Interview with Les Echos

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Édouard Lederer on 11 and published on 14 February 2020

14 February 2020

You criticise deficiencies in European banks’ governance and transparency. Can you tell us how serious the situation is?

The banks have made progress since the financial crisis: they have strengthened their capital position and improved the quality of the assets on their balance sheets. But governance is the only area in which, by contrast, we have seen a deterioration. We could be talking about weak internal controls, a lack of oversight by boards of directors, deficiencies in anti-money laundering measures or the inability to retrieve sound banking data because of outdated information systems. On taking up my position, I was surprised by the number of inspections that identified this problem at banks. We’ve seen a series of cases, one after another, without the banks taking effective remedial measures.

You also point to certain remuneration practices that you deem to be too aggressive…

The remuneration model for managers is regarded as one of the problems underlying the crisis of 2008, because it encouraged them to drive up short-term profits without paying sufficient heed to long-term risks. Various efforts have since been made to regulate remuneration and I don’t want to detract from the success of these reforms, which have helped keep bonuses in check. But banks are still obsessed with retaining “talent”, the “money makers”, and, even now, this can result in remuneration policies not being as risk-sensitive as they should be.

What do banks need to do to get back on track?

In some cases, the problem may lie with the composition of the board of directors and its mix of competences, particularly in terms of information technology, diversity or independent points of view. At some banks, the board finds it extremely challenging to face up to a domineering CEO. After clear cases of misconduct or money laundering we still don’t see the markets putting pressure on banks to improve their governance… unless they think there is a risk of a hefty fine. Shareholders are not exerting enough influence here. As for the banks’ bondholders, they are more interested in knowing whether the banks will fully repay their debt. They are not too interested in everything else. In effect, we as the supervisor are the only party that can speak out.

What will you ask the banks to do to put this right?

We approach this case-by-case. We ask them to take highly targeted measures, for example to strengthen their internal control function, where often the headcount is too low, or to overhaul their IT infrastructure. When major deficiencies are identified – for instance in the area of anti-money laundering – we may review whether the members of the board of directors with responsibilities in these areas have done the best they could. If not, then we begin to wonder whether they are the right people for the job. We could also demand that the banks strengthen their capital position. Of course, that’s not the best way of changing their behaviour, but I would not rule it out if qualitative measures prove insufficient.

You reproach the banks for their low profitability. But in their view, it’s precisely the ECB’s low interest rate policy that is dragging profits down…

The narrative that suggests there is a contradiction between monetary policy and supervision is misleading. Monetary policy has actually paved the way for the banking sector to repair its balance sheets. Would the banks have been able to sell such large amounts of non-performing loans if interest rates had been higher? Isn’t it true that the monetary policy stance favoured the growth in the volume of loans, which has supported the recovery in bank profitability? I think that monetary policy and supervision are very coherent with one another, with the former pursuing its inflation objective and the latter allowing banks to regain their strength. The two things go together. I am well aware that banks are operating in a very challenging market environment: interest rates are low, profit margins are squeezed, and the economic outlook is still not bright. Competition is high, which is putting a great deal of pressure on profitability, and regulation has become more stringent. In this situation, you can either go on complaining about the external environment, losing money and burning up capital, or you can accept the world as it is and evolve within it. The banks that have grasped this are improving their efficiency and concentrating on generating profits in areas where they are strong.

But haven’t the authorities given in to the banks on Basel III and ultimately watered down the regulatory framework?

I strongly support the new Basel III standards. They were informed by the EBA and ECB assessments of what wasn’t working with banks’ internal models. At the same time, I acknowledge the banks’ concerns about the impact of the output floor, which limits the benefits banks can derive from using internal models to calculate minimum capital requirements. But the output floor is an essential component of the international agreement. We have to bite the bullet and put the measures in place. I see two situations where we might take action to avoid unwarranted effects of the output floor. First, for certain banks, the Pillar 2 requirements today include charges for model risk, which could be removed as such risks would be adequately covered by the new Basel standards. Second, since Pillar 2 requirements are expressed as a percentage of risk-weighted assets, an increase in risk-weighted assets generated by the output floor could result in a purely arithmetic increase in the Pillar 2 requirements, without their being any actual increase in risk. In that case, we would sterilise those effects when calculating Pillar 2 requirements. Banks have also been given a fairly long transition period for the output floor, which will enter into force gradually by 2027. Personally, I have never been convinced of the benefits of long transition periods (on this, mine was a lone voice), as they generate the perception that capital requirements keep going up and up. It is as if the banks were permanently living with a sword of Damocles hanging over them.

