Interview with Market News

Interview with Édouard Fernandez-Bollo, Member of the Supervisory Board of the ECB, conducted by Luke Heighton on 19 October

25 October 2021

What will be the likely net effect of the implementation of the remaining Basel III rules, regarding the output floor and other key areas, on overall capital levels?

We really think this effect is manageable for banks. There was a delay of one year which we thought was fully warranted by the coronavirus (COVID-19) crisis. Now, it's also warranted that we begin the transposition process at European level. Some banks will be more affected than others, but that's what happens with any regulatory review and there will be a long transition period. And globally, the effect is perfectly manageable even with banks’ actual levels of profitability. With the current rate of retained profits, no one will need to raise extra capital.

You have spoken of “search for yield behaviour” in financial markets. While you called for bank governance to take action, could banking supervisors step in, and, if so, how?

Using our normal tools. That is, when we think that some risks are not captured by the practices that are developing in the banks, we can act through our supervisory instruments. These can be either qualitative – saying, for instance, reinforce your risk management procedures – or quantitative in some cases in which we can also have some capital add-ons where we see that this is necessary because the risks are not captured enough by the solvency ratio. So it’s business as usual in a situation where we have to be able to tackle what is, I believe, too much risk taking because banks are looking for yield, be it on traditional credit risk or on market finance, such as leveraged finance.

There have been moves to introduce an element of climate risk assessment into Pillar 2 requirements and stress tests. Given the difficulties of modelling the effects of climate change, what are the dangers and opportunities here?

The danger would be to get stuck in the present situation, where the vast majority of the surveyed banks say climate risk is very important to them, but most of those also say, “We don't have the tools to measure it”. Well, that's a situation that cannot continue. Our supervisory stress test on climate risk, which will take place in 2022, is a very important milestone, because it will push the banks to elaborate on the data they have. We are very conscious that banks’ data are patchy, but it's much better than just to remain without any kind of quantitative guidance. We are absolutely conscious that this is a journey that we are just starting and that there are difficulties. But that's why it's urgent that we get started.

Does banks’ responsibility begin and end with managing their own risk to climate change, or is there a role for banks to play in addressing climate change itself?

Certainly, banks are a part of society and they are part of global society movements. We are banking supervisors; our job is to see that banks manage climate risk for themselves. Of course this will in turn help banks finance the transition to a greener economy.

But that climate stress test exercise won't have an impact on capital requirements, and individual banks’ results won't be published?

Not at this stage, and we don't expect this stress test to have a direct link with the capital requirements. The objective is that we will make progress in this area. Later on, we will use stress tests for increasing the capabilities of the bank and also calibrating the capital needed for stress situations. But this time there will be no capital buffer defined as a result of the climate stress test.

So you would expect individual banks’ results to be published, but it's just too early….

Next year we won’t publish any individual results of the climate stress test, that's absolutely clear. At a later point, we really aim to incorporate climate risk into the ordinary stress test methodology, and then, of course, the results will be published.

Your colleague Mr Enria has called recently for banks to stop waiting for the implementation of the European deposit insurance scheme (EDIS) and to open branches in other euro area countries. What could be the risks and opportunities of such an approach?

What Andrea Enria said is a reminder of a basic characteristic of the Single Market. Since 1992 the principle of the single licence allows a bank, as an entity, to perform its activity in all European Union countries. And this can be done by branches or by the free provision of services without even opening physical branches in these countries. Because of the considerable progress made in digitalisation for the provision of services, it is becoming more likely that this kind of use of the single licence could develop in the market without the need for any additional legislation. That's one of the important parts of the message. It does not mean that we do not want additional pieces of legislation. As you know, at the ECB we are very strong defenders of keeping the ball rolling on EDIS. But what we are saying is we don't have to wait. The pandemic provided new opportunities to use this old tool, with the wealth of experience that banks have gained through remote banking and the potential for efficiency gains. Branching is a challenge but also an opportunity to expand and transform. We think that in the present situation there's an opportunity for making more of the Single Market not just for the bigger banks that we supervise, but for the smaller ones too. A truly integrated Single Market should have every kind of business model and banks of all sizes, be they small, medium or large. There's no silver bullet for integration - we have to try to explore all the avenues. We are just reminding banks that this is an avenue that in the present situation offers a particular opportunity.

And how do you rate the prospects for banking consolidation within the European Union at the moment?

We've been advocating for a long time some changes to the regulatory framework that will help to make consolidation easier. But what is important to us is to be clear that even if there is not a legislative push, there should be an economic push for more private risk sharing. And it is possible. Maybe not on the same scale, but there are benefits to be reaped. We are still very far away from taking full advantage of the Single Market. Brexit is an example of that, because almost all the banks that have relocated to the euro area are branching out. They normally keep their UK subsidiary, but they have created an EU subsidiary and this EU subsidiary is branching out.

The European Commission has proposed that the ECB supervise the branches of non-EU banks more closely. What do you say to those who say the proposals will have adverse effects on customers and on financial stability, or claim that they are becoming collateral damage in a bid to weed out a few bad apples?

I can understand banks saying this is a change that will make their lives more complex because it's a new regulation, but these additional harmonizing requirements are needed and we are very much in favour of this change because of financial stability concerns. And by the way, we are referring to a situation that is very well known in the US and the UK because they are experiencing exactly that. We are just proposing to do in the EU what the Americans and the British are already doing, which is – when they have third-country branches – to provide a mechanism to ensure that they have a global vision on what's happening in the jurisdiction. So it is indeed a change from the present standard, but I would argue that this is not an undue complication – it is just a normalisation.

We've heard a great deal about how monetary, fiscal and supervisory responses have worked together throughout the crisis to keep bankruptcies at bay. We also know that non-performing loans haven't increased to the extent many feared at the outset of the crisis. How confident are you that the longer-term impact of the COVID-19 crisis on banks’ loan portfolios won't be significantly worse than what we've already seen?

The monetary, fiscal and supervisory response has worked very well. But we are supervisors and clearly we are there to say there's no room for complacency in credit risk management. One of the reasons we have done well is that the public support has been prolonged more than we thought it would be in the first scenario. We still have to see the test of it being withdrawn. And it will come because when you see the level of public spending, it should return to what will be the new normal. We can discuss what that should be, but it certainly won’t be what we've seen in these past three years. So it's clear that the bigger part of the test is not yet there. The real time of reckoning will be manageable, but it will be all the more manageable if banks don’t relax now. In fact, we are saying to the banks: please don't believe your credit risk models that are projecting the three years that they've just seen into the ten years ahead, because these three years are completely unlikely to be like the ten years that are coming. It's precisely where you have to be even smarter about using your tools, because your tools may be telling you something that is not reliable.

Has European banking supervision passed the test of COVID-19? Or do you think there are still areas that could be improved upon, given that the pandemic has made us all more aware that crises can come from anywhere, at any time?

I think we did well. We were able to cushion the impact when there was a lot of turbulence. We are happy that we did what we did with dividends. We know the banks didn't like it, but we thought it showed that we were prepared to relax some things but keep control of others. So the supervisory stance was really a supervisory stance and not just forbearance because we had a crisis. Of course, there are always lessons to be learned, and one of them is the need to be able to swiftly shift our focus, to adapt our supervisory instruments to new situations. That's the first point. The second point is how to use the prudential supervisory framework in a counter-cyclical manner. We've had some successes, but we have also seen areas where it wasn’t used much, for example in the case of capital buffers. We have to reflect on that and see how we can make buffers more usable in case of a crisis. We need to learn the lessons of that to determine what our priorities ahead should be, because clearly we now need to be sure that the way out is also smooth.