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“The banks are not complacent”

Interview with Ana Botín, President of the European Banking Federation and Chair of Santander Group, Supervision Newsletter

16 February 2022

European banks have weathered the pandemic storm quite well. There have been no significant signs of a deterioration in asset quality so far, although this is in large part due to the stimulus and government support measures. Where do you see the biggest risks to the banking sector after the pandemic?

The European banking system has been able to withstand the severe economic shock caused by the coronavirus (COVID-19) pandemic thanks to the coordinated reaction by banks, policymakers and authorities.

At the outbreak of the pandemic in March 2020, the European Banking Federation (EBF) put forward a series of proposals, many of which were taken on board. These included implementing a moratoria programme across Europe, extending the time and scope of targeted longer-term refinancing operation (TLTRO) facilities – covering a wider range of counterparties including small and medium-sized enterprises (SMEs) – and revising some elements of the regulatory framework.

However, all of that would have been insufficient had the banking system not substantially recapitalised itself over the previous decade. At the start of this crisis our banking system had a capital ratio of 15% on average and a short-term liquidity ratio of over 150%. To put that in perspective, the level of capital and liquidity now is more than double what it was at the time of the previous crisis. And we have seen the difference: in 2008 banks were part of the problem. In 2020 banks were part of the solution.

As economies begin to recover from the health crisis, the four big risks in the coming years will be credit risk, digitalisation, cyber crime and climate change.

Starting with credit risk, I agree with the ECB’s view that credit risk needs to be managed proactively, and I believe the key to avoiding an excessive build-up of non-performing loans (NPLs) is for banks to identify distressed debtors in a timely manner. This has been happening: at the end of 2020 banks in the euro area had more than doubled their provisioning levels compared with 2019, mainly through the use of overlays.

As you mentioned, there have not been signs of a significant deterioration in asset quality. Not only has the NPL ratio not increased, it has continued to decline to the lowest level seen in the last decade, standing at 2.3%. The question now is to what extent a deterioration of portfolios has been prevented by moratoria and government support. That’s why banks are not complacent. We are analysing the affected portfolios, client by client. It is crucial to identify the viable borrowers in order to help them recover and get back to business-as-usual. Meanwhile, banks need to have responsible collection, recovery and restructuring capabilities in place so they can act decisively once distress signs appear in their portfolios, in order to maximise value recovery.

The second big challenge is the need for rapid action to ensure that banks are competing with tech companies on a fair and level playing field. Competition is to be welcomed: it spurs innovation, benefits customers and drives progress. But it must be fair competition, particularly on issues such as payments and access to data. I am delighted that the EU is taking action on this, and it cannot come soon enough.

One specific risk created by the tech revolution is obviously the potential for cyber crime. Here, the best way forward for the European banking industry is to foster cooperation between banks, regulators and supervisors in order to establish a coordinated and robust framework.

Last but not least, I would flag climate change as both a challenge and an opportunity. We welcome the ECB’s work – such as its Guide on climate-related and environmental risks – but there are numerous issues that need to be addressed. We believe that the supervisory framework still needs more consistency in terms of definitions and data. There are also issues related to agreeing on a common approach to methodologies, scenarios and the timelines. And there are practical steps – like adapting our internal IT systems – which take time to implement.

Banks, regulators and supervisors must work together to overcome these issues. More transparency and coherence in green financial regulation will help instil more confidence among investors, mobilising more capital to fund the transition. And that brings me to a key point. The transition is dependent on sustainable economic growth. So financial regulation must pass a simple test: does it help our customers’ transition and support green growth?

The European crisis management framework has changed considerably since the global financial crisis. Is “too big to fail” a concept of the past?

We have to turn the page on “too big to fail”. What went wrong in managing the great financial crisis wasn’t that some banks were too big to fail, it was that we had no roadmap for how to manage a bank failure – big, medium or small. At that time, there was no protocol for bank recovery and resolution, and improvisation is never helpful when it comes to resolving a bank.

