Interview with Bloomberg News

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB, conducted by Nicholas Comfort and Steven Arons

11 September 2023

The unravelling of Credit Suisse and collapse of several US banks shone the light on bank liquidity. Some supervisors say the ECB paid too little attention to liquidity in recent years. Will we see it given greater prominence in this year’s Supervisory Review and Evaluation Process (SREP)? Will you raise the liquidity coverage ratio requirements of individual banks, or is it more about focusing on the quality of liquidity rather than the quantity?

It’s true that liquidity and funding risks have not been very high on our supervisory agenda in the past few years. Banks were flush with liquidity; extraordinary central banking facilities had dampened liquidity risk quite significantly. Since the normalisation of monetary policy started, our attention has shifted back onto liquidity and funding risk.

The point is not really so much about having tighter requirements across the board. It is really to go deeper into the liquidity profiles and funding profiles of individual banks. We have done a lot of work on plans to replace TLTRO [targeted longer-term refinancing operations] funding. We have looked at the volatility of funding sources, concentration of funding, and the diversification of funding sources is also very important. We have also looked at the ability of the banks to easily access central banking facilities, having enough collateral already prepositioned or ready to be posted.

The feedback of all this work has been pretty positive. The banks have developed robust funding plans. The TLTRO reimbursement deadline in June did not raise big issues. We haven’t identified extreme cases or even very severe cases of concern like in the regional banks in the United States. Of course, we identified shortcomings in some individual banks. We have recommendations in the SREP – mostly qualitative, some also quantitative for some banks that have showed some shortcomings.

What kind of shortcomings?

For instance, if you have shortages in or excessive dependence on funding in some currencies, we might ask for additional buffers of liquidity in those currencies. Or if you have excessive reliance on very volatile funding sources, we might ask for additional requirements in terms of quantity, in terms of the survival periods.

Will the survival period be given more attention in dialogue with banks in the coming months and years?

That’s a metric we have always used. It is useful. It is something that we use as an additional metric on top of the regular regulatory yardsticks. Sometimes it helps us identify some shortages that would require some additional attention from the banks.

How about single-day liquidity?

The supervisory work needs to cover the specific business model of the banks and needs to be differentiated according to the specific business model of the bank. It’s clear that if you have a bank that relies more on overnight funding or has a lot of intraday liquidity needs, then the supervisor will pay extra attention to these profiles.

We’re not getting the impression that you are dictating to banks what kind of liquidity they should be using. Some of your colleagues speak so positively about covered deposits, but I’m not hearing that you would be forcing banks or pushing banks to rely on the most stable, most plain vanilla deposits either.

It would be inappropriate for us as supervisors to push through a one-size-fits-all funding profile for the banks. Banks need to find the funding arrangements that fit their business model. The more diversified the sources of funding, the better. Of course, the more stable the sources of funding they have, the better, in terms of protection against panic runs. But it’s not an issue of stigmatising wholesale funding or corporate deposits or institutional deposits. These are important sources of funding for our banks. What is important is that banks are sufficiently attentive to checking what the features and the likely behaviour of these counterparts are and manage the funding and liquidity risks in an effective way.

Are banks too positive on the benefit from net interest income and higher rates? Reserve requirements could increase as well. So are banks too rosy?

I wouldn’t express a judgement for the banking sector as a whole. There are banks that have excessively rosy projections that our teams challenge. We are still in a very uncertain environment. The interest rate environment has changed very fast and we still don’t know where it will stabilise. And there are lags in the way in which certain effects play through banks’ P&L [profit and loss] and balance sheets. We invite banks to be particularly careful in this respect. Margins are widening, but this is not something that can last forever. The pass-through, which has been much slower than in previous hiking cycles, is now picking up speed. Then there is the question of how much the increase in interest rates will also materialise in terms of asset quality and therefore provisioning needs.

In the stress test this year, banks had a smaller capital erosion than they did two years ago, so should banks and their investors assume that payouts or payout ratios will increase?

