Interview with the Financial Times

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Claire Jones on 13 March and published on 19 March 2019

You have mentioned in the past that the SSM is now going from a start-up phase to becoming a more mature institution.

I would highlight three points. One is that when you put together 19 different supervisory authorities, with very different traditions and practices, there is a period in which national dynamics are still very strong. You see this in the functioning of the supervisory board and in the public debate. I received, frequently, letters from MPs from Germany, enquiring about non-performing loans in Italy, and from MPs in Italy, enquiring about complex assets in German banks.

We need to move to a setting in which you really have a genuine feeling that you are a European organisation, dealing with European banks, with European processes and with a truly integrated European culture. A lot has been done already here, but I think that’s the first point.

The second is the issue of how rules-based the approach should be. It’s clear that, at the European level, when you start something, when there is an initial lack of trust, when you move from different starting points, the way in which you bring everything under a common umbrella is by writing down exactly how to do things, making it naturally a bit rules-based.

The more you move towards a mature organisation, the more you can let supervisors exercise their judgement on the basis of the specific situation of each and every bank. You will achieve consistency with lighter tools, such as ex-post checks and quality assurance.

And the last point is the issue of transparency. Everybody out there must be able to understand well what we are doing. We need to be predictable and it should be visible to market participants, to investors, to analysts, where the banks are with respect to where we want them to be.

If I achieve progress in these three areas I will leave my successor in a much more stable, business as usual place.

A final point. Supervisors don’t want to be in the news that much, so when you are in a mature organisation nobody should notice you are around anymore.

You mentioned that banking sectors remain very much drawn on national lines. To what extent do you think the onus is on the SSM to spur integration? And what still needs to be done by Brussels, working in tandem with national governments?

We have already done a lot in terms of what supervisors can do to produce more integration. At the political level in Brussels, the European Council level especially, there is still reluctance to move further ahead.

Two main points; the first is that a market which remains to a large extent fragmented along national lines does not help in absorbing shocks that hit one part of the system. If you have a shock hitting a specific Member State or region, you need a system that helps absorb it better; that’s why the capital markets union and banking union were conceived in the first place.

At the moment though, the banking sector is still not a shock-absorber, it is still a shock amplifier. This has serious implications also for the functioning of monetary policy. So, it is a big issue for the other side of the ECB too.

The second aspect is that, segmentation along national lines, together with the low interest rate environment, contributes to European banks being perceived as structurally lacking profitability. That, in my view, is a major concern.

I understand the position of Member States. National authorities think if something goes wrong, then there will be an impact in their jurisdiction. The safety net remains, to some extent, national. And they will have to respond to their national constituency. That makes them think they must constrain the ability of banks to move assets and capital liquidity freely across borders. They want to protect the local markets.

The problem is that the more you do this, the less you allow banks to be profitable. And, paradoxically, the more you make banks fragile, in the event of a shock.

There is a problem, which I view as political, which needs to be addressed.

We as supervisors can do something to develop an agenda for integration. But one important element will be to help the debate on policy in Brussels to become more aware of these issues, and to find positive ways forward.

To play devil’s advocate, if you’ve got local banking, you’ve also got a lot of local knowledge and does that not confer some protection on lending?

My point is not that you should have only large European banks fully diversified across the euro area. Having local banks is an element of richness of our banking sector.

What I mean is exemplified by what happens in the US. There, when you have a shock hitting banks in one particular area of the country, you have the FDIC entering the frame and allowing management of the crisis where banks from other states buy local assets, deposits, branches, restructure the business. That helps contain the crisis and absorb shocks.

Households and corporates, don’t even notice this. They receive a letter saying that your bank, which until yesterday, was called ABC, from tomorrow will be called XYZ.

In Europe, a number of crises have hit banks in some regions. You have had the Irish banks, the Spanish banks, the Portuguese banks, the Italian banks. Restructuring has been entirely national. The only players which have entered are private equity, which have entered mostly with a focus on extracting value from the distressed assets more than building a business. Don’t get me wrong, it’s good that they do that; that investors intervene and put money in the banks when there is a crisis is very positive. But there is a lack of diversification to absorb shocks, and this is still a weak feature of our institutional set-up.

Could you give a few examples of how this space for more judgement would work in practice?

