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Interview with Yle

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Antti Parviala on 15 August and published on 28 August 2019

The European economy is slowing down little by little. How well prepared are banks at the moment for this?

Well, European banks have strengthened their position a lot, in terms of both capital and liquidity. They have also improved the quality of their assets, so they are much more resilient than they used to be. So their position is much stronger, also thanks to the efforts which have been made in terms of financial reforms, and in terms of supervisory action undertaken by the European Central Bank. We conducted a stress test last year, which was quite severe and also compatible, in terms of scenario, with a hard Brexit situation. In general, the banks looked rather resilient. Having said that, we keep putting pressure on banks to accelerate their post-crisis adjustment, so that they can take shelter from the next crisis.

There was some criticism about this [bi-annual EBA] stress test. Some people said that it was too mild. Can you understand these critics?

The stress test was actually the strongest that we have run so far. It was not much different in terms of overall impact from the stress test conducted in the United States. So I think that the stress test was serious in terms of scenario – but of course there are some aspects where we can improve. We have got to discuss how to improve, because if you look at the stress scenario for the European Union as a whole, it might be that you are not testing enough banks in some countries or not enough banks with specific business models. So we might need to adjust a little bit and further tailor the stress test to make it equally painful for all the banks in our sector.

Returning to the economic slowdown, can we expect an increase in banks’ bad loans and credit losses? Is this something to come?

First of all, let me say that we still have a stock of non-performing loans as a legacy of the past crisis, which is still quite high. It has declined significantly in the last years also thanks to the policies deployed by the European Central Bank as supervisor, but there are still around €580 billion of non-performing loans in the euro area as a whole. The average ratio of non-performing loans to total loans is still much higher than in other jurisdictions such as the United States or Japan. So we still have some way to go, and it is important that banks speed up the process of cleaning up their balance sheets before the next recession comes. Then, of course, it is clear that when the next recession comes, there will be a renewed deterioration in the asset quality of banks, that's natural. What is new, though, is that both ECB policies and now also European legislation have introduced a specific process for banks to be faster to write off bad loans. Hence we should not have an excessive accumulation of loans in the next crisis as we had in the past.

Have banks been too slow to clear their balance sheets?

I think they have. If you look at the main difference between the post-crisis adjustment in the European Union and in the United States, we saw that four years after the peak of the crisis the US banking sector had once again reached the pre-crisis level in terms of asset quality. In the EU, ten years after Lehman, asset quality has still not reached the pre-crisis level, so the ratio of non-performing loans to total loans is still above the level that was prevailing before the crisis. So we have definitely been too slow. But since the ECB was established as supervisor and we set out policies to be more aggressive in this field, a lot of progress has been achieved. In the last three years, there has been massive progress.

Are there some countries where the problem is more worrying than in others?

Yes, indeed, there is a concentration of non-performing loans in some countries: Italy, Greece, Cyprus and Portugal. But also in Ireland and Spain there is still a legacy from the big hit that affected the banks. We must say, though, that major progress has been made in the last year; the reduction has been really substantial in non-performing loans, especially in those countries. There is a much more lively secondary market, so banks are now able to sell these non-performing assets to specialised investors, also via securitisation. All of this has helped quite a lot in reducing the levels. There are still banks which have non-performing loan ratios in double digits, so those banks will have extra work to do to move towards the others.

What does it mean in practice if banks are not well prepared for the next downturn?

Well, if you have already clogged up your balance sheet with non-performing loans, banking profitability is very low and a lot of capital is locked up in these non-performing loans, so the banks are not able to grant new loans either. If the macroeconomic outlook deteriorates, it is clear that this situation could deteriorate even further. So profitability and capital positions would be under pressure and banks would be impaired in their ability to support households and corporates.

The other big theme is Brexit at the moment – some British banks are possibly coming under European supervision. What is the effect of that for the financial stability of your area?

Of course, Brexit is an unprecedented event – we’ve never had a country leave the EU. Financial sector activity is particularly closely integrated between the United Kingdom and the whole euro area, because capital market activity, to a large extent, was taking place in London, which is one of the largest financial markets in the world. So the first concern for us and for the Bank of England was to make sure that the Brexit process is conducted in the smoothest possible way. So the banks prepared well in advance even for a possible hard Brexit – an exit without an agreement between the United Kingdom and the EU. We pushed the banks to make all the necessary preparations to make sure that they have the licences, the establishments of their branches and subsidiaries, in place to continue serving their customers in the EU.

