Interview with Reuters
Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Francesco Canepa, Balazs Koranyi and Frank Siebelt
6 May 2021
You have repeatedly asked banks to take credit risk more seriously during the coronavirus (COVID-19) crisis. Are banks listening to you? What’s your assessment of their progress?
First, let me say that I’m very satisfied with the supervisory process we set in motion towards the end of last year. We have identified a number of very diverse practices across banks in terms of provisioning choices, classification of loans, flagging forbearance measures and operational capability to prepare for the likely increase in non-performing loans. We set up a process that became very granular, intense and deep.
This process is delivering results. What we see is that the majority of banks are now broadly compliant with our expectations. Still, about two in five banks, i.e. 40%, have significant gaps in terms of what we expect.
In the past we were concerned that banks were not using sufficiently prudent financial projections and were relying on overly optimistic scenarios. That has improved. Most of the banks are adopting scenarios and projections more in line with our expectations.
At the other end of the spectrum, where we still have work to do, is credit risk identification, so unlikely to pay, forbearance and provisioning practices. But this is unsurprising because we started the banking union with different practices across banks. Nonetheless, we are doing a lot of work using peer comparisons to push banks toward what we consider good practices.
One interesting thing we found is that in some portfolios, especially in retail and residential mortgage portfolios, there is a significant decrease in credit risk parameters, especially for probability of default. That’s not what you would expect. When you enter a recession, banks typically start increasing the probability of default. This has an impact on capital and may restrict lending. But we are kind of seeing the opposite and the probability of default is going down.
This may be because a lot of loans are guaranteed by the state and counterparties are enjoying support measures via massive fiscal packages. There is also a surge in savings, so customers may have significant savings. But it’s a puzzle.
In which segments/loan types do you see significant classification problems?
We are drilling down a lot into sectoral exposures. We know that this crisis hit some sectors particularly hard, so we are doing super granular analyses. We started with the food and accommodation sector and we are now planning to extend the analysis into commercial real estate. If we have the capacity, we might go into retail trade, most affected by closures, and the move to digital distribution.
What did you find so far?
The most typical finding is that banks have not revised their indicators in a way we consider satisfactory. For instance, they still rely on backward looking indicators of credit risk, which are unreliable at this juncture. They are also unable to build indicators that effectively look through the moratoria and the support measures to estimate the probability of default. Procedures to assess forbearance and unlikely to pay are also among the weakest areas.
There is progress, but not as much as we’d like. Another area that has been worrying us is loans that transition directly from IFRS 9 Stage 1 (performing) to Stage 3 (non-performing) without having the significant increase in credit risk and without forbearance flagging. The fact that banks delay the recognition of the customer’s status implies that they are not taking steps early enough towards customers to actively manage or restructure the exposure at the first signs of distress.
Is this complacency or deliberate?
We supervise 115 banks so there’s a variety of reasons. There could also be reasonable justifications. This is an incredibly uncertain environment. My gut feeling is that there is a tendency to wait and see, banks say they don’t have enough information, so let’s wait a month, then maybe the recovery starts. But there could be banks that are really trying to sweep problems under the carpet.
Banks in the first quarter are reporting better-than-expected profits, due in part to lower provisions. How comfortable are you with that?
The cost of risk for 2021 is projected to remain above the pre-crisis level, so banks have not yet lowered their guard completely. But indeed, there needs to be a good deal of caution at this stage.
Some market analysts are expecting euro zone banks to start releasing provisions. I acknowledge that macroeconomic projections are pointing to a recovery from the second quarter. But it’s a bit early to relax provisions. This is a peculiar recession, unlike any we’ve seen in the past. In normal recessions banks start releasing provisions once we are close to the peak of bankruptcies. But now we haven’t even started seeing the materialisation of asset quality problems and bankruptcies are declining. We are still not seeing the peak in the materialisation of credit risk. So, it’s early to take excessively positive steps.
Are you happy with the rise in bank valuations?
We’ve seen more than a little uptick. Since September, European bank stock prices have increased by more than 60%. That’s a significant upward revision of valuations, which is linked to the positive sentiment that we are at the start of a recovery and banks are well positioned to benefit. I would not disagree with that assessment.
