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New Year’s resolutions for a stable banking sector

Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, at the European banking supervision and European Banking Federation boardroom dialogue, Frankfurt, 25 January 2017

It was the Babylonians who introduced the tradition of New Year’s resolutions. They celebrated their New Year late in March with a festival called Atiku, during which they made promises to their gods. They promised, for instance, to return borrowed things and pay back debt.

Today, some 4,000 years later, people still make New Year’s resolutions. However, now that we are four weeks into the New Year, it’s likely that most people have already fallen by the wayside. They have stopped their early-morning runs, have resumed smoking, and have again succumbed to burgers and French fries.

But what about banks? Do they make New Year’s resolutions? And if so, what would these be? Well, I can tell you what they should be from a supervisor’s point of view. Three things come to mind: adapt business models, improve risk management, and deal with legacy assets. Following up on these resolutions would make the banking sector more stable and more profitable.

So it is no surprise that these three actions constitute our supervisory priorities for 2017. Let’s take a closer look at what’s behind our thinking and what our expectations are.

What to focus on – supervisory priorities for 2017

Business models were already among our priorities in 2016 – this underscores how important they are to us. The backdrop is, of course, that European banks struggle to remain profitable. In short, many banks in Europe do not earn their costs of capital. And this is clearly not sustainable in the long run.

The reasons for low profitability have been widely discussed. And naturally, there is no single, all-encompassing explanation. No two banks are alike, and each bank faces its own challenges. But taking a bird’s-eye view reveals some issues affecting many banks at the same time.

One of these issues is the prolonged period of low interest rates. For some time now, low interest rates have dominated the discussion about the profitability of banks. And it is true, of course, that interest income is important for banks. On average, it makes up more than half of the total income of large banks in the euro area. So, low interest rates clearly affect them.

However, we have to be a bit more nuanced regarding the specific effects of low interest rates. Initially, low interest rates might actually boost profits. On the liability side, they push down funding costs for banks. On the asset side, existing fixed-rate loans ensure that yields remain stable. Altogether, net interest income rises.

And we should not forget that low interest rates support the economy, which indirectly benefits banks. After all, the banks’ well-being is closely tied to the well-being of the economy. So the choice is not between low interest rates and high interest rates but rather between low interest rates combined with economic recovery and high interest rates combined with economic slowdown.

But over time, low interest rates do take their toll. On the asset side, “legacy yields” disappear: high-yielding fixed-rate loans either mature or are repaid, and banks have to replace them with assets that offer lower returns. On the liability side, the decline in funding costs comes to an end unless banks start charging negative rates on deposits. Altogether, net interest income falls.

Next to low interest rates, banks often point to regulation as a drag on profits. It is true that the rules for banks have been strengthened since the crisis –rightly so in my view. And it does not surprise me that the regulated claim to be overburdened by the regulators – that’s par for the course.

But here too, we should take a more nuanced view. Of course, rules are a burden for those who have to comply. But with regard to banking regulation, we need to look at the bigger picture. Taxpayers and indeed the entire economy have had to shoulder a huge burden since the financial crisis. Everyone would benefit from stronger rules that help to prevent future crises.

Still, it cannot be all rules and no market. The rules must not be so tight as to squeeze the life out of banks. They should rather provide a strong framework that reins in excessive risks, while allowing the market to function normally. The fact that the final negotiations on Basel III are still ongoing shows how seriously regulators take these issues.

So, the economic conditions have changed and the rules have changed. But change doesn’t stop there. A powerful technological trend is transforming all our lives. The world is going digital, and naturally, banks can be no exception. Customer’s expectations are changing: people want to access banking services at any time, from anywhere on the globe, and receive them in real time. This trend brings new competitors to the market, the FinTechs. Experience is that technological shifts do not reverse. Banks therefore need to adapt to the digital world – not tomorrow, but today.

In a nutshell, there are many structural changes under way. And banks should embrace what they can’t avoid; they need to adjust their business models to remain profitable.

For the time being, our analyses reveal some options to increase profits. We see, for instance, that some European banks consistently outperform their peers. What is it that drives their success? One common feature of these banks is their relatively low costs. And indeed, most European banks suffer from high costs. On average, large banks in the euro area spend almost 65 cents in order to earn one euro. There is obviously room to become more efficient and, as a result, more profitable.

How will we as supervisors address this issue? First of all, we will further analyse banks’ business models and explore the drivers of their profitability. To that end, our Joint Supervisory Teams will thoroughly examine their respective banks. And we will also assess how developments such as FinTech and Brexit might impact the business models of banks in the euro area. However, at the end of the day, it is of course not our job to prescribe new business models. But we can and will challenge the existing ones.

The second item on my list is risk management. Sound risk management is crucial for any bank at any time; nonetheless, it has now become even more important. Banks have been handed a cocktail that is low in profits and high in liquidity – a combination that might tempt them to embark on a dangerous search for yield.

It is up to risk managers to take a long-term view and rein in excessive risk-taking. They play an important role in ensuring the soundness of their bank. But besides the right mindset and the right governance structures, good risk management also relies on high-quality data. We will therefore assess how banks comply with relevant international standards.

Another issue is the internal models that banks use to calculate their risk-weighted assets. These are important as risk-weighted assets form the basis for determining capital requirements. Capital, in turn, is the most important buffer against potential losses. So it is vital that internal models produce reliable and comparable results. Against that backdrop, we will this year roll out a multi-year targeted review of internal models. The objective is to assess and confirm that banks’ internal models are adequate and appropriate.

