Interview with Cinco Días

Interview with Kerstin af Jochnick, Member of the Supervisory Board of the ECB, conducted by Ricardo Sobrino

5 June 2024

From supervisors’ point of view, where do European banks stand?

There has been a huge development in regulation and supervision over the past ten years, which has helped build a more robust banking sector. Even though we have been through various crises, the banks are still in a solid position. Capital and liquidity are at comfortable levels and non-performing loans remain low. There are risks, of course, but at the moment we have a robust banking sector in Europe.

What are those risks?

In December we published our supervisory priorities for the coming years so that banks understand what we want them to focus on. The first step is to ensure that they are on their toes so that they can identify new risks. In the current economic context, we are asking them in to monitor credit risk in particular. Interest rates are high, and we are seeing a slight increase in non-performing loans, especially in consumer finance and commercial real estate portfolios. Second, we are also asking them to make more of an effort in terms of governance and risk management: decision-makers need to understand what the risks are and manage them properly. As part of our annual evaluation process, we examined governance. Many banks scored relatively low on this, so we have made it a priority. Third, there’s the digital transformation. It’s essential for banks to leverage new technologies, but they must also ensure they are operationally resilient. Lastly, we are asking banks to monitor and manage climate risk appropriately.

The ECB already announced that it could sanction banks that do not adequately measure climate risks. In general, are banks meeting supervisors’ expectations?

In 2020 we issued our expectations in this area, and two and a half years ago we set deadlines for banks to meet them. We expect all banks to be aligned with our expectations by the end of this year, and we have given them some interim milestones they need to reach in the meantime. We also announced that if they fail to comply, we will take more stringent measures if necessary to enforce our expectations. We could, for example, use our escalation ladder to implement different measures, such as requiring banks to increase capital in certain areas or imposing fines until they meet the requirements.

Have any of the banks been fined already?

We have notified a few banks that, based on our current assessment, they have not met the interim milestones, which means they face the prospect of having to pay a so-called pecuniary penalty. Supervisors will need to assess the documents that banks submit and the total number of days that they might have failed to comply past the deadlines we gave them. This will form the basis for any potential penalty, which would need to be decided upon by the Supervisory Board. So it’s a process that is not over yet.

Regarding the new risks you mentioned, there is much debate surrounding the use of artificial intelligence (AI). What risks does this technology pose to banking?

AI is in its early days, so it will develop more, but it’s certainly already here. Of course, it is something we need to follow closely. Last year we conducted a survey which found that, among the banks we supervise, 60% are already using AI in some shape or form. For us, it’s important to ensure they are using it wisely and prudently. We need to make sure banks are managing it in such a way that, if the technology fails, they have an alternative means of serving their customers.

You said earlier that European banks are robust. In recent years banks have taken advantage of good results to distribute dividends and launch share buy-back programmes. Are you concerned that they might be allocating too many resources to remunerate shareholders and not enough to increase solvency levels?

From our perspective, the most important thing is to ensure that banks have sufficient capital to cover the risks in their portfolios. We have worked hard over the past ten years to ensure this, and that banks are managing risks effectively. That said, we are aware that investors have long been hesitant to invest in European banks because they had high levels of non-performing loans and were not generating profits, so it’s understandable to some extent that shareholders now want to make a return on their investment. Banks are well capitalised overall, but this is no time for complacency.

But is there any level of payout you would consider worrying?

We assess banks’ dividend distribution plans and capital trajectories on a case-by-case basis, so it depends. If banks want to buy back shares, they need our permission. And before granting permission, we always ask banks to provide a medium-term capital plan which takes into account plausible adverse scenarios to ensure that they have enough capital to maintain their operations and to cover the risks in their portfolios.

Thanks to high interest rates, banks have posted large profits. Some countries, including Spain, have decided to impose an extraordinary tax on these gains. Are you concerned that these measures might remain in place at a time when rates are falling and banks are earning less?

This has been debated in recent years. The ECB has issued opinions to countries that have applied or plan to introduce an extraordinary tax, and our general stance has been the same for all of them. I think this issue came up because banks made very high profits last year. But from our perspective, 2023 was probably a transitional year, so profits may not be as high this year. I can understand the political discussion, but we look at things from a prudential perspective. In a year when profits were high, some may see the benefit of taxing banks. But we need to look at the bigger picture and ensure banks continue to support the economy and grant credit to households and businesses.