We seem to be facing conflicting factors. We expect bankruptcies to increase but we also expect the recovery to be rather robust. I think the only way to reconcile this is accepting that the recovery will be different from recoveries of the past: some businesses and sectors are likely to experience a robust rebound, while others might not come back unscathed. That’s why effective credit risk management by banks is so crucial now.
Do you stand by your January statement that a bad bank is unlikely to be needed?
I can confirm what I said then. The adverse scenario we tested banks against last July is much less likely. We have a much stronger baseline and even the severe scenario is much closer to the baseline than last July. Still, asset management companies are good tools and they are being used right now, with some success, despite the pandemic. In Italy, AMCO has been buying significant amounts of distressed assets recently and we have other tools, such as securitisation assisted by government guarantees, which have been used in Italy and Greece in massive amounts to reduce the stock of legacy non-performing loans (NPLs).
Would you make a projection about the peak of NPLs?
I just don’t have a figure. For me the key point is to push banks for early recognition of problems, early engagement with customers and early restructuring. If we move early, we have the tools to deal with the problem.
You’ve said the ECB stood ready to give banks extra time to build back capital. Do you think that will be needed?
We have announced the end of 2022 as the timeline. When we did this, we expected a rebound bringing the economy back to pre-crisis levels in the course of 2022. At the moment, we’re still there. If you look at the macroeconomic projections, they’re still pointing in that direction. At the moment, we don’t see a need to revise it. Still, I would have expected an earlier materialisation of defaults and bankruptcies and asset-quality problems. What we said in that communication in July last year is that we won’t ask banks to start raising capital before the peak in capital depletion. So, we need to see what would be the timeline to which these asset quality problems will materialise in banks’ balance sheets. If the materialisation starts later because the government support measures have been extended several times now, then we might have to extend our timeline.
When do you think you can lift your recommendation on capping dividends and other payouts?
I try to stick to our commitments unless there is compelling evidence that our commitments don’t match the reality around us anymore. So unless there is a real indication that the situation is materially deteriorating before September, we would repeal the recommendation in September and let banks go back to the old normal in which they have their plans to distribute dividends and do buybacks, and we vet those plans against their capital trajectory and the requirements that we impose. The idea is to go back to that stage in September.
I’m quite pleased that even if our recommendation was not a legally binding requirement, there has been full compliance by the banks under our supervision. It was not easy and there were some difficult conversations with banks that eventually fell into line, and I’m very glad about that.
Are banks still able to cope with negative interest rates?
The calculations made by our colleagues on the monetary policy side of the ECB show that this is still the case. Of course there is a compression on net interest margins generated by negative interest rates. But there is also the positive effect through an increase in volumes which we experienced last year and that would not have been there were it not for the extraordinarily accommodative monetary policy, and this has rebalanced to some extent. And the interest rate environment has also benefited banks through higher revenues in investment banking business and also through the valuation of holdings on their trading book. So, on balance, it’s difficult to reach firm conclusions as we don’t have the counterfactual but the impact on the banks still looks positive, especially as the extraordinary monetary policy support is helping the economy bridge this difficult period and moving into a recovery.
Have you identified any direct or indirect fallout from the Greensill and Archegos downfalls on euro zone banks?
In terms of direct impact there’s nothing relevant. There’s a minor indirect impact because Greensill has been affecting the deposit guarantee scheme, so indirectly the other banks are contributing to it. But there are lessons we can learn from these types of cases, such as whether there are areas on which we can focus our attention a bit more.
We have been concerned for a while about high-leverage finance. Now we’re seeing that banks are exposed to non-bank financial institutions which in most cases are not supervised and which sometimes take very highly leveraged and highly concentrated bets on financial markets. What concerns me the most is that sometimes banks themselves don’t have visibility on the portfolio of these entities. This world of the non-bank financial institutions has developed a lot in size and I’m afraid has developed a lot in leverage and concentration of exposure, and this could be an area of risk which we need to keep under our watch.
In 2016 the EBA issued guidelines on what was then called the shadow-banking sector. The point was to ask banks to have an appropriate risk-appetite framework, so how much risk they want to take with respect to these counterparts, to put individual and aggregate limits on the type and amount of risk they want to take in this sector. I think we should maybe brush up those guidelines a little and check how the banks have implemented them.
