Interview with Revue Banque
Interview with Édouard Fernandez-Bollo, Member of the Supervisory Board of the ECB, conducted by Jean-François Filliatre on 14 January 2022 and published on 1 February
1 February 2022
Jacques de Larosière, the former Governor of the Banque de France and former Managing Director of the International Monetary Fund, recently told us: “We talk about the European banking union, but it doesn’t exist.” Do you share his point of view?
I’m sorry I don’t share the view of Jacques de Larosière, for whom I have a great deal of respect and who was once my Governor! But we must be clear: the banking union certainly does exist and we saw it, fortunately, at the start of this crisis. If there hadn’t been this single supervision of all banks in the euro area, we wouldn’t have had such a swift response and we wouldn’t have been able to coordinate so quickly with the other European authorities, with the European Banking Authority… And don’t forget that we were in perfect sync with the measures taken by the European Central Bank (ECB) on the monetary policy side.
The fact that the banks were better prepared and proved to be resilient from the very beginning of this crisis, especially in the first few weeks when there was turmoil in the financial markets, was also thanks to the actions of European banking supervision since 2014. The banks have considerably strengthened their capital since then. We had also asked banks to put in place strategies to reduce the non-performing loans on their balance sheets. Those strategies had an impact before the pandemic and enabled banks to go into the pandemic with stronger balance sheets. The banks’ increased resilience is therefore partly due to the fact that we have this unified and strengthened supervision at the European level. In other words, the first pillar of the banking union.
Let’s rephrase the question: is the banking union complete?
The banking union is not complete, because single supervision by the ECB wasn’t the only aspect of it. We need to distinguish between an institutional part and an economic part. Of course, the institutional part of the third pillar – a fully unified deposit insurance scheme – has not been completed. This is something we regret. The responsibility clearly lies with those sitting at the negotiating table to draw up the rules. They need to come up with some constructive proposals. Maybe some new opportunities are starting to emerge at the moment...
From the point of view of the supervisor and its economic role, there is another subject of even greater importance: the difficulties in unifying the market. There can be other regulatory obstacles. For example, the fact that prudential regulation makes it impossible to have intragroup waivers. This isn’t strictly related to the banking union, but it relates to overall EU regulation.
Who is responsible this time?
Some of the different parts of the EU are still reluctant and wary about fully considering the banking union as a single jurisdiction. There has certainly been some progress but there isn’t a unified position among all the authorities. So the markets remain fragmented. What’s the result? In recent years we have seen less progress with market integration than with institutional integration.
The second pillar of the banking union is resolution. The major innovation was the “bail-in” to make the relevant stakeholders – and no longer governments – pay in the event of difficulties. Isn’t it a failure?
I don’t think it’s a failure. The only time resolution measures were applied, in the case of Banco Popular in 2017, it went very well. Remember, though, that these procedures are not handled by us but by the Single Resolution Board in Brussels.
But we have to acknowledge that, in some circumstances, governments have preferred not to apply this framework and have found other means instead. And in these cases, the governments judged that, for reasons of public interest, they should provide funds so that these liquidations could take place in an orderly way. But to be clear, we are talking about liquidation and not resolution.
This raises a question from the point of view of European convergence: what can be done to ensure liquidation happens in an orderly way? From an economic perspective, there will always be banks that don’t stay the course and they need to be able to exit the market without causing disruption. For now, some use the fact that deposit insurance is incomplete as an excuse for not making progress on that front. But there will always be banks that don’t come under resolution procedures. So effective and harmonised procedures for orderly liquidations need to be put in place.
France has just taken over the EU presidency. What are you expecting from it?
France has traditionally always been one of the key contributors to European progress in the area of the banking union. We expect France to be true to its tradition and, despite the difficulties – which we are the first to acknowledge – to put some of its energy into trying to overcome them! We need to grasp the few opportunities that might be starting to open up in places, for example on the resolution framework or how small and medium-sized banks are treated. And why not make progress together with Germany – a key partner on this issue – on the European deposit insurance scheme, the third pillar of the banking union.
In January 2021 the ECB published a guide on consolidation through mergers and acquisitions in the banking sector. What was its underlying rationale?
The intention was to clear up a misunderstanding. The point was to set out the prudential supervisory approach to consolidation projects. It was an exercise in clarification, in defining our criteria. We tried to show how much our approach considers the benefits of consolidation when they are plausible, in other words, when backed up by a coherent business plan and the capabilities to carry it out.
Do you think that this publication, which promoted the treatment of badwill – a key issue as the banks are bought at less than their book value – has changed things?
More and larger consolidation transactions took place last year than in previous years − that was particularly noticable in Italy and Spain. I think that our clarification reassured the market: if you present a sound project, then you will be listened to. That’s an important factor that may pave the way for consolidations.
As supervisor, would you like to see consolidation in the sector given the economic situation and the challenges in the medium term?
We are not the dealmakers. Consolidation transactions should be made for economic reasons, rather than for prudential supervisory considerations. Moreover, we have no ideal image of the sector, no preconceived ideas. We are not in a centrally planned economy.
On the other hand, we draw up assessments. There are structural profitability problems in the European banking sector. Traditionally, this signals insufficient restructuring to create value. There is room for greater efficiency in the banking sector. Concentration is one way of achieving this, but it’s not the only way! Other methods are to improve the efficiency of existing services and design new ones.
On the topic of profitability, the most frequently used criteria is the return on equity (RoE). In mathematical terms, with the same level of profits, banks that are less well capitalised will have a better RoE. But US banks are less well capitalised than their European counterparts. Are we using the right measure?
