Interview with Delo

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Miha Jenko and published on 11 June 2019

Mr Enria, can you describe the current condition and health of banks in the euro area?

European banks have improved considerably compared with five years ago, when the Single Supervisory Mechanism was established. Their capital adequacy has improved significantly, the quality of their assets is higher and their liquidity position is much stronger. At the same time, supervision of banks is also more robust and better integrated.

So are European banks a completely safe place for our savings and deposits now?

Some issues remain, of course. First, we are still dealing with the legacy of the last financial crisis: non-performing loans (NPLs). And this process is not yet complete. There are several banks and banking sectors in some countries where the ratio of NPLs is still very high. As a consequence, and in order to avoid the adverse impact of NPLs on banks’ viability and profitability, the European Central Bank (ECB) has created a consistent framework to address the problem. But there are other significant risks as well: macroeconomic forecasts are getting worse, there are political uncertainties linked to Brexit and risks related to new technologies and cyber security. So while the situation has improved, we should remain alert to the risks.

In your view, what is the current situation of Slovenian banks? It is widely known that some banks were in serious trouble during the crisis and were then rescued by the Government in 2013 through extensive recapitalisation and restructuring. Are our banks safe now?

Slovenian banks went through a severe crisis, which required the use of state aid. But the Slovenian banking system is much safer now. The capital adequacy and liquidity positions of Slovenian banks are higher than the European average, and asset quality has improved considerably. Of course, the process isn’t yet complete. The banks still have some work to do, but their position has improved.

You mentioned NPLs and that individual banks and countries are having varying degrees of success in addressing this problem. Could you specify which countries? Is Slovenia among them?

In general, we don’t want to talk about specific countries, because we consider the euro area to be a single jurisdiction. But it is true that the crisis affected banks in different countries in different ways and at different times. The legacy of NPLs is still having a significant impact in Italy, Greece, Cyprus, and Portugal. Spanish and Irish banks have made further progress, but they still have some way to go. And although Slovenian banks have decreased the ratio of their NPLs, there is still room for improvement.

Can you give us some up-to-date figures that illustrate the total volume of NPLs and the extent of the problem in general?

When ECB Banking Supervision started in late 2014, the total amount of NPLs was approximately €1 trillion, i.e. €1,000 billion. It now stands at €580 billion, meaning that it has almost halved. The ratio of NPLs to total loans has decreased from around 8% to below 4%. We see this trend across most of the euro area. However, there are still banks with NPL ratios in double digits, i.e. higher than 10% or even 20% or 30%. So, there is still a lot of work to do.

There is a saying that bad loans are made in good times. Over the past few years, in Europe we have had relatively good times, with relatively high levels of economic growth. Have banks – to avoid unpleasant surprises later on – made enough provisions for bad debt, which could be generated right now in these relatively good times?

There have been significant changes in the European framework to deal with bad loans. The ECB specified its supervisory expectations for prudent levels of provisions for both legacy stocks and new NPLs, and there is now also a legislative minimum loss coverage for new NPLs. Against this background, we expect banks to completely write off loans that have become non-performing after a certain period of time. This should prevent large build-ups of NPLs in the future.

The European Banking Authority (EBA), which you chaired for a number of years, conducts stress tests of banks. What is the current status of these stress tests? Will they continue in their current form or are any changes foreseen?

Stress tests are an important addition to the supervisory toolbox that was created after the crisis. They are also important for risk management within banks. Going forward, they should remain an important feature of the supervisory framework, but some adjustments could be considered. We are currently discussing the issue, so it is too early to predict the outcome.

What are the key future challenges and risks for the European banking industry and banking supervision? Do you consider new competition, such as fintech and cryptocurrencies, and new disruptive technologies to be among them?

I will start with an old risk, which is, however, linked to the introduction of new technologies and is the main issue for European banks right now – and that is low profitability. More precisely, current and expected weak bank profitability, as reflected in their very low market valuations, is a source of concern. A way of dealing with this issue is to improve their cost efficiency. And one means of achieving this is to invest in new technologies. We have seen that banks which invest in new technologies improve their profitability. Therefore, the advances in fintech and new technologies should not just be seen as a challenge to the banks, but also as an opportunity to increase profits.

You mentioned low profitability: there are currently around 6,300 banks in the euro area. Are there too many of them and does this increase costs?

AE: Consolidation is an important measure to restore efficiency after a crisis. This is not only true for banking but also in other sectors that have undergone a severe crisis, such as the automobile sector and the steel industry. It’s important that we look at similar processes taking place in other areas. There is excess capacity in the system and it is indeed a drag on profitability.

