Interview with Revue Banque

Interview with Édouard Fernandez-Bollo, Member of the Supervisory Board of the ECB, conducted by Laure Bergala on 11 December 2020 and published on 15 January 2021

15 January 2021

What is the current situation of European banks from your perspective as a supervisor?

When compared with previous crises, European banks entered the coronavirus (COVID-19) pandemic with stronger capital positions, higher liquidity buffers and better asset quality. This is the result of stronger financial regulations in recent years and higher supervisory standards since European banking supervision was established.

So far, we have seen three positive developments in the banking sector: banks have coped well with the operational challenges of the pandemic, including the lockdowns; they have continued providing credit to the economy; and their capital situation has essentially been preserved up to now.

So this time European banks have been part of the solution – a significant difference from the 2008 crisis!

We conducted a vulnerability analysis in 2020. It showed that the euro area banking sector is strong and resilient, and thus able to fulfil its role of lending to the economy. Of course, if a severe economic scenario were to materialise, several banks would need to take action to continue to comply with their minimum capital requirements but, according to our estimates, the overall shortfall would remain contained.

However, there is no room for complacency. It is clear that the negative impact from such a shock is unavoidable, and that the positive developments have been made possible thanks to exceptional support measures from public authorities. However, this public support will have to end, and it is necessary to be prepared for that.

How do you think the level of non-performing loans (NPLs) on bank balance sheets should evolve? What is your current thinking on a European system for selling NPLs?

The impact of the current crisis has not yet led to a noticeable increase in NPLs. On the contrary, in the second quarter of 2020, the NPL ratio for significant banks stood at 2.94%, compared with 3.22% in the fourth quarter of 2019. However, while it is important to help banks weather the current downturn, it is equally important to ensure that they continue to correctly identify and manage any deterioration in asset quality, also for exposures benefiting from moratoria or public guarantees, in line with the existing rules and the ECB Guidance on NPLs. It is particularly necessary for banks to engage with distressed debtors at an early stage and to provide them with appropriate solutions in a timely manner. Early identification of arrears, case-by-case reclassifications and prudent provisioning choices are of the essence. Banks have to proactively distinguish between viable and non-viable distressed customers by using borrower-specific debt restructuring and forbearance practices.

To answer your second question, according to ECB estimates, in a severe but plausible scenario NPLs at euro area banks could reach €1.4 trillion, well above the levels of the 2008 financial crisis and the 2011 European sovereign debt crisis. So we need a fast European response. The Chair of the Supervisory Board, Andrea Enria, recently expressed the view that a European asset management company could be an effective solution. Alternatively, one could also envisage a network of national asset management companies, if appropriately designed. This approach would be more efficient for addressing deteriorating asset quality than a plethora of uncoordinated national initiatives. The aim would be to enable European banks to keep supporting viable households and companies, while remaining solvent.

What are the main focus areas for 2021? Did the crisis change your priorities?

First, credit risk will be our key priority. We see it as the main challenge that lies ahead for the European banking sector. In our supervisory dialogue with banks we are going to focus on minimising any cliff effects that might occur when the moratoria measures begin to expire. And here, both supervisors and banks must remain agile and open to adapt to any new developments the pandemic might still bring.

Second, we should use the COVID-19 crisis as an additional trigger to more proactively address the structural weaknesses of the European banking sector, such as excess capacity, low profitability, low cost efficiency and insufficient preparedness for climate-related risks.

How are climate issues taken into account?

At the end of 2020, following a public consultation, we published our Guide on climate-related and environmental risks. It describes how we expect banks to account for these risks in their governance and risk management frameworks and in their business strategies. It also outlines how the ECB expects banks to become more transparent by enhancing their climate-related and environmental disclosures.

In the first half of 2021 we are asking banks to assess their practices against the supervisory expectations set out in the Guide and to draw up action plans on that basis. We will then review the banks’ self-assessments and plans, and discuss them in the supervisory dialogue.

In 2022 we will assess all the banks we directly supervise and take concrete follow-up measures. In addition, we decided to focus our 2022 supervisory stress test on climate-related risks. We will announce more details in the course of 2021.

What is the programme of stress tests for 2021, since those planned for 2020 have been postponed to 2021?

Compared with 2020, the European Banking Authority (EBA) has updated its methodology to take into account moratoria and public guarantees related to the COVID-19 crisis. The stress test exercises should start in January and conclude in July. Against the backdrop of high uncertainty about macroeconomic developments, the results of these stress tests will be important in assessing whether banks are resilient and able to continue lending to the real economy. Supervisors will use the results for the Supervisory Review and Evaluation Process (SREP).

ECB Banking Supervision has relaxed capital and liquidity constraints, the regulatory treatment of state-guaranteed loans and the implementation of IFRS 9. Have banks made use of these possibilities?

Let me be very clear: we did not change the rules, but rather provided guidance on how these rules can be used to respond swiftly and flexibly to the exceptional situation created by the pandemic. And there are important synergies between our supervisory measures, the ECB’s monetary policy actions as a central bank and the strong response from the fiscal side.

Two guiding principles of our package were supervisory relief and capital conservation – to ensure that banks keep providing financial support to viable distressed businesses without tightening their credit standards. So we granted banks temporary flexibility within the prudential framework so they could implement state-guaranteed loans and loan moratoria programmes more smoothly. We also allowed banks with high levels of NPLs to postpone the submission of their plans to improve their asset quality, while we of course expect all banks to maintain correct risk identification practices and to actively manage their NPLs. At the same time, we have communicated that our response to events is reviewed and adjusted as they unfold.

Regarding IFRS 9, we provided banks with guidance on how to estimate the expected credit loss in the context of heightened uncertainty. That guidance is in line with the accounting standards and we expect banks to continue to follow it, also after the end of the pandemic. To summarise, we are giving banks guidance within the framework of the current accounting standards to avoid excessive procyclicality when applying those standards.

We also urged those banks that have not done so thus far to opt for the IFRS 9 transitional rules. The purpose of this guidance was to help mitigate volatility in banks’ regulatory capital.

Returning to your question, according to a recent EBA study our relief measures, as well as moratoria and public guarantees, allowed banks to provide new lending to many companies affected by the crisis.

Our supervisory strategy has now moved into a new phase – bracing for impact. Over the next few months, we will continue to pay attention to banks’ preparedness to tackle the potential increase in NPLs and to curb cliff effects. We also plan to delve deeper into their practices and procedures around NPLs.

Do cross-border mergers and acquisitions remain a priority?

The ECB does not favour one type of consolidation over another, but looks at each operation from a prudential perspective, bearing in mind its sustainability in the light of the criteria communicated in our Guide on the supervisory approach to consolidation in the banking sector.

We are of course aware that cross-border mergers and acquisitions are currently much more challenging than domestic ones because the European banking market is insufficiently integrated. We need to make progress in this field. From the supervisory side, enhancing the role of group recovery and resolution plans should create adequate incentives for entering into group support agreements. The provision of financial support by the parent entity should be linked to internal recovery indicators at the level of the subsidiary – this would facilitate the granting of cross-border liquidity waivers. These steps would certainly help to ease concerns about the risks inherent in cross-border banking groups and bring us closer to a truly integrated European banking market.

More broadly, Europe needs to make further progress in completing the banking union by harmonising the European crisis management framework, creating a European deposit insurance scheme and achieving a single rulebook that is free from national discretions and “home biases”.