Interview with Cyprus News Agency
Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Gregory Savva on 18 January
19 January 2023
Mr Enria, thank you for the interview. I will get right to the point. It’s clear that economic activity is slowing down. Many economists project a recession in the euro area, and all this against the backdrop of tightening monetary policy, high inflation and an energy crisis. So the question is, how does this environment fit into the supervisory process for 2023?
2022 was a very good year for European banks. The increase in interest rates played a positive role for their profitability, their capital position is strong, and their asset quality improved throughout the year, throughout the pandemic and also in 2022, with a lot of disposals of non-performing loans (NPLs) or securitisation of NPLs. So the starting situation is positive. Of course, as you said, there are risks ahead of us and a lot of uncertainties. The recession, which is estimated now to be shallow and short, might prove to be deeper and longer than we currently expect, or the interest rate increase might be faster, stronger and longer in order to keep control of inflation. So banks need to be prudent, look at all the possible scenarios and manage to prepare themselves to also deal with these possibly adverse developments. But in the baseline scenario, I think that European banks should still see, on average, their profits increasing and their capital position remaining solid. Of course, there could be distributional effects across banks, so there could be winners and losers, and that’s why we’re putting a lot of emphasis on the need to strengthen internal controls.
So what will the supervisory priorities be for 2023?
We are focusing very much on making banks stronger and strengthening their controls, proactively managing credit risk and getting prepared to avoid a new wave of NPLs. They need to proactively manage interest rate risk and be careful with their exposure to those sectors which are particularly vulnerable to interest rate increases and to the energy shock, so energy-intensive sectors, for instance. Then, while looking at the immediate challenges, we also need to not lose sight of the longer-term structural challenges for the banking sector, which are mainly the digital transformation and climate change. We’re focusing more and more of our supervisory efforts and resources on these two areas.
Do you believe the pandemic, and now the energy crisis, has moved attention away from these more longer-term challenges like digitalisation and climate risk – especially climate risk?
No. I think digitalisation was actually accelerated, because when banks went virtual because we couldn’t go to offices anymore, they better understood the extent of the possibilities to increase efficiency by relying more on digital ways of connecting with customers. This is all well and good, but it of course comes with risks – the risks of potential cyberattacks, for instance, or risks that are linked to outsourcing certain functions to the cloud or to other jurisdictions. Climate change actually also accelerated. We have experienced a massive energy shock, so I think the arguments for moving towards greener sources of energy are now coming not only from climate pressures, but also from energy sovereignty pressures. So climate change is here. It’s a risk which has already confronted banks, and they need to factor this into their risk management processes as a matter of urgency.
You referred to credit risk. Do you have concerns about a possible wave of new NPLs, because that hasn’t been the case during the pandemic? What is the difference this time around, if there is one?
During the pandemic a huge amount of public support was granted to households, to small and medium enterprises, to corporates, and this of course cushioned the banks from the potential negative impact of the sharp recession that we had. I wouldn’t expect this amount of public support to be forthcoming on the same scale and with such a differentiated scope if we were to enter a new recession right now, also because government budgets are becoming burdened by higher levels of debt. So I think that the banks might face a more difficult situation. But honestly, again, we need to focus attention on the robustness of their internal controls and make sure that we have prompt identification and management of any credit that starts deteriorating. That didn’t happen last time, which meant that we had a pile-up of NPLs. This time we are more prepared, and I think that we can avoid it if banks are focused on the issue.
I’m sure you have often heard this accusation against European banking supervision: that US banks have always had more earnings growth and better valuations, and that many people associate this with the stricter supervisory requirements of European banking supervision, which puts European banks at a comparative disadvantage to their US peers. How do you respond to that?
We frequently meet with our colleagues in the US authorities, in the UK authorities, and compare the requirements that we place on our banks, and I must say that we are in the same ballpark as our peers. If anything, the capital requirements for the largest European banks are a little bit lighter. So I don’t think it is actually an issue of regulatory burden, although if there are criticisms, we are ready to listen to those criticisms. I think the issue is that the profitability of European banks has been subdued for a long time. Cost-efficiency has not been where it should be, and the low interest environment, the negative interest environment, has been a drag on the profits of European banks for a long time. Now conditions are changing and banks are more focused, so I hope that they can fill the gap.
Let’s turn now to the Cypriot banking system. At the outset I would like a comment on your collaboration with the central bank.
Collaboration with the Central Bank of Cyprus is excellent, I must say. We have very good cooperation in what we call the Joint Supervisory Teams that supervise individual banks, in the on-site teams, and also across the board, as well as at the senior management level. So collaboration is very good, and I think that the fact that we have a unified voice in sending messages to the banks has been one of the key factors in having so much progress recently in the strengthening of Cypriot banks.