So are you in favour of mergers between banking groups in the euro area?

It is not for supervisors to decide on consolidation and mergers. Such decisions are in the hands of banks’ management, owners and shareholders. But looking at the system as a whole, some consolidation would certainly help to restore efficiency in the system and eliminate excess capacity. And some cross-border consolidation might also help to diversify banks’ portfolios and make the banking union more resilient.

Yes, but the banking union is also not yet complete. What remains to be done? For instance, is a single deposit insurance scheme important in this respect (on which no political agreement has so far been reached)?

The progress made within and on the banking union in such a short period of time is really impressive. Just look at how joint supervision was set up and the truly integrated work that is done by the joint supervisory teams, which involve staff in Frankfurt and all the member countries. This is a real improvement on the situation we had previously – now we have fully integrated supervision across the banking union.

But to complete the banking union, we definitely need greater harmonisation of rules. The ECB is sometimes asked to apply 19 different sets of rules in the 19 different countries participating in the banking union. This is very difficult and does not ensure a level playing field for all banks. Furthermore, we need to complete the safety net. We have to make sure that every deposit, no matter the country or bank in which it is held, is protected with the same European guarantees. So yes, a single deposit insurance scheme is important.

Is political distrust among countries the main reason why this safety net is not yet in place?

So far, discussions have been divisive. On the one hand, some argue that, before any move is made to share the risks with a common deposit guarantee scheme, the risks themselves must first be reduced by cleaning up the NPLs on banks’ balance sheets. And then on the other hand, there are those who argue that the risks have already been sufficiently reduced and that it is therefore time to start sharing the risks by setting up deposit guarantee schemes on a more mutual basis.

This debate is futile, as risk reduction and risk sharing should go hand in hand. We should have a comprehensive roadmap for completing the banking union in order to accomplish both objectives – risk reduction and risk sharing – which mutually reinforce each other.

When I talk to our bankers, they often complain about European banking regulation being too much, in the sense that it is far too time-consuming and costly for them. What would you say to them in response?

The new regulatory framework introduced after the crisis is very complex and the costs of compliance can be very high, especially for small banks. Efforts have been made to reduce the complexity and costs: I worked on this during my time at the EBA and I continue to do so now at the ECB. But this constitutes a transition from an old system with inadequate rules to a new system that is more demanding. I am convinced that when this transition is complete, the costs will be much more bearable and the banking system will be safer.

So, will the bankers be more satisfied too?

Banks will also benefit from having a more robust regulatory system. If investors and the general public lose confidence in the banks, the banks cannot fulfil their role. Having a trustworthy regulatory system which ensures banks have sufficient capital and robust risk management mechanisms is also better for the bankers themselves in the long term.

The world economy is slowing and inherent risks are increasing. At the same time, global and euro area economic forecasts are deteriorating. What is your view on this and what are the implications for banks?

The deterioration in the macroeconomic outlook is worrying in terms of banks’ risk profiles. My primary concern is that the process of cleaning up the banks’ balance sheets should be finished before the next recession emerges. In this regard, we conducted very demanding stress tests for the euro area banks last year. They showed that the banks are sufficiently resilient to withstand a significant deterioration in the macroeconomic environment.

So this adverse scenario has already been tested in their balance sheets?

Yes. But as I said, what is important is that banks pay enough attention and make adequate adjustments to their balance sheets and asset quality, and that they make every effort to strengthen their profitability.

Is the low interest rate environment also a problem for banks and their balance sheets? How much longer can the period of low inflation and interest rates in the euro area last?

The low interest rate environment puts downward pressure on interest rate margins, but it also has positive effects on banks’ holdings of securities and makes it easier for them to clean up their balance sheets. An increase in interest rates would make a deterioration in banks’ assets more likely, and those banks that are still repairing their balance sheets would be in a more difficult position.

All in all, it is difficult to say what the net effect of low interest rates is on banks’ profitability and balance sheets. Generally speaking, banks should take the interest rate environment as a given and try to operate as best they can in the current circumstances.

In recent years, some money laundering scandals have been uncovered in European banks, exposing the euro area’s vulnerability in terms of fighting financial crime. Is there a sufficiently effective system in place to prevent money laundering?

These events have been damaging for the reputation of the European banking sector. They often date back several years – some even as far back as 2006 and 2007 – and in many cases, banks have already addressed the weaknesses in internal controls. Supervisors should pay great attention to these matters. Although anti-money laundering is not one of the direct competences of the ECB, we nevertheless pay close attention to this matter through our fit and proper procedures, internal controls and internal governance reviews. In this way, we can contribute to making the system more resilient to such threats.