We now have a European crisis management framework that can guide a failing bank through intervention, recovery and eventually resolution, regardless of its size. Also, there is no match for experience, and the European system now has that. In fact, Santander was the first banking group to engage in the resolution of a bank, Banco Popular, within the current framework. Banks have made great efforts to build up the new buffer for loss absorption – the minimum requirement for own funds and eligible liabilities (MREL) – and have assumed the associated costs, in order to remove any obstacle that would impede resolution and to ensure operational continuity in a resolution scenario.

That is not to say that there is not more to do. There are opportunities to refine the system. I think the way in which MREL instruments developed by subsidiaries can end up being deducted from parent entities does not make sense. We also need to find a pragmatic way to set total loss-absorbing capacity development targets for subsidiaries in emerging countries that reflects the longer implementation time frames established in the approaches of the Financial Stability Board (FSB) and the Bank for International Settlements.

What is important and urgent now is for Europe to close the gaps in the crisis management framework, taking into consideration the lessons learned since it was established over seven years ago. First, we need a liquidity backstop like in the United Kingdom and the United States to dispel market investor doubts. We will also need a consultation with the sector on how to repay the European Stability Mechanism, which could be used as backstop for the Single Resolution Fund. Second, we need harmonised insolvency rules. Third, we need to focus more on the sale of banks to sound players as part of the resolution process. In my personal experience, a lot can be done to make this alternative more effective and attractive, such as limiting the acquiring bank’s criminal and legal responsibility for the actions of the previous management.

A lot has been done since the FSB proposed the principles to ensure sufficient loss absorption and recapitalisation capacity. We are now much better prepared to implement an orderly resolution that minimises the impact on financial stability, ensures the continuity of critical functions and avoids exposing public funds to loss.

What’s stopping European banks from striving for more consolidation, especially across borders?

I think that the very low level of cross-border consolidation in the European banking system has a number of causes. Today’s economic conditions – the uncertainty created by the COVID-19 crisis – have come after a decade of recovery and retrenchment, weak European growth and loose monetary policy.

But more structurally, the regulatory landscape significantly limits the benefits that large-scale cross-border consolidation could offer. To some extent, the last decade has seen banks looking inward to adapt to the post-crisis regulatory and monetary policy landscape rather than outward to growth and expansion. At the level of supervision, changes to the treatment of Pillar 2 capital and the recognition of internal models, or a new approach to waivers for cross-border MREL, for example, would help support cross-border mergers.

Linked to this is the fact that further consolidation is often prevented by the fragmented European banking marketplace. From capital and liquidity treatment to deposit protection, there are still many areas where the EU market imposes national-level treatment that makes cross-border consolidation and operations uncertain or inefficient. Banking union, a true single market, is the primary solution to this, along with a generally supportive approach to capital and liquidity costs for EU parent companies with operations throughout the EU market. Waivers should be granted to manage capital and liquidity at the consolidated level.

These are the kinds of issues that the European Commission’s recent banking package needs to tackle if we want to encourage more consolidation.

How can banks remain relevant to customers and companies and prevent fintechs and big techs from gaining further market share?

Financial services have always been a tech-intensive sector. From the first ATMs and computers for trading accounts in the 1960s to user-friendly and quick retail banking mobile apps in the new millennium, banks have always invested heavily in better serving customers while safeguarding their trust. What has changed in the last 15 years with wireless technology, the rapid spread of smartphones and large online platforms is that banking has to a large extent moved out of the branch. Financial transactions can be carried out by anyone, anywhere, anytime, and financial services are offered by various – and often unregulated – actors.

Big techs can amplify fintech offerings thanks to their global scale, large user bases and cutting-edge technology. But above all, they use their vast troves of user data to offer a more personalised and seamless customer experience. In financial services, as in other markets, they can use this privileged access to data and the digital infrastructure to carve out a foothold for market entry.

Obviously, when this means better customer service and greater innovation, financial inclusion and competition, it is basically a good thing. However, it can also create “walled gardens” controlled by the owners of key infrastructures such as smartphones, which in turn creates captive customers. This reduces real choice and competition. It also creates new types of risks, blurs the lines of accountability and can shift the provision of financial services outside of the regulatory perimeter.

