Interview with Il Sole 24 Ore

Interview with Kerstin af Jochnick, Member of the Supervisory Board of the ECB, conducted by Isabella Bufacchi on 16 November 2022

25 November 2022

Banks are in a good position, with high levels of capital. They have fewer non-performing loans (NPLs) and are more profitable. But they also need to be more prudent when calibrating their capital trajectories. How far do you expect them to go?

It is true that banks are generally well capitalised, liquidity positions are good and NPL levels are low. But the economic outlook has deteriorated significantly in Europe and globally over the last few months. That is why we have asked the banks to update their capital trajectories to explicitly consider a potential recessionary environment. We are now analysing the updated capital trajectories that banks have submitted to us. This review is part of a bilateral dialogue between us and the banks and the next steps will be discussed on an individual, bank-by-bank basis. Ultimately, we want a strong banking system with well-capitalised banks that are able to support the real economy through the cycle. The argument that I hear sometimes – that the supervisor’s requests hamper credit extension – is not true, because only banks that are in a solid position can keep credit flowing into the economy, including in adverse circumstances. This was also shown during the COVID-19 crisis.

Do you treat all banks the same or do you now make a distinction between them on a prudent vs less prudent basis?

As supervisors, we oversee banks through a neutral lens and exercise impartiality in all our actions. What is of course true is that in the current situation, there will be differences in how banks’ exposures, credit quality and portfolios may be affected by the economic downturn. These are things that we have to consider when assessing the risk profile of individual banks.

But banks fear that this case-by-case approach, which is the norm, may end up resulting in a total ban – like the one imposed during the pandemic – on dividends and buybacks.

We have no plans to recommend that banks suspend dividend payments and share buybacks, as was the case during the highly uncertain initial phase of the pandemic. But now we are going through another kind of crisis, with a very high level of uncertainty regarding what will happen next year. As supervisors, we really want to see, with the help of bilateral discussions, that banks themselves have good insight into their own capital positions and that they will be able to cope with an adverse scenario. The times ahead will not be easy for the euro area economy: there are complex challenges to overcome. That said, as you know, there have been a number of sizeable share buybacks recently, with no restrictions on our side. Several banks applied to conduct buybacks and we approved them, as the banks in question had the space to make them. This shows that we are not placing blanket constraints on the industry under a “one-size-fits-all” approach.

Some banks have complained that you take too long to get back to them.

Normally we grant such approvals within three months. That’s standard, and it’s the same for other supervisors.

Is it true that banks should not set their dividend policies in terms of absolute amounts?

Indeed, there is a European Banking Authority recommendation that invites banks not to do that, and we are also not in favour of this approach. It is more prudent to use pay-out ratios. The reasons are straightforward: you never know exactly what the profit will be for the coming year. Therefore, if you promise your shareholders a specific amount, in the end you may not actually be able to pay it without weakening your bank, for example, in the event of a sharper-than-expected economic downturn. That’s true in general, not only for banks.

Banks are also complaining about supervisors sitting in on their board meetings, calling it “overly intrusive”. You’re just passive observers, aren’t you?

It is not a practice of ours to regularly attend banks’ board meetings, but occasional participation as observers is a useful tool to assess how banks’ governance frameworks work in practice. The Basel Committee’s core principles for banking supervision establish that supervisors should be able to attend board meetings as observers because, to evaluate governance, it’s important to understand the executive decision-making process. The tone comes from the top. Therefore, we occasionally listen to the discussions, the interactions and the board’s culture to understand whether they are working efficiently and in line with the agreed strategy. We are certainly not the only major supervisory authority that engages with its supervised banks in this way.

Do increasing risks that banks face also include rising interest rates? Credit conditions are tighter for businesses and households, while asset prices have fallen. Will there be a wave of NPLs?

Interest rate increases should generally be positive for banks’ profits, if they remain gradual, and banks are already benefiting from this effect, although there are differences depending on banks’ business models. However, the faster and the higher interest rates go, the greater the potentially adverse impact on banks’ asset valuations. Furthermore, rising interest rates in a low growth and high inflation environment, mostly determined by the war in Ukraine, are also making it more difficult for SMEs and households to repay their loans. This is a combination of risks that needs to be considered in its entirety. In these circumstances, we have to maintain a strong focus on banks’ asset quality. For now, the NPL to total asset ratio remains low at around two per cent. In order to better manage risks and not be surprised in a few years’ time with a sudden deterioration in banks’ balance sheets, as has been the case in the past, we want banks to be proactive in their provisioning policies. Hopefully, non-performing loans will not rise too much this time.

Stage 2 loans are, however, increasing. Does that concern you?

That is not a good sign. A rise in Stage 2 loans, which are loans with a worsening risk profile, is a sign that there could be an increase in non-performing loans. This is why, as I have said, credit risk is one of the most important issues we are looking at right now. It is crucial that banks remain prudent and proactively adjust their strategies and planning to reflect the risks stemming from the current environment.

What about the increased risks that the energy crisis poses to banks? These are in a sense abnormal risks. Are banks managing them well?

The banks have extended ample credit to energy suppliers. Although there have been tensions in certain cases, the banks are so far playing their part to ensure the markets can function.

Market volatility can however have a negative impact on banks’ balance sheets.

Banks should indeed take account of the fact that adverse scenarios could also materialise for liquidity and market risk. Our discussions with banks on their individual capital trajectories will therefore also deal with these downside scenarios.

Will we also see a tightening of prudential capital requirements for climate risk and Basel III?

As you know, European banking supervisors would like to see Basel III fully implemented. It is an international regulatory framework agreed back in 2017 and it applies not only to European banks but also to banks in G20 countries, including the United States and the United Kingdom. The new standards do not entail a generalised tightening of capital requirements but target in particular those banks that have been especially aggressive in using their internal models to operate with lower levels of capital. In terms of banks’ management of climate risks, the glass is filling up, but there is still a long way to go. We expect banks to meet our expectations by 2024. Until then we will continue to check whether banks are doing enough, and we will be able to intervene in cases where banks are lagging behind.