Does the sector need to consolidate in order to recover?

Looking at the sector as a whole, I do see overcapacity, and this is one of the factors weighing on profitability. In order to adapt, banks should refocus their business model, and consolidation may also be a useful strategy. This has been the case in many other sectors that went through global crisis, such as the steel or car industries at various points in time. It hasn’t been the case in the European banking sector, or at least not to the necessary extent. This is a consequence of the strategy followed in Europe during the financial crisis: banks were supported by their national governments and, as a result, either consolidated at the domestic level or retreated to their domestic market after giving up their foreign holdings. This means that there hasn’t been enough restructuring in Europe and markets are too fragmented along national lines. Our inability to take action at the European level has ended up weakening the sector. In my view, consolidation is one way of rectifying these problems.

What can you do to encourage some movement here?

What I can do is look at whether there are any obstacles to consolidation within my area of responsibility. If banks and investors feel that we are negative about mergers, that we would systematically impose higher Pillar 2 requirements in the event of a merger (well beyond what is necessary to cover for execution risk), then I should at least change that perception. Our role is to look at the business plans and check that the bank that would result from the merger would continue meeting the regulatory requirements, particularly in terms of capital. We also have to clarify how we deal with mergers from a prudential perspective, for instance when it comes to the treatment of “badwill”. But there are other obstacles to cross-border mergers that are out of our hands and that are more linked to the discussions around the banking union. While we wait for these discussions to develop, we will look at what we can do to move things forward.

Since the crisis, in theory banks should no longer be rescued with public money, but the cases are stacking up. What should be done?

I fully agree with the resolution authority [the European body responsible for resolving banks in serious trouble], which is asking for more clarity in the rules. The ABLV case is particularly striking. We assessed that this bank was failing or likely to fail, following deficiencies in terms of money laundering that led to liquidity problems. Once we had declared it failing or likely to fail, the bank went before a tribunal in its country, which deemed it not to be insolvent because its assets were still greater than its liabilities! The legal situation was even more complicated for ABLV’s subsidiary in Luxemburg. To conclude: as bankruptcy laws are not harmonised in Europe, the outcome may well be different from one country to the next. Also the room for intervention of local deposit guarantee schemes is very different across member states. That’s not how a banking union should work. When we assess a bank as failing or likely to fail, I need to know what will happen to it afterwards. There’s a perception among the public that the promise to no longer rescue banks with public money hasn’t been kept. And perception is important in this field.

The political situation seems ill-suited to making progress with European projects like the banking union…

European debates get stuck when everyone brings red lines to the negotiating table. And sometimes, all these red lines cross. The only way out would be to reach a sort of balanced disarmament. What we usually do in the EU in situations like this is to agree on a roadmap, with small steps that can be verified and that enable us to arrive at a result. This approach led to the creation of the Single Market and single banking supervision in the euro area, and we should follow the same approach here. I’m still optimistic because there is an absolute necessity to complete the banking union, and sooner or later positions will evolve to achieve this common goal. Red lines tend to be a short-sighted approach. I witnessed this during the financial crisis. When I was in Italy, the Dutch finance ministry proposed a common European fund to support the banks following the Lehman crisis, and the Italian position was negative because they considered that Italian banks were not exposed to risks in structured finance products. But then their position changed when the non-performing loan crisis began, and ironically the Dutch position changed in the opposite direction! These political discussions can be complicated, but implementing a system of risk-sharing is clearly in the interest of European citizens.