Interview with Večernji list
Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Ljubica Gatarić
13 May 2023
Deposit insurance is a hot political topic for the banking union. Several days ago the Commission put forward a proposal for a resolution framework for small and medium-sized banks to avoid bank resolution that uses taxpayers’ money. You recently pointed out that reigniting the discussion on regulatory reforms would not be productive. What did you mean?
I wanted to emphasise that recent developments should not call into question the regulatory and crisis management achievements of the last few years, which have been very valuable. The EU’s existing crisis management and resolution framework, which was developed after the global financial crisis, represented a turning point and is already well established and fully functional. Supervisory and resolution authorities have taken significant steps to prevent crisis situations and have acquired a certain amount of experience on how to handle them. We have seen examples of this very recently with the failure of the Sberbank group following Russia’s invasion of Ukraine. This does not mean that we should not draw any lessons from what has happened in the last few weeks, including as regards depositor behaviour and protection, but we should not hastily jump to premature conclusions regarding the need for major changes to Europe’s regulatory, supervisory and crisis management apparatus.
What is your assessment of the proposals of the Commission? Will they help to better manage future crises and heed the lessons of the past?
They are certainly a very positive step forward and will enable the authorities to manage banking crises in a more effective way. However, they are not the end game that we have long been wishing for with a view to completing the banking union. The Commission’s proposals seek to further harmonise the rules on how to deal with small and medium-sized banks exiting the market, building on the lessons learnt from past crises. This should help to ensure that those players have a smooth exit from the market, without implying higher losses for the insurance scheme or any need for the deployment of taxpayers’ money. After the global financial crisis, the fact that different approaches were adopted by different authorities in different Member States made resolution more cumbersome than was necessary, resulting in a lower rate of market exit than would have been desirable. In my view, this also helped to undermine trust among members of the euro area. Having a harmonised set of rules for crisis management and resolution that is agreed by everyone, regardless of the size of the bank, would help to restore this trust and would represent an intermediate step towards the completion of the banking union.
Croatia has a good model for bank resolution; it relies on banks’ resources, which is exactly what the proposals of the Commission aim at. Yet, Marija Hrebac, the Director of the Croatian Deposit Insurance Agency (CDIA), the Croatian regulator in charge of bank resolution, recently expressed reservations about the proposals coming from the EU, fearing that they involve some other potential long-term dangers to the efficacy of the deposit insurance scheme in the country. She noted that the main fear was the elimination of the least-cost principle in the adoption of resolution decisions and the concern that Croatian money would be used for the resolution of foreign banks. What is your comment on Ms Hrebac's statement?
As indicated, our verdict on the Commission’s proposals is positive. From our perspective, they will further shift the burden of bank failures from taxpayers to banks – which, as you say, is an important element. At the same time, they also seek to reduce the need for a national deposit guarantee scheme to pay depositors large sums when a bank fails, with greater reliance being placed on preventive interventions on a least-cost basis. This will improve the protection of all depositors and reduce the likelihood of bank runs. This proposal does not increase risk sharing among Member States in the area of deposit insurance. We have long argued in favour of a European deposit guarantee system, but unfortunately we are not there yet. I believe that this would make the framework even more resilient, increase trust, strengthen financial stability and benefit depositors and banks across the banking union.
What was your reaction when the instability in the United States (the Silicon Valley Bank crisis) spilled over to Europe? What was your view on the problems that Credit Suisse had? Is there a risk of contagion for the banks under your control?
There is no direct read-across from the events in the United States to significant banks in the euro area. This is mainly because the banks that we supervise do not exhibit the specific features that SVB had – namely, extreme exposure to interest rate risk, coupled with heavy reliance on a concentrated, uninsured depositor base. There are also important regulatory differences between the United States and the EU, notably in terms of the extent to which international standards are applied to smaller banks, which would help to cushion any liquidity stress on European banks. However, the failure of Silicon Valley Bank and the other cases that we have observed since then remind us that specific features of a bank’s business model can make its balance sheet particularly vulnerable to interest rate risk. Given the macroeconomic environment that we are in, this risk needs to continue to be monitored in Europe – as we have been doing since as far back as end-2021, when the first signs of inflationary pressure materialised. This year’s stress test – which is currently ongoing, with the results due to be published in July – will give us an update on the resilience of our banks, including as regards these types of risk. Credit Suisse was ultimately also a case of very weak governance, although its demise had much less to do with interest rate risk. A recent history of scandals and lawsuits was coupled with repeated negative profit and loss results. Besides the governance driver, what these two cases also had in common was the surprisingly high volatility of the deposit base, which should prompt a dedicated discussion.
Deposit withdrawal is a nightmare of every banker. How will the digital currencies that are being prepared by many central banks, including the ECB, respond to the challenge?
The risks that a central bank digital currency could potentially pose to financial stability and bank intermediation have been core considerations since the start of the digital euro project. A digital euro would be designed in a way that prevented any risk of sudden large-scale deposit withdrawals or a structural disintermediation of banks – e.g. by placing a limit on individual holdings and by designing appropriate remuneration features. Moreover, banks would also have a role to play in its distribution, as they would be responsible for customer relations and would be the main counterpart for users.
Coming back to Credit Suisse ... holders of Credit Suisse AT1 bonds will lose their investments. In a way, AT1 bonds were devised by central banks, which thus have a shared responsibility for their destiny. What is the situation with this debt security today? What are the losses on EU banks’ investments in the Swiss bank? Has the Swiss regulator compromised this significant debt security? What guarantee do potential buyers have that the ECB would not do the same in an emergency situation?