I would say banks welcome competition in digital finance, so long as that competition is fair and benefits society. To achieve this, European banks have been asking EU policymakers to ensure a level playing field for financial institutions regarding big tech activities in digital finance and to make sure that big tech firms are not exploiting asymmetric privileges in terms of access to data and infrastructure. Finalising regulatory initiatives such as the Digital Markets Act and the Regulation on Markets in Crypto-assets will help in this regard, as will moving forward with initiatives on a European data-driven economy that puts users at the centre and does not only target the opening of financial sector data to third parties. The basic principle should be “same activity, same risks, same rules, same supervision”.

Do you think Europe will move away from bank-based financing towards more market-based financing, like in the United States?

We know the US and EU financial markets are different: the US market relies heavily on retail investors and pension funds, whereas the participation of EU retail investors in capital markets remains low.

During the most acute phases of the pandemic, many European companies turned to the banking sector for support. Today, we are entering a new phase in which Europe is looking ahead in search of a more inclusive and sustainable formula for economic growth. In particular, hitting the climate change targets will require an unprecedented shift in both public and private funds to finance the green transition. Bank-based financing alone may not be sufficient for this. We will need a mix.

In this sense, the increased demand for sustainable investment products observed during the pandemic is a positive sign that capital markets are assuming a larger role in this process. After all, in their dual capacity as users and service providers in capital markets, banks strongly believe that increased levels of market-based financing are needed to promote innovation, stability and risk-sharing. This is why it remains fundamental, especially on a global level and in a post-Brexit environment, to foster the attractiveness and competitiveness of European financial markets by completing the capital markets union.

Do crypto-assets threaten the business model of traditional banks? Do you think they should be regulated?

Crypto-assets open up possibilities in terms of payments, transaction costs, scale and agility. They also create new challenges for banks and authorities in terms of a level playing field, systemic risk and transparency.

A robust regulatory regime for crypto-assets in the EU is essential to ensure a competitive financial ecosystem in which all players are subject to the same rules. A harmonised European regulatory framework that is technology-neutral and innovation-friendly protects users and provides a level playing field through the “same activity, same risks, same rules, same supervision” principle. I am confident that regulatory discussions are going in that direction.

At the same time, it is necessary to allow banks to be part of the development of crypto-asset markets. Banks need to be able to compete in these new markets and offer their customers access to products and services in new digital forms while maintaining the highest standards of compliance and risk management.

Although different from crypto-assets, central bank digital currencies are, in a broad sense, part of the same discussion. A digital euro touches on the core of what banking is and what banks do within and for the economy and society. Given its possible far-reaching impact on financial stability and the whole financial ecosystem, European banks are eager to be part of, and should be fully involved in, the ECB’s project.

The goal is to ensure that if a digital euro is launched, it benefits European citizens, while safeguarding European financial stability and enabling the payments industry to flourish.

How much are European banks committed to environmental, social and governance (ESG) issues and, in particular, how well are they managing climate risk?

European banks are fully committed to the ESG agenda and the transition to a net-zero economy.

We are moving quickly to revamp our internal systems, especially for risk management and credit approvals, to ensure we work towards that goal. It is a challenging task given that the methods to calculate these risks are still uncertain: large swathes of the economy are still to be classified in terms of greening and there is a scarcity of good data. But there is consensus that acting now is a priority, and we are all working hard on it.

However, banks cannot drive the transition of the economy on their own. Governments need to define policies that incentivise all sectors and companies to progress in the transition. That will help deliver a just transition – one that provides certainty and clarity to support people and businesses and avoids any potential cliff effects when transitioning from brown to green exposures.

That’s why we believe it is important to do three things. The first is to avoid regulatory fragmentation and work towards a global, common approach to regulation, consistent reporting standards, climate scenarios and stress tests.

Second, stress tests should be learning exercises, as the ECB itself has said. Their results should be treated with caution, given the data limitations and methodologies that are not yet sufficiently mature.