To be honest, the banks have done all we asked them to do, so they are prepared. They have defined the operating models and plans to gradually move their assets into the euro area, and for banks in the euro area to move assets into the United Kingdom, in an orderly fashion. We will have approximately – at the end of the process – €1.3 trillion in assets that will move from London to the euro area. We will have 24 banks, basically, that will move – seven will be directly under European Central Bank supervision and 17 will be under national supervision where they chose to relocate to. So in terms of processes, we have done the best preparation we could, the banks did what we asked them to do and a contingency plan is in place. Having said that, it is an event which can always be accompanied by shocks and turbulence in financial markets, so it is something that is giving us a bit of a headache.

In practice, what are the risks and what are the effects going to be?

Well, again, where there were integrated markets, both financial markets but also trade relationships, there will now be barriers – so these frictions on trade, these frictions on financial transactions, will in any case potentially have an impact on macroeconomic activities. There will be corporates that will be affected and trade will slow down. If some contracts have not been moved in a smooth way, there could be some contracts which are difficult for banks to honour because they can no longer provide services according to the single market framework they are now operating in. So this could entail some disruption. As I mentioned, we have tried to identify and address all the most important topics: dealing, for instance, with the clearing of securities trades, which was one of the most important concerns that we had. You never know, there will always be some turbulence in markets that can affect financial activity in some way – so we need to be prepared for that.

A couple of questions about banking regulation: after the last crisis there has been far more regulation. Banks are complaining that there is too much regulation. Do you think this increased regulation, as a side effect, has caused any trouble, any harm, for economies so that banks are not able to lend as much even for “good purposes”?

Banks complain a lot about the fact that regulations have become too strict and that this is impairing their profitability, their ability to lend to corporates and households. Honestly, these are arguments I am not convinced about. The same global rules have been rolled out across the G20, including in the United States, where banks are much more profitable. Even within the EU, we see banks – for instance in the Nordic region – which maintain quite a significant level of profitability, and I do not see any particular problems under the same regulatory framework. Lending growth has been quite good in recent years. So I do not think the rules in general are a constraint on the ability of banks to serve the economy. What I can understand is that the regulation has become very complex – and especially for smaller, simpler banks, brick and mortar banks in local communities – sometimes the compliance burden might be a little bit too high. There have been initiatives: we have tried to do our best to reduce the burden of regulation for smaller and less risky banks. There is also legislation that will be applied a few months from now that tries to lower this burden – the reporting burden, for instance, or the compliance burden more generally, for these types of banks. So in that area, I think that we could do something. But in general, in terms of tougher requirements, I think this is needed with respect to the lessons that we had to learn from the crisis.

Small enterprises complain that when the banks are more regulated they are not able to give loans for small and medium-sized enterprises (SMEs). SMEs are thus forced to get their financing from, for example, crowdfunding. Do you accept this train of thought?

No, I do not accept that this is driven by regulation. In the European regulation we have for a long time had what is called – I don't particularly like the term – a “supporting factor” for SME lending. So we already had a discount on the capital charges which are applied to banks lending to small and medium-sized enterprises. There is a broad awareness among European regulators that SMEs are the driving factor of employment and growth in the European economy, so there has always been a very accommodating regulatory framework for SMEs. Actually, in the past, we in the European Unio] have even been pinpointed by the Basel Committee for deviating from the Basel III international standards, because we apply softer requirements for loans to small and medium-sized enterprises. So I do not think that this regulation constraining lending to SMEs is actually the case. Again, as I said, there might be a point that banks are now facing such a complex set of rules that especially smaller banks can have increasing costs of compliance that they try to pass on to their customers. This is indeed something which we could, and we should, do something about.

Some banks have said that regulation is leading to rising house prices, for example. What do you say about these kinds of critics?

There are of course very different situations in different countries. What I would say in general is that real estate crises have been one of the main drivers of disastrous events in the banking sector. Think of Ireland, think of Spain – the need for support by the government to the banks in those countries was huge. In Spain – actually, in both countries – we even had to intervene with European programmes to support the national authorities in bailing out the banks because of the massive impact that the real estate crisis had on the banking sector. So there was surely some mispricing of loans in those cases; the risks that were entailed in these types of activities were not sufficiently taken into account by the banks. So to some extent, there are cases in which banks are now more accurately pricing the risk of lending for real estate. That is positive for financial stability. But this could be painful in the short term for getting a loan. But in the longer term, in terms of the stability of the system, there is definitely a benefit.

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