The Pillar Two process is very cumbersome at the moment. It’s clear that this is the area where the national approaches were more diverse when we started. We have some way to go before they are so fully integrated that you can rely on the supervisors dealing with the banks on a one-to-one basis to exercise more judgement, make the assessment and help the bank improve its own position.

This links also to the point on transparency. Sometimes the banks have complained that they don’t entirely understand where the Pillar 2 outcomes come from. You need to be more able to communicate to the bank which actions you want to see taken in order to correct the shortcoming you identified.

I’m not criticising. It’s a huge effort to bring the different national processes together, and the first way to do that has been to codify it. This has made the process a bit heavy and a bit opaque so far. The point is, really, to make sure that it is more tailored to the bank. And to have a system which is more effective in identifying the specific risks that you want the banks to address.

Sometimes I hear supervisors say, ‘I see a banker trying to do the right thing, we would like to help but then I play through the rulebook and I make his or her life more difficult’. You want to have a situation in which the supervisor has sufficient leeway and confidence to use tools to do the right thing. Of course you always need to ensure consistency as well. The consistency of outcomes, the fairness, the fact you apply the same approach in similar circumstances is and will remain an important element of European supervision.

And in terms of there being more transparency, would you see it playing a big role in the SREP?

At the moment we publish a lot of data but we do not publish clear information about where the supervisor is putting the bar. The disclosure differs across countries. You have Member States where everything is published -- the Pillar Two requirements, the Pillar Two guidance, and even the soft recommendations that we send to banks. Then there are other Member States where only the Pillar Two requirement is published, and others where almost nothing is published. We need to have a more unified way of communicating this information to the market.

While there is some soft information in terms of recommendations that supervisors give to banks, which should remain part of a private dialogue between the supervisors and the banks, other aspects -- such as the Pillar Two requirements, and maybe even the Pillar Two guidance -- are information which is relevant for investors to understand where the banks are with respect to where the supervisors want them to be.

One important reason for this is that we are moving from taxpayers bailing out defaulting financial institutions to the concept of bail-in, where private investors are first in line to take losses. We need to create an environment in which investors have an adequate access to information about the banks they invest in.

Should banks have their business models assessed to see whether or not they can still make a profit when interest rates are zero?

A low interest rate environment might be a challenge in terms of profitability. Still, if you look around the European market right now, we have banks that in the same environment have been able to make changes, adjustments to their business model, that allow them to be profitable. They have been very effective in terms of cost reduction, cutting the number of branches, investing more in new technologies for the distribution of their products, refocusing their business on core areas and exiting other less profitable areas.

So there is a lot that banks can do. And that’s what we, as supervisors, need to push them to do.

Banks need to be able to cope with any interest rate environment. When I started, I remember my first meeting with a board member at the Bank of Italy in the early 90s, was about the high interest rate environment and all the damage that it was doing to banks and growth. The tendency is always to consider the environment in which you live as permanent, but this will not be permanent. There will come a time when there will be a normalisation of interest rates and banks will again face market risk and funding risk, and they need to be prepared for that as well.

Let’s also not forget that a low interest rate environment is of course compressing interest margins, but it’s also helping in other areas. In terms of trading income, or managing non-performing loans, it has provided an incredible window of opportunity for dealing with asset quality progress. To some extent, I am glad that we still have this window to allow more space for the adjustments.

Some people think that European banks are now lagging behind the US and Asian counterparts; is this true? And is it something that you think the SSM should be addressing, for example with a policy of favouring national champions?

It’s undeniable that European banks, at the moment, are not perceived by the market as particularly strong and profitable. If you look at the market valuations and the price-to-book values, this is the judgement of the market. This is no surprise; in Europe the sovereign debt crisis has left a major legacy on top of the Lehman crisis in terms of heavy recession and a deterioration of asset quality across the continent.

Having said that, I don’t particularly like the idea of national champions, of European champions; I think that, especially when you are a supervisor, you shouldn’t promote any particular structural outcome. And, actually, you want to have a market which is open, so if there are foreign banks, foreign investors, bringing their expertise, their capital, into your jurisdiction, that should be welcome.

Of course, as a supervisor, I care if I see European banks are not seen as attractive investment propositions for investors, that’s a problem. Until this changes I think we cannot say that the post-crisis adjustment process has been completed.