Finally, banks’ prudential frameworks must remain risk-based. For climate risks, banks have to consider new perspectives, including a horizon which is longer than the usual risk and business cycle horizons. The current risk measurement models are not developed for such a long-term risk horizon.

There are tough political decisions ahead in areas such as tax. We can’t sidestep those by relying on financial regulation of lending or of banks’ exposure. Banks shifting resources towards a low-carbon economy and engaging with customers is key in financing the transition, but to change businesses’ and people’s behaviour and financial decisions in a major way, we need significant changes to the incentives that underpin economies. While banks will play their role, they cannot be the primary enforcers of climate policy.

Banks have pledged to reach net-zero carbon emissions across their lending portfolios by 2050. To achieve this, they need to initiate green projects. What are banks doing on that front?

Through the Net-Zero Banking Alliance (NZBA), more than 100 banks have committed to transitioning greenhouse gas emissions from their lending and investment portfolios to align with pathways to net zero. They are also setting intermediary targets for 2030 or sooner, focusing on priority sectors where the banks can have the most significant impact in a transparent and publicly accountable way.

Several major European banks have also announced their divestment from coal mining and/or coal-fired power plants and are committing to reducing total fossil fuel exposures while increasing their commitments to finance alternative sources of energy.

Banks can help incentivise their customers to reduce their emissions through financial products and lending, for instance through green loans or bonds. Banks are not only revisiting their relationships and interaction with large corporate or institutional clients. Innovation is also starting to take place in retail and SME segments.

But as I said before, banks can’t do it alone. We need more governments to set out detailed plans to cut emissions, including – crucially – how to mobilise their populations to go green.

Banks often complain that European regulation and supervision weaken their competitiveness, especially globally. What do you consider the biggest obstacles to competition?

The biggest obstacle for European banks’ competitiveness is market fragmentation caused by having to deal with 27 different regimes and supervisors. The lack of a truly single market limits the potential to bolster European banks’ profitability and competitiveness and reverse their relative competitive decline.

The wave of regulatory reform after 2008 has been broadly successful, as proven during the COVID-19 crisis. However, all achievements have drawbacks. One of them is that the number and length of regulations has increased significantly and, therefore, so has the cost of compliance. If we consider the whole rulebook, regulation is arguably too complex. I think there is a lot of room to reduce the complexity of the current regulation without impairing the soundness of the framework.

What we need is simple. First, to develop a holistic analysis of the regulatory burden that European banks are facing, including the prudential rules, the crisis management framework, anti-money laundering rules, consumer protection and the new set of rules related to sustainability and digitalisation. This analysis should be the basis for reviewing and recalibrating the requirements, including capital requirements.

Second, we need to move from directives to regulations. Third, regulators need to consider European specificities when transposing international standards and, importantly, already during the negotiations, as they have done with the Basel III proposal. Some of this is about simple recalibration. Regulation is a competitiveness issue internationally. Take the United States as a reference: here in Europe, banks hold mortgage exposures on their balance sheets until maturity, while in the United States, the bulk of the mortgage portfolio is transferred to Fannie Mae and Freddie Mac. In Europe, the dual recourse to the property and the borrower makes mortgage exposures safer, and given that the mortgage portfolio is the biggest, representing almost one-quarter of total loans, conservative prudential measures like the output floor hit the European banking system harder. There are even other banking authorities, like the UK authorities, that are considering expressly introducing competitiveness into their regulatory and supervisory objectives.

And then there is the problem of market fragmentation again. In Europe, many of the regulatory requirements are set at national level. There are buffer requirements at local level and the stand-alone view of the subsidiaries prevails over the consolidated level of a banking group. This has an impact on the competitive position of groups when they operate internationally.

The dividend restrictions during the pandemic, which are still weighing on European banks today, are a good example of how different regulatory approaches can affect markets’ attractiveness, with a higher impact on euro area bank valuations relative to US or UK ones.

So, we need to take a global view as well as considering the absolute level of regulation in the EU. We don’t live in a bubble. With the United Kingdom likely to take a new approach to managing regulatory costs outside of the EU and the United States usually more alert to regulatory burdens, EU legislators and regulators need to see the wider picture.


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