Interview with CNN Portugal

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Pedro Santos Guerreiro on 24 May 2022

26 May 2022

Are the European banks strong enough to face today's challenges?

They entered into the recent shock in a strong position. When the pandemic struck in 2020 we were very concerned. It was a very steep recession. We were expecting a further deterioration in asset quality. And instead, what happened was that − also thanks to the massive support measures deployed by governments, by the European Union and by the ECB − the pandemic was much less of a concern than we had expected it to be. The capital position strengthened [on average], asset quality improved, the liquidity position was very strong and profitability at the end of the year was very positive.

And then came the war.

And then came the war, exactly. And then, when there was also very positive momentum amongst investors in the European banks, markets began to review the position of European banks. In the first weeks of the war we focused our attention on the direct exposures of our banks towards counterparts in Russia, Ukraine and Belarus. We concluded that their direct exposure is not a big issue, but is something which is manageable. Even if you write down to zero all the exposures of European banks towards Russian counterparts, that would not be a major problem for them. The real issue is what the second-round effects will be in terms of a slowdown in growth in the euro area and in terms of energy and commodity prices soaring. So we are now focusing a lot of our attention on credit risk, shifting from the service sectors that were most impacted by the pandemic to the energy-intensive sectors which are more impacted by the war, and on sectors like residential real estate which are potentially impacted by the increase in interest rates which is now expected.

Are the banks ready to absorb this impact?

All in all, as I said, they started from a much stronger position with capital and liquidity positions very strong, and better asset quality. We put a lot of effort over the past few years into strengthening the credit risk management of banks. So we wrote letters to all of them, putting a lot of supervisory pressure on them to improve their risk management processes. And I think that they are in a stronger place, but of course, everything will depend on the macroeconomic scenario that they will be confronted with. I think that if we are in a scenario of reduced growth with respect to previous expectations, but still positive growth, despite inflation which is then being reabsorbed and going back to the 2% target next year for instance, that type of scenario which is seen as the baseline scenario from the European Commission's projections will probably be absorbed without major troubles. If we enter into a recession scenario or if we have a sharper spike in interest rates than is currently forecast, then that could be a more difficult scenario for European banks.

What about the Portuguese banking system specifically?

In recent years, Portuguese banks converged very much towards the European averages. So we've seen an improvement in asset quality: [non-performing loans of Portuguese banks] are a bit higher, but still close to the European average. The capital position is basically also aligned with the European average. Profitability, too, is a little bit lower but in the same ballpark. So this means that Portuguese banks have the same problems that other European banks have: rebuilding profitability, strengthening governance and being really prepared on credit risk management in light of the potential challenges ahead of us.

You’ve mentioned credit risk management twice. And you mentioned inflation. You yourself don't decide on the interest rates but they are being brought up because of inflation. What impact will it have on banks? Can we first expect the profits to rise, but second the non-performing loans to grow?

You're right in a sense, the first impact of increasing interest rates, of the exit from a negative interest rate policy, should be a positive effect on the bank's interest margin, so on profitability. The other effect could be also a depressive effect on the valuation of the fixed income holdings of securities that banks have in their portfolios. And the third effect, especially if this increase in interest rates is coupled with lower growth, could be the fact that the borrowers are perhaps less capable of paying back their loans. So an effect on the asset quality of banks. We have done some exercises internally and the expectation is that, if you remain in the current scenario of a slowdown of growth but still a positive growth in 2022-23, and the spike in inflation this year being reabsorbed, I think that probably it should be still a net positive impact for European banks. But again, if we enter instead into a more pronounced slowdown or even a recession, then it might be that the asset quality element would be predominant.

You are putting forward a climate stress test that has never been done before. What can we expect from it?

The climate stress test that we are doing this year is a learning exercise. When we launched the exercise, the banks complained that they did not have enough data to perform the exercise. And that's exactly the point: the risk is there, we are really seeing more frequent floods and wildfires. And we see right now an energy shock through the war, and the possible need for a sharper than expected transition to net zero and to sustainable energy policies. This means that banks need to become able to measure and proactively manage these risks. That's the full purpose of this stress test exercise. If banks don't have the data, they need to develop proxies to estimate these risks. And they should start engaging with their customers to get the data that they need, because the risk is there. The fact that you are unable to measure and manage it is a problem. That's the overall objective of the exercise. We don't target capital requirements as a result of the climate stress test. But we target an assessment of the loopholes in the banks’ ability to measure and manage the risks, both the physical risks and the transition risks.