RoE gives the market’s perspective. The market doesn’t know the intrinsic risks, but it knows the implicit cost of capital. Moreover, the market is a significant force in the economy so we need to look at its indicators. However, the supervisor must also focus on risk-adjusted return, which is what we are doing.
Let’s come back to our mergers. Wouldn’t a large cross-border merger show that the banking union actually exists?
The completion of the banking union should make that possible. But let’s be clear on what we want to see, namely a deeper integration of the European market and that there be more risk-sharing and cross-border activities in Europe. So a large merger would be a good thing, but it’s not the only way to advance banking sector integration. We could also see European players emerging on the scene and developing their business through branches and the free provision of services. There are cases where branches may enable greater efficiency than subsidiaries in respect of capital budgets, with a simpler governance structure…
In recent times, the oppportunities offered by the system were more often used by third-country banks than by EU banks. Notably those who, in the wake of Brexit, relocated to the EU with this business model. That is to say they have a head office in the euro area and they use branches and the free provision of services in the other countries because they find that easier and more efficient. In other cases, on account of the value of brands, for example, consolidation without merging could be the best approach. But a straightforward merger makes sense in certain situations.
We are not the market participants. We want to promote the movement of capital and risk-sharing within Europe so that the banks, as part of their strategic transformation, can also enjoy the advantages of diversification and benefit from economies of scale related to the single European market.
The European Commission presented its proposals on Basel III at the end of October. What do you think of them?
We very much welcome them because, as you know, we think − and indeed it’s the ECB’s deeply held conviction − that this regulatory chapter absolutely needs to be completed. And the best way to achieve that is precisely to transpose the international consensus on the prudential banking rules that should apply after the great financial crisis.
But it must be truly completed. In other words, not just intellectually, but actually transposed into European law, as faithfully and swiftly as possible. The Commission’s proposal goes, in the main, in this direction. We are therefore very much in favour of this work being carried out as quickly as possible, so also under the French presidency.
And that’s something you were just asking me about: it’s important for this Presidency that we manage to draw a line under this part of the reforms and provide a stable regulatory framework that has been approved internationally by all the large financial jurisdictions.
You said “in the main”, which sounds as if you may have some reservations…
There’s no such thing as perfect, of course. For example, it would be preferrable to do without temporary deviations. Some deviations are authorised temporarily for very important issues. But it’s absolutely crucial that they don’t become permanent. Let’s not get into every detail of this extremely technical text. Instead, keep in mind the main thrust of our position – sticking as close to the international agreement as possible!
You’re not going to be making French bankers happy. They are also challenging the output floor. When calculating their capital, banks can choose to use either a standard model or an internal model. The output floor limits the benefit of using an internal model. But internal models are very popular in France. What would you say to bankers who criticise the increase in capital requirements under this rule?
First of all, according to our own calculations, the capital requirements have only been raised by a relatively small amount. Second, these international agreements allow French banks to be subject to lower requirements than US banks – more than 25% lower. The output floor for US banks is 100%. But through negotiations in which I was personally involved, we’ve managed to set an output floor of 72.5%.
The October package includes a section about the reputation of board members and managers. Was that necessary?
It was completely necessary to try to deliver on one of the major promises – European harmonisation. Today, because the issue of board members and managers is linked to company law, the rules differ widely from country to country. With this text, harmonisation will be achieved. We will have the same criteria, at the same time, with the same degree of certainty, at least for the very large banks at the highest level of consolidation.
Let’s talk about risks. In January 2021 you told us you were worried about credit risk. How are things looking now?
We’re in an extremely paradoxical situation. We’ve come through the worst economic crisis since the post-war period in terms of GDP, but at the same time we’re at the peak of the financial cycle.
Financial valuations are at their highest level. Provisions have fallen once more and are close to their historical lows. When you’re at the peak of the cycle you should exercise caution and not let your guard down. That’s why you need countercyclical prudential policy. There’s a very old US definition of a supervisor’s role that’s relevant here: a supervisor is charged with tidying the drinks away while the party is in full swing. From a financial point of view, the party seems like it is currently in full swing.
A couple of words on emerging risks. Particularly on everything happening around digital, crypto, digital identification…
This is a major topic for the future! And you have to look at it from both sides. On the one hand, it’s a risk, but on the other, it’s a source of profitability. The efficiency concerns that were just mentioned will certainly pass if there is substantial purposeful investment in digitalisation.
To conclude, what is your stance on climate risk?
We think it’s a central risk for the future. It’s absolutely crucial to start being able to quantify it. Unlike other risks, where we have forecasting scenarios, with climate risk we still don’t have reliable forecasts and this risk is still not being strategically integrated into banks’ business models. Banks are data-driven, after all.
Why does the climate stress test, as it is currently planned, not envisage the publication of individual, bank-by-bank results?
Precisely because we know very well that the climate stress test is just the first step in learning to quantify this risk – it’s a learning exercise to improve the reliability of the figures. But we’re hoping to gain some valuable feedback. In other words, this stress test isn’t the end of the story – eventually we will have capital requirements. For example, if we have figures that are reliable and that demonstrate that banks need to set this capital aside.
Remember that the banks must make internal calculations to measure risks to their capital, independently of the regulations. There is a genuine financial risk linked to climate issues. The banks should be able to quantify it and take it into account in their internal allocation. If they don’t take it into account, they won’t develop reliable mechanisms. In that case, the supervisor will be there to spur them to do so.