Moreover, the wider spread also increases the cost of funding. The extent of the negative impact varies from bank to bank. It has to some degree been limited by the diversification of banks’ portfolios, which has led in recent years to a gradual reduction in the volume of Italian government bonds held by the banking system and by a shift of securities to accounting categories less sensitive to the “spread effect” (securities held to maturity). But it remains significant. The way forward is to reduce the spread, which has a knock-on effect, including through the banks, on all Italians.

The European Council and the Commission have launched important financial reforms. Some expected more, some less; as usual, the result was a compromise. What is your view?

The “banking package” is important. This is the first time banking law in Europe has been revised since the launch of banking union. It was an opportunity to make the legal framework in which banks and supervisors operate more coherent and harmonised, and thus less complex and easier to apply. More could have been done; in some respects it is a good package, while in others it is lacking. The new regimes on liquidity, maturity transformation and leverage are positive. However, a consistent effort towards harmonisation across countries and further simplification of the rules has not been made. In many cases, what remains is a case-by-case approach. And in some respects, the situation has actually been made worse, because the tools needed for effective supervisory action are being limited.

Worse in what way?

For example, measures to accommodate specific situations and interests are being introduced.

Can you give an example?

One of the provisions of the new banking package, for example, relates to a form of state-backed savings account in France, which will be facilitated by legally exempting it from the rules on leverage. By its very nature, leverage must be measured on the basis of the whole balance sheet, without exceptions and independently of risk level. For this reason, government bonds are included, for example. Legally exempting part of the balance sheet from the leverage calculation goes against international standards. It is necessary to find a balance between different financial intermediation systems and forms of saving, some of which are common only in certain countries for reasons of tradition, but it is equally necessary to continue decisively and consistently towards harmonising the rules for the whole system.

Are we far, then, from the goal of a fully liberalised and harmonised European financial and banking market?

Capital and liquidity are insufficiently mobile within the large banking groups that operate in several euro area countries. The European Central Bank pushed for more liberalisation in this respect in the banking package. That didn't happen. After the financial crisis, individual countries erected barriers (“ring fencing”) to retain capital and liquidity in locally domiciled banks, despite there being a unified supervision system in Europe. What is needed is more liberalisation, removing those prohibitions that prevent capital and liquidity from being allocated among European countries efficiently; otherwise, the costs of cross-border banking will rise. And banking integration will not move forward.

Could the SSM also do more?

ECB Banking Supervision is not a regulator, it is a supervisor. The Regulation that established the Single Supervisory Mechanism in 2013 gave us powers and tools, but only within the legal framework: we have to use the law to carry out the tasks conferred on us. If the law allows one thing in one country and something else in another, that limits us in our work, and we can't do anything about it. Banking law and secondary regulations need to be made the same for everyone, gradually leaving behind the concept of specific rules and the national scope of banking systems. In addition, in some areas the scope of supervisory action has been further restricted, by European legislation itself.

Can you give us an example of that, as well?

I can give you two. In the first place, with the current revision of the legislation, some details of which have not yet been approved, it seems that the intention is to introduce the possibility for banks to meet Pillar 2 requirements (those imposed by the supervisors for specific risks) with capital of a lower quality – for example, subordinated debt. This capital is not able to absorb losses as efficiently as CET1 (Common Equity Tier 1), the definition of which was introduced after the crisis precisely to make banks more secure. So far the ECB has always requested the use of CET1; with this new rule, we'll be going backwards. The second example: the legislator wants to allow banks that sell large quantities of non-performing loans to not take the conditions of sale into account in their valuations of other loans still on the balance sheet. The legislation in force requires that all relevant information be used within margins of flexibility managed by the supervisor. This new rule (which would even have retroactive effect) will not make banks’ balance sheets any clearer. In the long term, the Italian system will also suffer, rather than benefit, from that.

Does the fact that the banking union is not moving forward show that individual countries are thinking about themselves, in a nationalist spirit?

The banking union is a collaborative project that pursues the general interest and can only progress if all the euro area countries, as well as the European Union institutions (the Commission, the Council and Parliament) are committed to it. Sometimes, certain political forces seem to find it hard to identify with this project, perhaps suspecting that because it is “European” it might conflict with national interests. They should be reminded that the banking union was designed first and foremost to reduce risks for depositors and taxpayers. In Italy there are over 40 million depositors and 40 million taxpayers, not counting all the citizens who pay indirect taxes. The banking union is therefore in the interest of everyone, or, if you prefer, of what we might call “the people”. The Community has given the SSM the task of supervising banks in the general interest. Independent institutions with a specific mandate do not evade the democratic system, but are an integral part of it.

What’s your view of the new law establishing the ESM backstop for the Single Resolution Fund for banks in Europe?

To function as a lender of last resort, the backstop should be unlimited. But instead it will be the same size as the Single Resolution Fund, that is, €60 billion. Not only will the backstop be insufficient in size, but it will begin operating only gradually and will be constrained by a number of conditions. It will therefore be weak and probably not enough in itself to reassure the markets. In the United States the resolution fund has a credit facility with the US Treasury, for instance. In Europe the backstop will come into effect after the resolution fund has exhausted its resources, and its use will be strictly limited.

What about EDIS? There’s been no progress on that front.

The European deposit insurance scheme is, unfortunately, at a standstill. This is a further demonstration that the initial banking union project has stalled halfway. In the next few years we’ll need to find a new impetus to pursue the essential goals: limiting the burden on taxpayers as far as possible and making bank deposits throughout the euro area increasingly safe.

Brexit: if the United Kingdom leaves the EU without a deal, will this be a “black swan” event for banking supervision in 2019?

European banking supervision is engaged right now on two fronts: European banks with a presence in London and non-EU banks that use a European “passport” to serve their customers in continental Europe from London. To the first category of banks, we said that we will not accept “back-branching”, that is, the use of branches in London, sometimes very well equipped and very big, to operate with a European customer base. Otherwise, we could not properly monitor and control the risks that our banks would be exposed to through those branches. As for the second category, we ask that non-EU banks establish a real presence, not just a formal one, on the continent. That means structures of a sufficient size, managerial capacity, risk control, prudential requirements, and so on. Essentially, everything that’s needed to create a sound bank.

And the post-Brexit derivatives time bomb?

In the event of a no-deal Brexit, central clearing of derivatives in London can continue without disruption, albeit for a limited period of time. The European Commission decided this recently, specifying a transition period of one year. Similarly, the Commission decided to put in place measures to ensure that there is no disruption to the services provided by UK central securities depositories, specifying a transition period of two years.