Interview with Il Sole 24 Ore
Interview with Elizabeth McCaul, Member of the Supervisory Board of the ECB, conducted by Isabella Bufacchi
16 February 2021
When the pandemic crisis struck, European banks were in much better shape than at the start of the great financial crisis, boasting solid capital ratios and ample buffers. Non-performing loans (NPLs) have more than halved in the last five years. We are entering the second year of the coronavirus (COVID-19) crisis: what shape are banks in now?
When we entered the pandemic crisis, there was a great deal of uncertainty but, fortunately, also a strong resiliency in the European banking sector. And after one year, in the current situation, the capital position is sound and buffers are available to absorb losses if needed. This is a strength that gives room for lending to the real economy. Banks have a very good basis to cope with continuing or new adverse circumstances. Banks built their strong capital position after the great financial crisis and this has enabled them to weather this unexpected pandemic crisis so far. Banks now are absolutely part of the solution as they continue to fund the economy.
European banks continue to lend to households and firms, also thanks to unprecedented measures taken by national governments, European institutions and supervisors to support them. What is your assessment of these actions: have you been successful?
The fiscal, monetary and supervisory cooperation in response to COVID-19 has been extraordinary. It has been key and it has been a success. The health crisis, which threatens lives, the economy and businesses, has not turned into a banking crisis. The collaboration has been across the board and not one sector was left in isolation. At ECB Banking Supervision, we introduced prudential flexibility to avoid a procyclical crisis. We did not want banks to react to a temporary pandemic by strangulating the credit flow. We wanted to make sure the economy continued to operate. And it all worked as we hoped and better than many had expected.
Yet a new wave of NPLs is expected this year. Maybe a huge one. And in 2021 moratoria and supervisory flexibility are ending. This could provoke a tightening of credit conditions, if not a full-blown credit crunch, banks might turn out to be less willing to lend to the economy this year. What is your opinion?
Whether or not these risks will materialise this year will depend very much on the recovery. And we have reason to believe that the worst-case scenario, of €1.4 trillion worth of NPLs by the end of the pandemic, is less likely to materialise. I want to emphasise that we expect 2021 to be the year of the recovery. Even if the recovery is delayed by COVID-19 variants or longer lockdowns, it will not be eliminated. We know we are not out of the woods and we need to remain prudent. So at the ECB we continuously assess the situation as we are hopefully moving towards healthier times with the rollout of vaccines and improving therapies to treat the virus. To be sure, the uncertainty is still very high.
Banks and markets fear a cliff edge effect as fiscal support and supervisory flexibility are lifted this year. How concrete is the cliff edge risk?
It is important to focus on the positive aspects of the fiscal and monetary support, of the moratoria and the State guarantees. There is no plan that I am aware of to make an abrupt withdrawal of any of these measures, but there will be a gradual reduction, calibrated with the evolution of the health situation and the ability of the economy to operate. We will unwind our measures only gradually. The cliff edge risk from withdrawal exists, but it is mitigated through an appropriately calibrated, gradual reduction of the support to banks. This gives me confidence to say we will continue paying meticulous attention to this calibration. Since the beginning we have been providing flexibility and guidance for banks to avoid a mechanistic interpretation of prudential rules and classification of exposures which would not reflect the temporary effects of the pandemic.
No automatisms. At the same time, though, you are telling banks to identify in a timely and adequate manner the deterioration of credit risk and to respond with provisions for potential losses. And to continue to lend. Is there a clash of messages?
When we, at ECB Banking Supervision, introduced this extraordinary flexibility, we also emphasised that the existing accountancy and prudential rules should be used to identify the unfolding of credit deterioration as accurately as possible. Banks must differentiate between a temporary and a permanent credit deterioration induced by the pandemic. If banks ignore this, if they do not provide adequate transparency in their balance sheets, if they start to be opaque, if they do not take care of NPLs now, then − when the recovery arrives, when healthier times come around, when the economy reopens − we will face the cliff edge effect, as banks will not be there exactly when we need them most. Delaying the management of permanent credit deterioration and NPLs will have the unhappy outcome of ultimately delaying the recovery, undermining everything we have put in place to date to cushion the effects of the pandemic. This is why banks must now pay timely and accurate attention to their balance sheet and increase transparency in their credit book. This is vital to delivering the conditions to allow banks to continue lending to the economy. Banks that deliver transparency by having robust credit risk management and reporting in place will be in a much better position when the recovery comes. There is no reason to delay the assessment of credit quality: this is the moment to make sure we have very robust credit processing in place. This is what ultimately makes the markets realise the strengths of the banking sector.
Is this what you are expecting from Italian banks too? Italy is one of the hardest-hit countries in this pandemic from a health, social and economic point of view. This year Italian banks are facing an explosive mix: the Supervisory Review and Evaluation Process, stress tests, new definition of default, calendar provisioning, and the steep rise of NPLs.
Italian banks’ progress in NPL exposure has been very substantial: the gross NPLs ratio came down from around 10% in 2014-15 to 3.1% in June 2020. What tremendous progress! So Italian banks must continue to do just that, make sure they manage NPLs in their books. This will make their balance sheet stronger and enable them to continue lending, especially to small and medium-sized enterprises. We know that Italian corporates entered the pandemic crisis in better shape compared to when they entered the great financial crisis: they had gone through much restructuring and these efforts are paying off. Italian enterprises showed resilience and exports reacted well to the headwinds. The stress tests will take all this into consideration, they will help us to assess the resilience of European banks. This is what we are going to do in the first half of 2021.
On a broader scale, what more can be done to make the banking sector and the European economy stronger after the pandemic?
It is essential that we finish the banking union, which is an incomplete construct. The crisis itself has emphasised the need to increase the level of integration so that Europe can deal better with shocks. We must have the European Deposit Insurance Scheme (EDIS): it is a safety net for all depositors. EDIS would grant all depositors the same protection and this would facilitate cross-border banking activity, eliminate the need for depositors to transfer deposits – which creates instability – and foster consolidation, which is an important tool to enhance profitability and sustainability in the European banking sector. I really hope this crisis will give impetus to completing the banking union and the capital markets union: this would make European banks more powerful, more financially stable, better funded and enable them to give better funding terms to citizens and businesses. I cannot imagine what would have happened in this pandemic crisis if Europe did not have European banking supervision.
Mario Draghi launched European banking supervision while he was president of the ECB. And you arrived at the ECB soon after he left. Do you know Mario Draghi?
I worked for the ECB as a consultant when Mario Draghi was at the helm. I led the Promontory consulting team back in 2012-13 to help set up European banking supervision. Mario Draghi spearheaded this process. I saw Mario Draghi in action, he is an extraordinary person, he has the requisite knowledge, courage, and humility as well as exceptional qualities of humanity and credibility for excellence in public service: he has a very powerful toolbox for Italy now. I saw his ability to pull together the European project, European banking supervision, which was needed to end the doom loop of sovereign and bank risk. The banking union was then a dream and it started to become a reality.