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Andrea Enria
Chair of the Supervisory Board of the ECB
Níl an t-ábhar seo ar fáil i nGaeilge.

Interview at the IIF Annual Membership Meeting

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Tim Adams on 11 October 2022

17 October 2022

May we just start with a broader view of how, from Frankfurt, you see global dynamics? I know the World Economic Outlook is out now and I haven't had a chance to look at it, but what is the perspective of the ECB in terms of how you see global dynamics?

Well, it's a peculiar moment because there is a sort of dissonance from a banking supervision point of view. If you look at the balance sheet of banks, everything looks very good. The first half of the year was very positive. I'm sure the third quarter will also close very well. The full year will probably be a good year. If you also look at the projections, if you look at the baseline assumptions – even shallow recession, downside scenarios – the positive effect of the interest rates on margins seems to be predominant, even in the light of a possible deterioration of asset quality or increasing funding costs and revaluation of securities portfolios. So very positive for banks.

Then you look at the global developments, and I think you start seeing a much gloomier picture. I am particularly concerned because if you go back to the pandemic, what you had there was a situation in which we had a cold shower at the very beginning, but then the successive projections started improving and improving. Here we have the opposite – we started with the idea that the war in Ukraine was maybe a sort of targeted shock to banks with exposures there. Then you start seeing that one macroeconomic projection after another is getting worse and worse. That is something that leaves me a little bit wary, and I think that we should stay very focused on the risk scenario ahead of us.

After the great financial crisis, we put in place a number of really important changes: a lot more capital, high-quality capital, more liquidity, looked at the way in which the leverage ratio was employed. There is a lot of resiliency in the system. We have gone through two big shocks. You just noted one: COVID-19, obviously. How do you think the system has come through those shocks and what lessons have we learned from COVID-19 and what are we learning in real time from this energy shock?

I think the system has shown very good resilience, honestly. It has been able to process a number of shocks so far, say from the pandemic, very nicely. Also thanks of course to quite massive monetary and fiscal support, but still, the system worked very well. If you look at European banks right now, the capital position is at its strongest since the start of the banking union. Asset quality continues to improve, even in the current environment. Profitability is still not where we would like it to be in the longer term, so still not earning the cost of equity, but still improving, and the return on equity is also at its highest since the start of the banking union. So things are pretty strong and positive. However, as I said, in our supervisory work we are focusing quite a lot on the potential downsides, on exposures to commercial and residential real estate, consumer finance, so segments which are particularly sensitive to interest rate increases. Those sectors such as energy-intensive sectors, which are most exposed to energy shocks and the fallout from the crisis. So I think that the sector is very resilient. I was reading a note from Autonomous yesterday and the point at the end was: what could be potential curveballs? I think that if we look at the topics that we and the banks know about, we have them under control, but there is always the risk of some major…

The black swan…

Yes, the black swan – especially the impact of these faster-than-expected and probably stronger-than-expected adjustments in the interest rate environment. It is a positive but can also have some hiccups in the process.

Obviously a push-up of the yield curve is good for the banking sector, but some jurisdictions have put in place bank taxes. We have seen that in Spain, the Czech Republic and others try a windfall profit tax, in some way replicating what has been done in the energy sector. Does the ECB have a view on whether these taxes are helpful, harmful? Do you weigh in?

It might be that we will have to issue opinions on these legislative proposals, so we have not yet formed an official view. We need to look at the concrete details of the proposals first. My impression is that sometimes I see these levies targeting the overall figures of interest rate income and fees and commissions, without considering provisions, for instance. I think in terms of incentives, maybe they are not exactly right. I now expect banks to start reassessing the need for provisions in their banking book. So maybe if you calibrate taxes on gross income, I think that could be a little bit misleading and maybe also a wrong incentive.

There is a lot of concern about leveraged lending. Are you concerned from the ECB's perspective?

We have been concerned for a while. Actually, we issued guidance already back in 2017 to banks asking for prudence, asking them to specifically try to reduce origination of highly leveraged transactions, defined as those transactions with counterparts which have debt to EBITDA of higher than six. Since then we are actually seeing quite the opposite happening: we are seeing that the amount of highly leveraged transactions has increased. At the moment, leveraged transactions cover 65% of Common Equity Tier 1 capital at European banks. It was 40% back in 2017, so there has been an increase in stock. There has been an increase in the share of highly leveraged transactions compared to the overall book. There has been a deterioration in lending standards, so the covenant-lite transactions that used to be basically non-existent in Italy after the great financial crisis and are now almost 100% of new origination.