Have you taken any concrete steps in that direction?
The work on high-leverage finance is still in train, we are still planning to carry out some on-site inspections, so we need to bring this to completion. And maybe when we are able to travel again and our inspectors are able to go on site, this type of focus could become more central to our activity. I think you can drill down into this kind of exposures much better if you’re on site, take the credit file and start to ask questions about the specific counterparts.
You said banks needed to move more and more senior staff to the EU in the light of Brexit. How happy are you with the situation as it is?
First of all, I’m happy to see that the transition was very smooth and there were no hiccups in continuous servicing from banks that were previously located in the United Kingdom for EU customers and the other way around. We have agreed with the banks targeted operating models and we’re happy with these agreements and we now expect that banks will gradually move to the models we have agreed. The focus is now on how to implement in practice the policy of “no empty shells”. We are supervisors so we look especially at strategic and risk-management capabilities. This means having staff of sufficient quantity and quality to guarantee an effective management of risks that are taken in our jurisdiction. This means going deep in the way risk management is conducted, so the operation of trading desks − the use of back-to-back operations, the use by some banks of split trading desks whereby the same products are split in two different jurisdictions, and risk-managed and hedged in parallel ways across different desks. We’re looking now in a very granular way into these practices and we’re seeing different practices.
Don’t get me wrong, we don’t want to put people in chains and move them to Frankfurt – that’s not the objective. We understand that the pandemic has slowed down the move of people. The key issue for me is: the people who are in charge of interactions with European customers and products, are they actually part of the organisation I supervise? Or is there just a front office and then all the risks are brought back and then I lose visibility on the risk? The angle we’re taking is recovery planning: if something goes wrong in the bank, you cannot have all the ability to manage risk somewhere else and not be able to interact locally with your risk manager.
Are we there yet?
It’s different across banks. There are banks that have done the “full monty” and are already there and we’re fully satisfied and there are banks that have done much less. Another element that I would like to mention is the possible fragmentation of the presence of international banks in the euro area, so banks that are present with subsidiaries and branches. The use of branches is quite substantial and there are actually more assets through third-country branches than subsidiaries. Don’t get me wrong, I’ve got nothing against branches. The point is when you have different ways of being present in the banking union, in one case being under the responsibility of the national authorities and other cases under the ECB’s direct responsibility, it’s hard to get a global view of the risks that these entities are taking in our jurisdictions. This is an area of concern that we’re discussing with banks.
Frank Elderson, the Vice-Chair of the Supervisory Board, recently said that banks need to make “drastic” improvements to manage climate risk. Are banks not doing what you asked? Are they dragging their feet?
We issued a guide in November setting out our expectations. We have asked the banks to self-assess themselves against our expectations, and to set up plans on how to bridge the gap.
I am positively impressed by the fact that banks are being candid with us. We are at very preliminary stages of the process. We have not yet received the plans on bridging the gap, so it’s too early to draw further conclusions. But still they are being quite open in admitting that there are significant gaps between where they stand today and where our expectations are. I think that only 10% of the banks basically self-assessed themselves as compliant with our expectations. We have a gap and we don’t have centuries to fill it. We need to start moving and we need to start moving now.
The point now for us is to give a clear message to the banks that once the actions are well identified, we need to see change. The stress test that we are planning for next year will be an important step to move in that direction. The area in which there is more misalignment with our expectation is risk management.
You just released your response to the Commission consultation on the crisis management package. Anything you would highlight?
The core of our contribution focuses on two big areas.
The first one is about areas of the crisis management framework that do not function well in practice. Like dealing with the limbo effect of banks declared failing or likely to fail, but which remain in the market because the national liquidation process doesn’t manage to bring them off the market. Once we pull the trigger on failing or likely to fail, we need to understand what the differences are across different member states in managing the crisis.
The second, more important part of our contribution, is to reiterate our strong call for the completion of the banking union and to have a fully-fledged European deposit insurance scheme (EDIS) established. We are also open to an intermediate step, which is based on a hybrid system in which EDIS would not actually fulfil a loss-sharing function but would provide liquidity funding for national guarantee schemes. This would require a harmonised European framework for dealing with crises at smaller banks with the same tools used in resolution.