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Interview with La Repubblica

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Francesco Manacorda

18 May 2022

Mr Enria, let’s start with the economic situation and your reflections on what it means for banks. How have things changed since March?

The situation in the banking sector at the start of the year was very positive, prior to the Russian invasion of Ukraine. Banks in the sector were generally deemed to have a strong capital position and had made good progress in cleaning up their balance sheets, and therefore in reducing their stocks of non-performing loans. Their outlook for profitability was also good, including in the light of prospects for normalisation of monetary policy and exiting a prolonged period of very low interest rates.

Then there was the war, the sanctions against Russia, European banks having to write-off assets tied to Russia, the economic slowdown …

The write-offs aren’t the main problem. Even in the worst case scenario, if European banks were to, hypothetically, write-off the value of their exposures, even their derivatives exposures, towards counterparties in Russia, Ukraine and Belarus, they would still be more than sufficiently capitalised to meet the requirements set by the supervisory authorities. The big question is not so much the extent of the direct exposures of banks towards these countries, but whether the deterioration in the outlook for growth will be worse than currently expected. Yesterday the European Commission published its macroeconomic projections, which foresee a significant slowdown in GDP growth in the eurozone. However, the forecasts still indicate positive growth, of 2.7% in 2022 and over 2% the year after. This is a very different scenario to what we were facing at the beginning of the pandemic, with the prospect of the deepest recession in Europe since the Second World War.

Had the banking industry completely overcome the effects of the pandemic before the outbreak of the war? 

The significant monetary support received from the ECB, combined with the fiscal stimuli from the European Union through the Next Generation EU programme (which was a major structural change), led to a strong rebound in growth, with an exit from the crisis that was faster than expected. From the banks’ perspective this also meant a significant recovery in profitability, with the prospect of returns finally exceeding the cost of share capital. In 2020, but above all in 2021, clear progress was made on reducing impaired assets. Nonetheless, in the last quarter of 2021 we also saw a slight increase in distressed and restructured loans. This means that with the withdrawal of public support measures, the pandemic is still having a somewhat negative impact on asset quality, even if this has not yet reached worrying proportions.

You are meeting with Italian bankers today. What is the state of the industry at national level?

The Italian banking sector has made notable progress on cleaning up its balance sheets and is now close to the European average in terms of asset quality. Moreover, the industry has regained profitability and is working effectively on refocusing its business models. We have seen more bank mergers than in other countries, as well as the reform of the credit cooperative banks.

Meanwhile, inflationary pressures are pushing the ECB towards a rate hike, which risks cooling down the economy.

The prospect of interest rate normalisation is a positive thing for banks. It increases interest margins and makes banks more profitable. Obviously that same dynamic could also have a negative impact on credit quality since some borrowers may find it more difficult to pay off their loans. Furthermore, a rate hike could also have a negative effect on the valuations of fixed-income securities held by banks. There will be winners and losers among credit institutions. But the overall impact on the system will be positive.

Doesn’t inflation actually risk causing damage to the real economy, which will then spill over to the banking system?

Looking at the baseline scenario of a sharp rise in inflation in 2022, followed by a gradual decline towards the target of 2% in 2023, I do not see it as being particularly harmful for banks. What remains a considerable risk – perhaps the second biggest risk after a scenario involving a significant slowdown in growth or even a recession – is if there is a period of high volatility, as well as large and unexpected increases in yields on the financial markets. This could have a negative overall impact on market segments at high risk, if valuations were too high and some players – in particular non-banks – were to take concentrated positions and ignore signs of deteriorating asset quality. For instance, the leveraged lending market, i.e. highly leveraged loans.

Does that scenario make you want to call for banks to exercise more prudence?

We have for some time now been asking banks to adopt more prudent strategies in those markets, with more robust risk management and systems for limiting exposures. But to date we have not seen the follow-up to our recommendations that we would have expected. We are still concerned that this could be a risk factor in the coming months. Since the start of 2018 highly leveraged exposures have grown by 66%, increasing by around €300 billion to stand today at €500 billion. These exposures are often subject to low contractual protection which, all other things being equal, increase the risks for banks.

In what ways are the risks to the real economy reflected in banks’ balance sheets?

We have asked banks to reassess their projections and capital trajectories in the light of the new macroeconomic picture, also considering adverse scenarios. Meanwhile, we are keeping an eye on the possible increase in risk in some economic sectors that may be hit harder by the rises in the prices of energy and other raw materials. While COVID-19 hit services, now the risks are more focused in the manufacturing sector, with its high energy consumption, and in the real estate sector, which is more sensitive to interest rate rises.

Banking union is running out of steam. It was discussed at the Eurogroup meeting on 3 May and will be discussed again soon. But there is still resistance in some countries. Why is that?

There are very strong arguments for completing banking union. We also need to move towards a full system in terms of building a safety net: not just European supervision, not just European resolution of the most significant banks, but also a truly European system of crisis management for all banks and deposit protection. I am not expecting great strides to be made, but it’s important that we make progress in the crisis management of medium-sized banks in line with the flexible and efficient model used successfully in the United States. Banking union also encourages consolidation and cross-border transactions. After the global financial crisis we saw a slump in cross-border banking activity; concentration within the banking system is insufficient and is mostly taking place within national borders. Banks still do not look upon the banking union as their home market, posing a problem for the system’s efficiency and competitiveness. What’s more, it will affect the real economy.

Between the pandemic and the war [in Ukraine], the EU seems to have found new impetus. Could this also help banking union?

The European Union has shown an amazing capacity to respond to these common challenges in a swift and united manner. For the first time, through the Next Generation EU programme, we used European financial resources to mitigate the impact of a shock affecting the entire Union, and certain countries in particular, through an important exercise in European solidarity. Critical issues for the Union’s future, such as the extension of majority decision-making, are also being discussed. As regards banking union, there are still some misleading interpretations around. In Europe we have more than €7 trillion in covered deposits (below €100,000), which could climb to almost €8 trillion by the end of 2023. From a political perspective, we look at this astronomical figure and believe that a European deposit insurance scheme would lead to a common public guarantee covering the entire amount. This frightens the politicians who are responsible for taking the decisions. In reality, the situation is different. First of all, the deposit insurance scheme applies mainly to small and medium-sized banks, since systemically important financial institutions are already covered by the single resolution mechanism and related fund. In addition, the deposit insurance funds are financed by the banks themselves and, even in the event of a huge crisis, such as the global financial crisis which followed the Lehman Brothers’ collapse, 489 small and medium-sized banks in the United States managed to exit the market using only the private funds raised by the banks, with no need for any public money. If the system works well, the likelihood of the public guarantee actually being used is extremely low. I hope that the new institutional context will help us make progress towards completing banking union, but this political hurdle is still a difficult one to overcome.


European Central Bank

Directorate General Communications

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