Even in 2022 we have seen that origination continued and when the market froze in the summer, the pipeline risk materialised and the banks found themselves with exposures in the holdbook there. We issued a letter in March to the CEOs asking them to have a risk appetite framework, clear risk limits, strong stress testing in this segment of the market. We have seen that there has not been the responsiveness we would have expected so far. So we are now also going to have some capital add-ons for some banks that have shown weaknesses in this area.

By any objective measure, European banks' balance sheets are in the best shape they have been in decades. But one question from the audience is: then why do investors disagree? Why do we see them trading at half their book? Why the difference between market perspectives and what appears to be a very solid balance sheet?

We have this Banking Supervision Market Contact Group at the ECB where we gather together a group of investors, analysts, rating agencies – we had a meeting in January and I must say that I was surprised at how upbeat these people were about European banks. There was at the time the perspective of a gradual increase in interest rates, so the exit from negative interest rate policy in the euro area. Asset quality was great, profitability was on the rise. So the mood was very positive. Then of course, you have a war in Europe after 75 years and an energy shock that has also sowed some divisions in the response in the European Union. So I think at the moment, this has frozen the mood and unfortunately, it's not that good. The valuations remain very depressed, but I hope that if we manage to overcome this macroeconomic shock, we could resume the trajectory towards a stronger assessment also from the market, from investors, of European banks.

How would you evaluate European banks’ competitiveness? Where are European banks front-runners in terms of services or technologies? Where are they most competitive?

Well, if we start discussing competitiveness, the first observation should be the market valuations, which are very depressed. The price-to-book ratios of US banks are more than twice as high as those of European banks. It has been like that for a while and this reflects a number of drivers, some of which are in the hands of banks themselves. So, cost efficiency; maybe a lack of sufficient investments in technology until recently; some excess capacity in the sector; the need for some refocusing of business models, which was not proceeding as fast as was perhaps needed. On the side of the authorities, the negative interest rate policy was also a factor. Also, we have created the banking union but we have not given great incentives to banks to consider the banking union as their own domestic market. There is still a lot of segmentation, which didn't maybe help consolidation or with mopping up the excess capacity in the sector.

The good news is that a lot of these things have been on the mend. On costs and business models, I think banks have made good progress in the last couple of years. I've also seen a lot of consolidation to some extent – if you look at the big figures, it's not that much, but if you look at business lines, there have been a lot of transactions on asset management business, structured equity, leasing, and on custody and settlement services, which meant that banks were actually trying to grow in the areas where they wanted to increase their competitiveness. So this has been improving. In terms of where the strengths of European banks lie, the European market has a big pool of savings and is anchored to strong traditional credit intermediation. Also lending to the huge number of small and medium-sized enterprises that we have in Europe. So I think that traditional credit intermediation is still the strength of European banks. Of course, the interest rate environment has not helped.

Then there are also other areas. If you look at investment banking as well, they are not top of the class, but if you look at individual business segments, for instance in syndicated lending and debt issuance, they have increased their global market share in the last three years. Of course not in equity or mergers and acquisitions, which are the most profitable lines of business. So there are some segments in which the European banks have a good franchise. Project finance is another one, maybe a bit niche but still very important. So I think that the competitiveness is there. Of course we need to see how we sail through these difficult times and how we come out of them.

Might we see greater consolidation? Is this a period where we can see mergers and acquisitions occurring?

When I joined the ECB, the vibe I got from bankers and investors was that there was a perception that the ECB, the supervisor, was hostile to consolidation because of concerns about “too big to fail” and the like. I think we clarified extensively that that is not the case. We gave clarity on how we treat consolidation from a prudential standpoint, which is neutrally, so without any increase in capital add-ons. As a rule, we grant full recognition of badwill, which at the moment is of course a big issue. So we tried to clarify, and there has been some increase in consolidation, but it has been mainly domestic and it has faded out a bit. At the moment, I don't feel there is a lot of appetite. I don't think that this is coming from the regulatory or the supervisory side – it's more a market issue. I do think that, looking ahead, there is room for consolidation and banks should consider options in that area.

Let’s switch to climate sustainability. The ECB has been a leader on climate risk for a long time. Europe is ahead of the rest of the world in terms of the way you think about everything, from taxonomy to the way you do stress testing. How do you see the evolving role of supervisors in terms of looking at climate risk with respect to European banks?