Distributions have already increased. I’m not a bank manager. I’m not a bank shareholder. It’s not for me to decide where to set the bar in terms of distributions. But if banks have significant capital, if they have good profitability, then I understand that to recover a good level of attractiveness vis-à-vis investors, they might wish to distribute more. If the bank reassures us that it will remain above our supervisory yardsticks in a sufficiently conservative adverse scenario, we will not be in the way of these distributions.

We’ve been in a somewhat depressing period in which banks have been burning capital; they do not earn their cost of equity. Coming to a moment in which they are sufficiently profitable, and they regain the trust of investors, I think that they can start investing in their future. There are plenty of investment needs: the green transition, digitalisation, strengthening their IT infrastructure also in the light of cyber risk. The hope is that the season of ever higher distributions will come to an end, will stabilise and we’ll go back to a normal world in which banks start thinking about how to grow their franchise.

Are you concerned about the fact that European banking continues to be unappealing to international investors?

I am, yes, as a supervisor.

Why is it that banks continue to trade at a discount? People are puzzled.

It’s not up to me to say honestly. It’s more for analysts and investors. We regularly discuss with some market participants, including investors in banks. They say European banks have had a good season, a good year of profits and distributions, but one good year does not prove that they have now re-established profitability on a sustainable long-term basis to remunerate the cost of capital. So I think that there could be an issue re-establishing credibility. When you lose trust, you need to go the extra mile to regain it. But a lot of progress has been made. So I hope that this journey in the desert is almost over.

You have said that bank CEOs are more focused on buybacks than M&A [mergers and acquisitions], but if I look at developments in Italy, it does seem like there could be some consolidation starting there. Do you see some initial signs that the banks will be pursuing deals in the coming months?

A merger is something that banks should decide on the basis of their business strategy and their perception of market developments. My concern is the idea that the only good use banks can make of their profits is to give them back to investors. That could be good in this moment when they need to regain the trust of investors. But in the longer term, I hope they will invest more in their own business by developing their own franchise, also through organic or inorganic growth. There has been a lot of business model adjustment in the last few years, which is also the basis of the regained profitability. We have seen a lot of banks selling business lines that were not profitable and buying other business lines that enabled them to gain scale and become competitive in certain market segments. We’ve seen this in asset management, leasing, custody, structured equity. I hope this continues.

One more question on profitability. Windfall profits attract windfall taxes. We’ve seen the ECB’s opinion on the Spanish bank tax, but now it looks like there’ll be one in Italy too. What are the pitfalls of such taxes?

I won’t comment on specific countries. In general, as we already said in our opinion on the Spanish law, there is a concern that a one-off tax that can also last for a relatively long period of time will hit a bank in a specific moment of a transition – when margins widen during the hiking cycle, just before the catch-up and the pass-through to depositors erode this temporary effect. The other concern is that we want banks to pay proper attention to the credit risk associated with the increase in interest rates, and we want them to provision accordingly. If you have taxes that target the interest margins without considering the provisioning and the cost, you could negatively affect the incentives for banks to provision. Finally, the need to be attractive to investors once again and to earn the cost of equity. Giving the impression that whenever European banks make profits, there is somebody who steps in and reduces them could reduce the attractiveness of investing in banks. I also understand that there could be some responsibilities on the side of banks. We expect competition to make this pass-through process as smooth and timely as possible. In some markets, this has not worked very well. So the banks have been lagging behind, probably for too long, before passing these higher interest rates on to customers.

The Bank of England has actually been quite adamant in telling banks that they need to do more. There has been little in the way of that from the ECB. Are you pushing them to pass through at a quicker pace to make sure consumers benefit from this?

We have sent signals to the banks, but I don’t see this as a responsibility of the supervisor. If something is not working properly in competition, if you have some markets which are extremely concentrated and banks are projecting very, very significant bumps in profitability, I understand that there is a policy concern. I wonder whether the right approach to take on this issue is a tax, or more competition policies and interventions from that side.

