SREP results 2020: banks show resilience but weaknesses remain
17 February 2021
The coronavirus (COVID-19) pandemic has forced banks and policymakers to respond to rapidly changing circumstances. One of ECB Banking Supervision’s responses was to adapt its annual assessment of banks’ risks – the Supervisory Review and Evaluation Process (SREP) – to the reality of the pandemic. This more pragmatic SREP reduced resource intensity and alleviated the operational burden for banks while still ensuring a rigorous assessment approach. Supervisors focused on a few key questions: how are banks handling the challenges and effects of the pandemic? Are they prepared for future crises and, most importantly, what valuable lessons can be learned from the pandemic?
The outcomes of the 2020 SREP assessment reaffirmed some of the areas of concern flagged by ECB Banking Supervision in the past. As a result, credit risk, profitability and internal governance will remain high on the supervisory agenda.
In more detail, the 2020 assessment revealed a decline in banks’ profitability, as banks anticipated increased losses in their loan books from debtors struggling to repay their loans. Lower net interest income and a decline in fees and commissions put additional strain on profitability. On a more positive note, the trend towards more innovative business processes for customers and employees has been accelerated by the pandemic. Moreover, the pandemic crisis has made some banks rethink broader strategic issues, such as the need for further restructuring.
Regarding internal governance, the assessment highlighted that, on the whole, banks were able to adapt to the unprecedented circumstances, with many banks swiftly establishing effective crisis committees to help steer them through the pandemic. However, some banks were much slower to adapt. ECB Banking Supervision also found that the non-executive directors of some banks had not played an active enough role in the decision-making process for the bank’s crisis response. Some banks failed to ensure adequate bottom-up reporting or continued to have difficulties in producing high-quality data on the risks to which they are exposed. In many cases, the pandemic further exacerbated existing issues.
Banks entered the crisis with stronger capital positions than in 2008, meaning that they were more resilient to any shocks. However, as loan losses directly affect capital ratios, ECB Banking Supervision will continue to closely monitor banks’ capital adequacy and non-performing loans (NPLs). The fallout from COVID-19 may be especially challenging for those banks with a significant concentration of exposures to sectors that have been most affected by the pandemic. Supervisors are therefore looking into these exposures in detail and factoring in the situation and outlook for each vulnerable sector. It is important to note that the expected increase in NPLs is yet to materialise and is not yet fully reflected in balance sheets and capital ratios. To deal with what lies ahead and keep NPLs contained, banks need to ensure that they are able to adequately identify and manage distressed debtors. ECB Banking Supervision will remain vigilant to under-provisioning. Furthermore, many banks were unable to produce reliable forward-looking capital projections, which are crucial to steering a bank’s capital position through the COVID-19 storm and beyond. To address this issue, ECB Banking Supervision will further refine its methodology for assessing banks’ capital plans in the 2021 SREP.
The 2020 SREP assessment also highlighted one very positive outcome: banks proved to be operationally resilient when suddenly confronted with the pandemic. Despite branch closures, banks continued to serve their customers thanks to digitalisation and increased use of online banking. However, in other operational risk areas supervisors noted room for improvement in the quality of business continuity plans and in addressing related recommendations. Some banks were also asked to make their critical banking services less dependent on third parties and to resolve significant IT issues.
In 2020 ECB Banking Supervision adapted its annual assessment of banks to the pandemic crisis but scrutinised their practices nevertheless. Work will continue on the longer-standing issues, such as low profitability and governance. Credit risk management and NPLs will also remain high on the agenda for 2021 with a view to safeguarding the banking sector’s capital levels. Things will return to normal for the 2021 SREP cycle. The results from the assessment will be used to determine banks’ capital and liquidity requirements for 2022, while allowing banks enough time to restore any buffers that they used during the pandemic.