First of all, let me say that we tried to have an approach which I would qualify as proportionate and very prudential in its perspective. We tried to set out prudential expectations and we asked banks to self-assess themselves against these expectations. Banks were serious and candid in admitting that there was quite a gap. They developed plans on how to fill this gap, and now we are in the process of checking their progress on disclosure, and we conducted a stress test recently which was also interesting in terms of seeing where the banks are with respect to their capabilities, and the thematic review, which also tries to follow the progress of banks. I think our role is to instil a sense of urgency in this area. So my perception is that on the industry side, there is sometimes an attitude of “Yes, this risk is here, but a lot of things need to happen before we will be able to actually measure and manage this risk properly. We don't have a clear classification of sectors or a taxonomy, we don't have data, we cannot classify the customers properly, legislation is in the making…” And I think that our point has always been: the risk is there, it’s already material, by common acknowledgement of both the industry and the supervisors. So we need to do our best to measure and manage it now. The stress test was a very good learning exercise because banks started saying, “Well, why don't we postpone as we don't have the data?” Then we pushed and the banks made a serious effort to gather the data and to develop proxies. And there were good practices. There is a very heterogeneous set of outcomes but there were good practices, so I think that our role now is also to create platforms to engage in a dialogue with the industry and to share these good practices and try to disseminate them – learning and trying to move the dial forward. I must say, the response by the European Banking Federation was very good: they are setting up a network of chief sustainability officers and we will engage in a dialogue with them. So I think that's the role I see and the sense of direction.

The challenge is, as you're doing that within the EU, you have other jurisdictions doing similar exercises and what we have globally is over 20 different taxonomy regimes. Then on disclosure there's a huge transatlantic gulf in how we define materiality – double materiality versus not double materiality. How do you manage these two processes; one domestic but also looking out the window and knowing that there are other jurisdictions that are doing similar things? How do we land all these planes at approximately the same time, in the same way?

It is an area where we actually made a huge effort to step up global cooperation. Frank Elderson chairs the Network for Greening the Financial System. He also co-chairs – with Kevin Stiroh of the Fed – the group in Basel. So we are doing a lot to bring this under a common umbrella and have global approaches from the supervisory point of view. Of course, in terms of broader policies, sometimes banks come to me and say, “You know, I have a number of different parties domestically that are asking me for different data than what you are asking. It's a lot of hassle. Couldn't you come together and agree?” I understand the point but again I think that in Europe at least, once we have legislation, there is a mandate for the European Banking Authority to develop reporting standards. At that point, there should be some sort of common data yardstick that all the banks would be supposed to abide by. That would be a major step forward, at least for the European Union.

The Bank of England has a conference next week on the role of capital and we have submitted a fairly lengthy document on whether we need more Pillar 1 or Pillar 2 capital; we argue that we don't. How do you see the capital discussion going in terms of climate risk?

We have been clear from the very beginning that we are still in the learning stage, both the industry and ourselves, so for the moment all the exercises that I mentioned before – the thematic review, the disclosure stocktake, the stress test – will only have qualitative outcomes. We have recommendations that we are issuing to banks, which are incorporated in the annual letters we send to banks under the supervisory review and evaluation process. So for the moment it's only qualitative. But if we see that the distribution of banks starts widening, with some being in the right place, moving at the right pace and going in the right direction, and others lagging behind, then that would be a moment when we could also consider a quantitative recognition of these aspects.

Last question, and that really goes to the survey questions we had up. It’s about crypto but really it's about innovation: how do you balance the need for encouraging innovation, whether it's stablecoins or the use of artificial intelligence, how do you balance that with also the need for safety and soundness and protecting the consumer? How do you think about the trade-off?

I envy very much those who have well-formed views on this difficult question. I must say that in this debate I started as a bit of a segregationist, so my idea was: let's leave a space outside the banking sector for innovators to experiment. But let's try to avoid contaminating what is a very speculative and volatile area of business with very highly leveraged institutions dealing with depositors' money. And let’s maybe start developing for this area of innovators an expansion of the requirements on anti-money laundering, for instance, and investor protection, because there you need to do something already. Now I'm changing my attitude a bit but I am not yet sure where I land on this. I think that these new technologies are here to stay, and they will bring a lot of change in the way in which our financial markets work in terms of financial contracts, market infrastructures, payments.

I think that we need to find a way to let the banks experiment with these areas of business in a protected and prudent environment. Now in Basel there is a discussion ongoing after a second consultation. Then the approach at the European level is also to attract for instance these stablecoin issuers which are non-banks, under some umbrella of regulation and prudential supervision. So these two types of direction of travel will probably create the new environment. I see it very much as we did in the payments area when we had payment institutions, third-party providers and banks, and we eventually created an ecosystem in which they could live together and interact with each other.


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