It’s also important to have a level playing field, because if you levy a windfall tax on banks in your own country, they might be competing against banks in other countries where this kind of tax doesn’t exist. You also need to be careful when deciding to levy extraordinary taxes on banks, because it could make shareholders and would-be investors a bit hesitant. European banks need their shareholder base and investors to know for sure which activities will be taxed on a regular basis. So some of these effects are of concern, and we feel it’s important to make a full analysis of the situation when taking this kind of decision.

In Spain, BBVA has launched a takeover bid for Banco Sabadell. There has been a considerable amount of banking consolidation in recent years. Is this something that concerns you or do you feel that it helps to improve banks’ solvency levels?

When a merger takes place, many authorities are involved. Our role is to ensure that there is a viable business model, sufficient capital and liquidity and good governance in place. This is what we discuss with the banks. We issued guidelines a few years ago to make sure that our role as prudential supervisors was fully understood, because at one time there was a perception that supervisors were hindering mergers, which is simply not true. We assess any merger proposal from a strictly prudential perspective.

Is there a risk to financial stability if there are fewer and fewer banks but they become larger?

We have around 110 banks under our supervision. Harmonising supervision in the euro area has been very important for financial stability. After the great financial crisis, there was a lot of discussion about what could have been done better. One topic raised was how to improve regulation of the most significant institutions. Measures have been taken to ensure that globally systemically important institutions have higher capital requirements and that banks are financially resolvable if there is a crisis. So action has been taken to mitigate this risk and to make sure that taxpayers’ money is not used if there is a problem.

Even so, there does seem to be concern about these kinds of mergers in certain countries.

We have seen a fair amount of bank consolidation in some countries and less in others. As the European supervisor, we look at the banking union as a whole. It’s important to focus on the fact that we have a single currency, a single supervisor and a single resolution authority. It would also help if we had a single deposit insurance scheme in place to create more trust in the system as a whole. But right now, the financial system is robust and we do have regulations in place to mitigate these concerns.

There is also a lot of interest in cross-border mergers. Would these types of mergers make sense in the EU?

When we started to build the banking union, we thought that having a single rulebook, single supervisor and single resolution board would pave the way for more cross-border activity, make it easier for banks to expand and bring benefits in all kinds of areas. The reason we haven’t seen a lot of cross-border mergers is because, despite having a single prudential rulebook, differences remain in other areas. There are different tax rules, different accounting practices, different bankruptcy legislation, and deposit insurance schemes are still national. This makes it more difficult for banks to merge across borders. Certain hurdles need to be overcome to foster free movement of capital and liquidity amongst banking groups in a cross-border context. That’s why we would like to see greater efforts being made to complete banking union. That said, there are still things banks can do to expand beyond their national borders under the current legal framework. For example, Spanish banks can open branches and offer financial services in all other EU Member States, even without having subsidiaries in those countries.

At the start of the interview you mentioned that non-performing loans were still low. With next week’s expected cut in interest rates, how will this loosening of monetary policy affect banks’ loan portfolios?

I can’t comment on monetary policy, but I can say that non-performing loans have remained very stable at a low level. They were stable throughout the COVID-19 pandemic and have remained so following Russia’s invasion of Ukraine. If growth slows down a little and interest rates remain high compared with previous periods, it would be normal to see a slight uptick in non-performing loans. We are seeing a slight increase in consumer finance and commercial real estate. It’s not much yet, but we think that this year or next, we will probably see a rise in non-performing loans.

This year is the tenth anniversary of the Single Supervisory Mechanism. What challenges will it face in the coming years and what role will it play in the future of the financial sector?

Our annual Supervisory Review and Evaluation Process is vast and covers 21 countries, so it’s quite a challenge. In the past year we have invited experts in supervision to give us their views on how we can make our supervisory process more efficient. We have also decided to make better use of digitalisation so our supervisors can really focus on the most important risks, on their discussions with the banks and on communicating with them. As supervisors, our key challenge is to remain at the forefront, making sure that banks do their utmost to identify risks early and that they have enough capital to be prepared for the unexpected.