Do you think that Cypriot banks are well placed to respond to this challenging environment?
Cypriot banks have made a lot of progress recently so, yes, I think that they are entering this difficult phase, this uncertain phase, in a stronger position. Of course, there are differences across banks, but in general the sector is much more resilient and robust than it was a few years ago. A lot has been done in terms of reducing NPLs, notwithstanding that sometimes the legal environment is not so easy – I have noticed this especially for foreclosures where there have been these suspensions of the framework, which has increased the uncertainty for banks on their possible recoveries on NPLs. But in general, a lot of progress has been made by Cypriot banks. So they are well ahead in the normalisation process, which puts them in the same boat as the other European banks.
So, because you mentioned foreclosures, you are saying, essentially, that this continued suspension of foreclosures creates a problem for the banks when recovering bad debt?
Yes, that’s exactly the point. You need a stable and supportive environment to ensure that banks can manage their NPL portfolios effectively and clean their balance sheet quickly when a crisis hits. If they don’t do so, there is an impact on the economy as a whole because when you have a balance sheet which is clogged with NPLs, the lending capability of a bank is impaired. So the ability to support households, to support corporates, or to support the recovery of the economy is much reduced.
On another issue, we now have the Cypriot systemic banks which say they are well placed to capitalise on this tightening monetary policy. They say they have strong liquidity held at the ECB and now they will start getting paid over that liquidity as interest rates rise, and this, in combination with rising lending rates, will translate into an increased net interest margin. So they’re upbeat about their projections for this year and, in the same context, the two banks are now preparing to return to dividend distributions, more than a decade after the previous crisis, and are engaging in a dialogue with you. So, what is your view on that, as you – European banking supervision, I mean – will have the final say on this, and what are the preconditions for you to give the green light to this request?
It is indeed true that the increase in interest rates, the exit from the negative interest rate policy, has had a positive impact on banks’ profitability – that’s a fact. And it will also continue playing a positive role for some time, but we should not forget the second point, that the deposit rates will also start increasing and, therefore, the positive effect on margins will reduce accordingly. Anyway, the positive effect is there. The way in which we have approached the discussions on distributions with Cypriot banks, and any other bank under our supervision, is that we have asked them to provide us their estimates on their capital trajectories, under the baseline scenario, which as I mentioned is a shallow and short recession, but also under an adverse scenario, which would imply a more negative outcome in terms of growth and in terms of interest rates. If the banks are able to prove to us that they would be able to remain above our supervisory requirements, even in an adverse scenario, paying dividends would not receive negative feedback from our side. That’s the same for all European banks.
On another issue, we’ve had some developments recently concerning Greek Eurobank, which has significantly increased its stake in Hellenic Bank here in Cyprus. Eurobank is poised to become the largest shareholder, pending regulatory approvals. What is your view on that, as European banking supervision has always supported cross-border mergers and acquisitions?
First of all, we are not talking about a merger here. It’s an increase in a stake, and there is regulatory approval underway, on which I cannot give you a final answer. I don’t like to speak, especially publicly, about individual banks so you will forgive me if I cannot be detailed on this case. I will take your question as an opportunity to discuss more generally the issue of mergers. For me, mergers are an important tool that European banks can use because they are the most transformative opportunity for business models. So, to make the business models more profitable, generate more capital, and put banks on a steadier course going forward. They are a way to reconsider strategies, to reconsider digitalisation and to embrace the changes which are necessary at the moment.
Cross-border mergers could be an important element of that. They are positive from a European perspective because they enable banks to diversify risks. I understand that in several jurisdictions there are still concerns which are a legacy of the past crisis, but now the difference is that we have the banking union. So we will have a fully integrated board that discusses possible cases, and we are the supervisory board for the parent and for the subsidiary, so we can see the pros and cons for all the parties in the group. So I think that this creates new conditions, and I think that within this framework cross-border mergers could be a positive development.
Many say here that Cyprus is, essentially, overbanked. There are a lot of banks here, even though we are a small place. Do you share this belief as a regulator?
To be honest, I think that Europe is overbanked. Overbanked is maybe not the word I would use. I think that there is some degree of excess capacity. We saw a lot of increase in the size of the European banking sector in the run-up to the great financial crisis, and after there haven’t been a lot of exits from the market. In the United States, for instance, you’ve had a lot of banks that have exited the market, you’ve had a lot of consolidation, and we haven’t experienced the same process in the European Union. So I still think that there is some leeway to consolidate and reduce excess capacity in the European banking sector.