Going back to the issue of more integration; how important a part of this is a Europe-wide deposit insurance scheme?

Having a deposit guarantee which offers the same level of reassurance to retail depositors everywhere in the euro area is an important component of the framework. If a deposit in Greece is not considered as having the same value as a deposit in the Netherlands, it’s clear that the single currency suffers as a concept amongst citizens.

On this issue there seems to be a misperception at the political level. The impression of politicians is that with such a scheme you are signing a cheque for a joint guarantee on all deposits, which total around €6.2 trillion. That’s not the case. A deposit guarantee scheme is private, so it’s financed with fees paid by the banks that are risk-based. And if you calculate insurance fees in an appropriate way, there shouldn’t be any need to activate any backstop. And even if that happened, for example in a systemic crisis, the scheme would be replenished by the banks themselves. The only point of having the guarantee is to provide reassurance to all citizens that the protection of their deposits is not dependent on local conditions, but truly European.

One example of where you have seen some cross-border integration take place is here in Germany, with ING DiBa which, through its internet banking operation, seems to have done quite well. In what sense do you see digitalisation and technology as a means to promote more integration?

Whenever we talk about new technologies, it’s always presented as a challenge for the banking sector.

Actually it could be a golden opportunity for more cross-border provision of banking services.

So far no bank has really been able to take an important position in a non-domestic market via remote provision of services or branching, as it was expected 30 years ago, when the single passport for banking services was launched. The only way in which there has been sizeable integration is via banks buying local banks in other countries.

I can tell you a personal anecdote about this. I’m from a small city in Italy, on the seaside, La Spezia, and a local bank there years ago went through a crisis and was eventually bought by Credit Agricole. It has taken quite a number of years to substitute the local brand featuring the name of the city, with the Credit Agricole brand, as the perception was so strong that you needed to maintain a local brand to retain your local customers.

But when I look at the younger generations, I see that they are very comfortable using digital banking accounts, with zero cost of entry, no matter where they are located. They are much more open to using these technologies.

This can really change the way in which services are provided within the euro area, leading to more integration through that channel.

Big data is also changing the credit scoring banks need to do to grant, say, a mortgage.

To what degree are you concerned about the sovereign-bank doom loop? What could you do as a supervisor to address sovereign risk at banks?

As supervisors, we cannot apply different rules than the ones which are in the rule book.

During the sovereign debt crisis, while I was at the EBA, we were unable respond to the request of investors for greater capital coverage for sovereign risk in our stress test, as our Board felt that we had to apply existing rules which led to zero or very low risk weights for sovereign exposures. So what we did was to provide more disclosure. But eventually, after a few months, we also asked banks to put some capital aside to cover for the mark-to-market losses on sovereign exposures, irrespective of how they were classified for accounting purposes. I believe the application of mark-to-market valuations can go a long way in addressing this issue.

The regulatory framework, with the liquidity coverage ratio, requires banks to hold liquid assets, mainly sovereign securities, to be better able to withstand a liquidity shock. So we want it to be that if there is this shock, they need to be able to sell these assets in the market at short notice, which means that they should mark to market these exposures, basically. This would already give a very strong incentive to banks to actively risk-manage these portfolios.

Then as a supervisor, what concerns me is the high concentration of exposures on the domestic sovereign. There are levels of concentration, sometimes, that are extreme.

The last time I saw the data you had banks which had ten times their tier one capital in the domestic sovereign. If you mark to market this exposure, with a decline of five per cent in the price of that sovereign, you have half of the capital of the bank wiped out. As a supervisor, you cannot like that.

And you think the way to apply pressure is just to be checking the mark to market value and be asking banks to book that, and then hold capital against that?

Sure, mark to market pushes the bank to manage these risks more actively. The second point is to avoid excessive concentration.

And what are the other key risks that you see to European banks at the moment?

We still have the legacy issue of non-performing loans. And the macroeconomic outlook seems to be deteriorating. You need to complete this process of cleaning the bank’s balance sheets before you enter the next recession.

Market risk and funding risk could also increase in the future as rates rise. That is not an issue right now, but it’s a point on which we need to keep our attention.

