Strengthening the resilience of the European banking sector
Contribution by Elizabeth McCaul, Member of the Supervisory Board of the ECB, published in the Eurofi Magazine, February 2022
3 March 2022
The good news is the euro area banking system has proven resilient in the coronavirus (COVID-19) pandemic: banks remain generally well capitalised, hold ample liquidity and are performing their key role as sustainable lenders. While reassuring for now, this may not be good enough for the future. European banks have been struggling with low profitability for a decade. Low interest rates and excessive risk-taking as investors push for more yield, may make financial markets vulnerable to abrupt asset price corrections and disorderly deleveraging. Achieving higher profitability is important for strengthening resilience, as is transformation towards more sustainable business models, sufficient investment in digitisation and consolidation to remain competitive. All of this in an environment that is fraught with uncertainty and risk, providing significant challenges requiring action from both bankers and policymakers alike.
For a start, the full impact of the pandemic on balance sheets is not yet known. Nor is the impact of supply chain bottlenecks on growth. Underperforming loan classifications are higher than before the pandemic and loans benefiting from COVID-19 support measures appear to have a slightly higher risk profile. Bankers must ensure solid credit risk management is in place to avoid a new surge in non-performing loans and losses.
Bankers need to adapt their strategies to two major structural shifts: first, digital transformation is an opportunity or even a must for banks to reduce costs, gain efficiencies and identify new sources of revenue. Areas that have historically been the domain of the banking sector are seeing new entrants, reinforcing the need to adjust strategically. Exposure to IT and cyber risk both within and outside the supervised banking sector will increase as this profound shift takes place. Policymakers should ensure a level playing field on risk management between banks and bigtech. The Digital Operational Resilience Act and the Regulation on Markets in Crypto-assets are therefore welcomed. The second structural shift is the green transition. The climate crisis is exposing banks to physical and transition risks, and they will need to strengthen and reassess their strategies and risk management frameworks accordingly to safely finance the greening of the European economy.
For European policymakers, the positive role played by the regulatory reforms since the global financial crisis to reinforce our banking system, and the coordinated supervisory response in the Single Supervisory Mechanism to the COVID-19 crisis should be forceful reminders of the importance of completing the reforms agenda. The implementation of the final Basel III standards effectively addresses important issues concerning the reliability and consistency of capital requirements, especially when risk-weighted assets are calculated by the banks themselves via their internal models. The reform package proposed by the European Commission goes beyond the Basel III standards and introduces other desirable changes, such as environmental, social and governance risks and the individual and collective fit and proper criteria and harmonised early approval mechanisms.
Achieving a truly integrated European banking market would put banks in a much better position to reap benefits of scale and scope and to finance the green and digital transitions of the European economy. It would enable a greater degree of private risk-sharing, so that shocks hitting a region of the banking union would be more easily absorbed, without the need to consider public support measures. Differences in local rules and practices for crisis management prevent progress towards cross-border banking, so a revamp of the EU’s crisis management rules is welcome.
Meanwhile, bankers can choose existing options such as expanding across borders through branches and the direct cross-border provision of services. Increasing digitalisation makes it easier for banks to offer services competitively across borders, while the framework for single supervision should allow a smoother transition to a branch-based structure for all entities willing to take that route – a solution that has already been adopted by many non-EU banks that have relocated to the euro area after Brexit.
Challenges and risks abound, but there are clear paths for bankers and policymakers to manage safely on the road ahead.