I’d like to speak about the incoming banks after the Brexit referendum. No other authority has had to assume oversight of so many foreign investment banks over such a short period of time. You conducted the desk-mapping review to make sure that the banks weren’t still too reliant on London. Has that had the effect you wanted? Is it bread-and-butter supervision from now on?

Yes, we have turned the corner. I’m very proud of this process. It was not a territorial grab of business. It was very prudential, very focused on risk management, identifying the materiality desk by desk and asking the banks to have proper risk management and strategic capabilities in place. We have done this in full transparency with our colleagues at the Bank of England and the Federal Reserve System. It was crucial for me that banks were not confronted with different or even conflicting requests from different authorities. We have just sent the banks final decisions on what we want them to do with respect to individual desks. Some of them already have sufficient risk management capabilities in those desks. Some desks need to be beefed up. The banks know what to do, they have a certain time frame to comply with our requirements. Then, of course, it’ll be a case of monitoring the business. At the beginning, banks that were relocating business were very much in the mindset of minimising any change. Now that they have, to some extent, completed the transition or seen where they need to be, they are starting to think about how to develop their business in the banking union.

What work is still outstanding on the incoming banks, then?

On internal models, we provided the banks with what we call temporary tolerance. So an additional period of time in which they could continue operating with models that were approved by their home authorities. We need to go through the approval of these models in the near future. For some of these banks, the process has already started. We have a huge bottleneck of requests for approval of internal models. But the process is very well advanced and we are close to the situation in which they would be like any other bank under our supervision.

One of the lightning rods of credit risk has been leveraged finance. There’s a handful of banks that have had capital add-ons because they didn’t listen to you in terms of addressing deficiencies. You’ve said that those capital add-ons will stay in place as long as the deficiencies persist. Have the deficiencies stopped? Will the banks have their capital add-ons removed this year?

Some banks have fixed the problems and will see the capital add-on go away. Others have not and will keep it for a bit longer. Some that didn’t have the capital add-on but that haven’t fixed the problems we identified last year will probably have a fresh capital add-on reaching them.

So will the number of banks with a capital add-on for leveraged finance increase?

We have not finalised the SREP process, so it’s too early to say.

There has been some unhappiness at banks about how you conducted oversight at the ECB. Has the relationship been fixed?

We listen to the banks. We review internally, we discuss. Sometimes we conclude that their remarks are unwarranted and we ignore them. Other times we come to the conclusion that maybe we have something to adjust in our own internal processes and we do so. We had a flurry of reports this year. I’m proud that we mandated a group of highly esteemed international supervisors to review the way in which we do our SREP process and to advise us on potential changes. This group also consulted heavily with the industry and stakeholders. I think everybody appreciated the outcome of this report. For instance, trying to make the process more risk-focused and have multi-year planning in the SREP, rather than ticking all the boxes every year. So focusing on what really matters and also not being excessively capital-centric. Although I think this might hide a little bit of unwarranted hope on the side of the banks. They might think that not being capital-centric means lower capital requirements. Probably it will mean a higher amount of enforceable qualitative measures, which are not necessarily less demanding or less challenging for the banks. But still, I think there is a good understanding and a good dialogue between us and the banks on those topics. I think we show that we are not in a sort of ivory tower in which we don’t listen and we protect our practices at all costs.

Can you flesh out the qualitative requirements?

Sometimes it might be more appropriate to set out clear enforcement. For instance, in the area of climate and environmental risks, we have this never-ending debate with the industry on whether we are about to brandish the capital stick for banks which are not in line with our recommendations. What we said is that we might also use other tools. We might use, for instance, periodic penalty payments: we tell a bank to remedy a shortcoming by a certain date and, if they don’t comply with our expectation, they have to pay a certain sum every day until they correct this shortcoming. That would be an equally effective – or, hopefully, an even more effective – way of getting remediation within a reasonable time frame.