Another area to which we are devoting more and more attention is conduct risk. I had seen this as a legacy issue, but it seems it’s more a case of different cycles of cases while the underlying problem is not going away. First, manipulation of market benchmarks, then mis-selling, then financial crime and money laundering.

We need to find ways of dealing with that.

What can you do to combat the money laundering scandals we have seen over the past year?

We are prudential supervisors, we are not primarily responsible for conduct.

There are limits to what we can do. One of the key elements of anti-money laundering (AML) supervision, for instance, are Know Your Customer processes. We cannot go into these files and review the Know Your Customer processes of the bank. That’s not our task. And if the bank doesn’t want to show us this information, the law is on their side.

But via our focus on governance and internal controls we can and should contribute to address these issues. We need to find ways of engaging more and more with conduct supervisors, AML supervisors. We have signed an MOU with the AML supervisors, in which we commit to exchange information in both directions and to cooperate in the performance of the respective tasks. So we need to make this work in practice.

You ultimately need stronger European arrangements, though. We can help, but we cannot fully substitute for a lack of such arrangements.

If there’s a merger of two very big but rather problematic banks, what role does the SSM play in addressing whether or not it should happen?

We have a very straightforward set of tasks. We need to look at the business plan, how robust the business plan is in terms of the viability of the bank that will result in the case of a merger. You look at the continued compliance with the regulatory requirements, you look at execution risk.

You look at the solidity and sustainability of the resulting bank with a prudential eye.

And how do you deal with an institution that’s already deemed too big and too important and too interconnected to fail becoming even bigger?

There are internationally-agreed standards that imply that the more systemic, interconnected, and internationally relevant the banks become, the higher the capital buffers they are required to have. This is codified internationally, it is the same for any global bank and it is therefore neutral in terms of the competitive position of the bank.

What do you do if you don’t really see there being a strong business case for something, if you see it being more politically-motivated?

Well, again, for me political motivations don’t matter. I cannot even consider them. What is relevant for us is the deal which is put forward to us, and the only things we care about are the sustainability of the project, the viability of the project. So, the ability to deliver a bank which has a strong business, a good capital position, is able to generate profits, and to respect in the medium term the standard requirements, prudential requirements, that is what we look at.

Does Europe need a big global investment bank?

We should not have a policy of promoting a European champion in this area. I hope that European banks will be strong and profitable enough to gain market share and to be effective also in the provision of capital market services and to compete with US players. Some of them are, actually.

What are the risks from a hard Brexit? And do you feel on top of them?

This is an element of risk that we could have done without, but we had to prepare ourselves, and ask the banks to prepare. We have done what was needed to be ready. At the moment we are completing the licensing processes linked to the relocation of business from the UK to the EU. We asked the banks to have a significant managerial risk management capability moving to the EU, and we are now satisfied with the models and the approaches that we see. If you are interested, I can provide you with some figures.

Yes, that would be good.

We will have seven additional significant institutions coming under our remit as a result of Brexit, 17 new less significant institutions. We see banks primarily moving to or expanding existing operations in the financial hubs in Germany, France, Ireland and the Netherlands. There are also both significant and less significant institutions that are expanding their business in the rest of the EU as a result of Brexit. We are asking banks to provide us with their target operating models on how they will gradually move assets from the UK to the euro area, and we expect around €1.2 trillion of assets to be moved to be under the supervision of the SSM. This is concentrated -- let’s say 90 per cent -- in the seven largest institutions. So that’s what we see.

We have a few cases in which the banks will not have the licence completed by the end of March, but these are banks with not very significant business with European counterpart and that were in any case planning to start or expand operations later. And they have prepared contingency planning anyway.

The most important thing I want to stress is that we are prepared for Brexit but it’s something unprecedented. We cannot rule out that there will be market disturbances -- or developments which had not been priced in by markets. In this situation what is most important is to have strong cooperation with the UK authorities.

We have from the very beginning had very good cooperation with the PRA and the Bank of England. The arrangements are now basically finalised. The EBA conducted the negotiations for the MOU between the EU authorities and the UK, and technical negotiations have been finalised.

I understand there has also been progress in the finalisation of the legislation on investment firms at the European level. There will be a clustering of different investment firms, in four buckets. And one of these buckets, the one containing firms which are more bank-like and systemically relevant, will come under the ECB’s supervision.

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