We at the ECB have been very clear, together with the Single Resolution Board and the European Banking Authority: here in the EU, the hierarchy of claims is clearly defined in our resolution framework and will be respected. This means that shareholders will always be the first to absorb losses in a resolution context. This principle has been applied consistently in past cases and will continue to guide our actions in all crisis interventions, even outside the area of resolution, to the extent that supervisory powers and decisions are involved. We note that the feature linked to the provision of public support which is included in the Swiss AT1 instrument contracts (which allowed the inversion of the creditor hierarchy in that case) is present in hardly any European banks’ AT1 contracts, and is not something that EU authorities would ask for in any event. As regards the impact that this decision had on EU banks, their AT1 holdings were negligible, so there were no material losses.
Are you losing the bigger picture and missing potential risks due to your focus on bank capital, an issue brought up in a recent report prepared by independent experts and published by the ECB?
The issue that the expert group raised as regards capital was somewhat different. They said that the overall level of capital requirements was in the right ballpark, but argued that it was questionable whether specific risk areas such as weak business models and poor internal governance practices should be addressed by making sure that banks maintained higher levels of capital, or if they would be better addressed by requiring managerial action to reduce and control risks. The sustainability of business models and internal governance are two areas where supervisors have repeatedly flagged deficiencies but the pace of progress has not been satisfactory.
Beyond that, the expert group’s analysis is part of a more general review of our processes, which we started last year and will conclude early next year. I very much welcomed their recommendations, which we have already started to evaluate and work on. They will undoubtedly help us to remain an agile, effective and risk-focused supervisor in the future.
What are currently the biggest risks to the banking sector? Are they government debt securities, the real estate sector, the steep rise in interest rates, or something else?
Since the start of the pandemic, the macroeconomic and financial stability landscape has been changing quite rapidly. Risks can differ from one year to the next, and we need to be ready to face them as they emerge. That’s why every year we define our priorities for the next three years, and we then fine-tune them as time goes by.
One area of special attention since 2021, as discussed earlier, has been the fast-paced normalisation of monetary policy conditions and the re-assessment of financial asset prices that has ensued. This has led to an increase in our banks’ exposure to interest rate and credit spread risks in the banking book, which needs continuous monitoring. The rising cost of funding has also led to a significant tightening of credit standards for both non-financial corporations and households. So far, this has not resulted in a widespread deterioration in asset quality, but that could change if borrowers’ debt‑servicing capacity worsens, particularly in sectors such as commercial and residential real estate, leveraged finance and consumer lending.
Moreover, the current geopolitical situation and banks’ increasing reliance on IT systems have caused operational and cyber/IT-related risks to surge. We should also not forget that banks are facing several medium-term challenges, such as the transition to the green economy, the need to address digitalisation challenges and governance-related issues.
Do you expect to see an increase in non-performing loans (NPLs) in the coming months? There is mounting concern in Croatia over the sale of unpaid loans and the position of debtors in general. Will there be any regulatory changes in that regard?
In the past year, the NPL ratio has dropped from 2.1% to 1.8%, standing at its lowest level since the establishment of the banking union. However, the pace of reduction has slowed compared with previous years, particularly in the last six months. Although rising rates and inflation have not yet had a significant impact on asset quality, we are seeing some early signs in some portfolios and increases in the number of loans with delayed payments. It is essential, therefore, that banks focus on the early identification and management of loans that start showing signs of deterioration.
The sale of NPLs is one of a number of possible measures that a bank’s management have at their disposal to reduce NPLs which do, of course, also need to respect the rights of debtors. We as European banking supervisors assess, among other things, the feasibility and ambition of the NPL reduction strategies which are presented to us by banks, but also the progress made in implementing such strategies, so as to ensure the viability and stability of banks. It is important, in that regard, that such strategies are diverse in nature and do not rely solely on sales.
Early and proactive management of viable debtors in distress should be a key element of NPL management.
Croatian banks struggled with unpaid loans for a while after 2008, but the situation is now much better. How do Croatian banks fare in your examinations, their reserves being somewhat higher due to a more conservative approach taken by Hrvatska narodna banka?
Croatian banks have adequate capital and liquidity levels. Over the past few years, they have been successful in reducing NPLs, which is a welcome development and mirrors progress made across the banking union, although levels of NPLs are still above SSM averages. There is still strong variation across institutions, and further efforts are needed to bring NPLs down, particularly for those banks with high NPL levels. Thus, we expect banks to continue focusing on asset quality, while the ECB will keep monitoring progress.
It should be borne in mind that Hrvatska narodna banka remains the direct supervisor for smaller, less significant institutions, for which the ECB has an oversight function. However, Croatian supervisors have quickly aligned themselves with SSM practices, particularly since Croatia joined the SSM under the close cooperation framework in 2020 and as a full member in 2023.
We should not forget, either, that it ultimately falls to the management of the relevant bank to come up with a credible NPL reduction plan. The high coverage of NPLs should give banks a welcome tailwind in their efforts to reduce NPLs without a strongly negative impact on their capital. Lessons learnt from 2008, combined with a prudent approach by supervisors and the management of individual banks, should help to prevent large stocks of NPLs from being generated in the future.
The ECB has established that 60% of European banks do not have in place stress testing frameworks that would explain their exposure to the risk of climate change and only 6% of them produce at least generally appropriate information in all five assessment categories. Do you expect banks to be more clairvoyant than politicians and governments when it comes to climate change?
I would argue that you do not need to be a clairvoyant to see that the effects of climate change are enormous, and certainly pose material risks to banks – which is, by the way, also regularly confirmed by our supervised banks themselves. It is for this reason that we conduct exercises such as our climate stress test and thematic review, where we assess whether banks comply with our expectations regarding climate-related and environmental risks. These exercises show that while banks have made progress, they still need to get better at identifying and managing climate-related and environmental risks. It is time for them to start taking these risks as seriously as the more traditional ones they are used to dealing with.