There could be other tools, there could be sanctions, or reviews of fit and proper assessments if it was a serious management or governance shortcoming. We also need to look at other supervisors across the world. For instance, in the United States they have these cease and desist orders in which they sometimes constrain the ability of banks to make acquisitions if they don’t have proper internal governance, controls or IT infrastructure in place.

How far are you in advancing that enforcement toolkit? Will you see it through before leaving at the end of the year?

This isn’t a seismic change in the way we do supervision. We do have an issue of effectiveness. We have a significant amount of measures and sometimes it takes an excessively long time for these to lead to remediation. To some extent, this is our fault. We throw too many measures at the banks and it is difficult for them to tick all the boxes within a very compressed time frame. We need to be better at telling the banks “These are the areas which are really serious, I want you to remediate these shortcomings within a certain time frame, and if you don’t do that, you know that there will be a hammer brought down on you”. The other shortcomings which are not as relevant could be deprioritised, and sometimes even passed back to the internal audit of the bank and not trigger any supervisory actions. The best tool could sometimes still be capital. In leveraged finance, I still think that the capital add-on is the most effective measure.

Looking back at your tenure, do you regret crying wolf on some occasions and do you regret not getting certain things done in those four-and-a-half years?

In crying wolf on asset quality, I was doing my job. The outcome of this wasn’t raising the capital bar or anything that has affected lending. It was actually very serious granular work on the quality of credit risk controls at banks. This put the banks in a much stronger position. We can still have a deterioration in asset quality. We have a significant downturn in commercial real estate, for instance. So I’m glad that we put pressure on the banks.

Regarding the areas in which I’m a bit dissatisfied, I would have expected to leave European banking supervision having made greater progress in creating a more integrated banking sector in the banking union. We did what we could in terms of giving clear indications that we were not against mergers, that we would have treated domestic and cross-border mergers the same way, that we were open to activating waivers and branchification. We made a number of efforts to convey a positive message, but the conditions were not right. I hope that the fruits of what we started will be reaped in the future.

Do you think your successor, whoever she is, can take those issues further or are they just immovable issues, such as the liquidity waivers?

I don’t think there is more that we can do from the supervisory point of view besides, of course, being supportive and not giving the wrong signals. The ball now is in the industry’s court.

What do you consider your legacy within European banking supervision then?

If I look at what I was targeting when I started, there was still a major adjustment in banks’ balance sheets to be completed. I think that’s a box ticked. In terms of asset quality, capital positions, liquidity and now also profitability, the banks really are in a different place. I don’t think that this is my personal achievement, but I think that it’s something that we contributed to.

In terms of our supervisory processes, we showed probably unexpected positive agility in reacting to an unprecedented series of external shocks: a pandemic, the war in Ukraine, an unprecedented shift in interest rate environments with crises in regional banks in the United States and in Switzerland. In all these cases, we were able to shift our supervisory work very quickly, to give clear indications to the banks and clear communication to the markets. I think the level of maturity we showed as a supervisor is a major achievement.

We increased transparency about what we do, we publish more. We started publishing individual SREP requirements, holding the press conference with all the information on this SREP on the table. We have published more guidance. We explain our policies. We increased the quality and the quantity of information we give in the stress test.

We try to be open and to review our supervisory toolbox in a way that makes it more effective, maybe also less procedures-based and more risk-focused and therefore maybe also less heavy-handed in terms of processes than it has been in the past. I think these are all positive achievements that I leave to my successor.

So people will remember you from more than just the dividend ban then?

I’m not ashamed of that. If I were in the same situation, I would do it again. It is a pity that, in other jurisdictions, the moral suasion of the supervisor is more effective and the banks themselves realise that maybe it is not a very good idea to pay hefty dividends when there is a pandemic raging around you. In the banking union, the banks were not willing to take on this responsibility themselves, and we were therefore left with the only possible action of issuing a recommendation ourselves. But I think it was the right thing to do at the time.