Finally, our third priority for 2017 is credit risk. And this is mostly about non-performing loans, or NPLs for short. I don’t have to tell you that non-performing loans can literally be a real drag. The objective should be to remove them and free up balance sheets. This would help banks improve their profitability and it would enable them to extend more credit to the economy.

We have been working extensively on NPLs for some time now. Most notably, we developed a draft guidance which was published for consultation in September 2016 and will be finalised in spring of this year.

The guidance covers those aspects of strategy, governance and operations which are most relevant for resolving NPLs. It fosters consistent forbearance, recognition, provisioning and disclosure for NPLs. And it requires banks with high levels of NPLs to define and implement specific reduction targets. The best practices defined by the guidance will constitute our supervisory expectations for the future. Our Joint Supervisory Teams have already started to actively engage with banks on how they plan to implement the guidance.

But the issue of NPLs is not just one for banks and their supervisors. How quickly a bank can resolve its NPLs also depends on the national legal and judicial systems. And in some countries, these systems hamper the speedy resolution of NPLs. Here, national policymakers could help the banks. They could make judicial systems more efficient, increase access to collateral, create fast out-of-court procedures and align fiscal incentives.

Who runs the banks – fit and proper assessments

Our three supervisory priorities are what we will focus on in 2017. But, of course, that is not all. Another issue we are working on is the fit and proper assessment of bank managers.

Among many other things, the success of a bank depends on those who manage it. How safe, sound and profitable can a bank be if it is managed by the wrong people? And don’t forget reputational issues! So the banks should have an interest in choosing the right candidates. But to some degree, their selection is also in the public interest. A bank that fails because it is badly managed can do much harm, as we have seen in the crisis.

So, what is the role of the ECB as a supervisor? The ECB assesses the fitness and proper standing of all candidates for the management bodies of those banks it directly supervises. The relevant criteria are laid out in the Capital Requirements Directive, CRD IV. For instance, the candidates should have the right amount of experience; they should not have any conflicts of interest in their new position; and they should have a flawless reputation.

CRD IV is a Directive, which means that Member States had to transpose it into national law. And they have done so in diverse ways. There is some common ground, that’s true. But CRD IV left Member States enough room to establish different standards for assessing candidates. This runs counter to the idea of a truly European banking market.

In the spirit of Europe, the ECB and the NCAs have therefore joined forces to create a more harmonised approach. But be assured of two things. First, we do not plan to do away with national law, of course. Second, we do not intend to take a one-size-fits-all approach. Judgement, proportionality and a case-by-case approach will remain inherent to fit and proper assessments.

We have drafted a guide, which was published for consultation in November 2016. This guide explains how the ECB applies the main criteria for assessing candidates. And it provides greater detail on the legal framework, the assessment procedure and possible outcomes. The guide will help banks to take the ECB policies into account when selecting candidates. It will also help to make the process more efficient, as banks will be aware of the information that the ECB needs to conduct its assessment.

The public consultation on the guide ended on 20 January 2017. Our work and your feedback during the consultation on the policies and practices proposed will contribute to better and faster assessments in the future.

When things go wrong – recovery plans

Strong rules, good supervision and prudent management go a long way towards ensuring the stability of a bank. However, we cannot rule out that individual banks might get into trouble. And in such cases, it helps to be prepared. That’s why the Bank Recovery and Resolution Directive, or BRRD, requires banks to draw up recovery plans.

Are recovery plans a useful tool? I’m sure they are, even though they are pretty much untested – in many countries, recovery plans were not required prior to the BRRD. But even the sole act of drawing up such a plan has benefits: it raises awareness of potential problems; it enhances preparedness with regard to cross-border aspects of crisis management; and it summarises a set of options that could be enforced by supervisors.

Banks are, of course, required to share their recovery plans with supervisors. And that’s where we see the benefits of European banking supervision. We receive recovery plans from banks across the euro area, enabling us to benchmark and establish best practices. This will help us in assessing future recovery plans and in providing better guidance to banks and to our supervisors.

From our benchmarking, we have already drawn some preliminary conclusions, the first being the huge variation in recovery plans, in terms of both size and quality.

Regarding the size of the plans, there are issues with both extremes. We have received very short plans, which were often incomplete. And we have received very long plans, which might be difficult to implement during a crisis when time is of the essence. Regarding quality, some plans were quite advanced and established best practices, whereas others did not adequately incorporate the legal requirements.

Based on what we have seen so far, there are some key areas for improvement. First, banks should use standardised reporting templates in their recovery plans. This would allow them to provide complete, comparable and current data. Second, banks need adequate procedures for escalating problems and enabling quick decisions. And third, banks should ensure that material entities are covered in group recovery plans. That is particularly important with regard to cross-border banks.


Ladies and gentlemen, in 1942, the folk singer Woody Guthrie made a list of New Year’s resolutions. This list comprised items such as “shave”, “take bath”, “wear clean clothes” and “wash teeth – if any”.

The New Year’s resolutions I suggested to banks are a bit more ambitious, that’s for sure. But just like those devised by Woody Guthrie, they are based on common sense. If the world around them changes, banks have to adjust their business models to remain profitable; if banks want to remain stable, they have to care about risk management; and if bad loans are weighing down balance sheets, banks have to free themselves of those bad loans.

These are things which are easier said than done. I know that. Still, there is no way around them, and banks should start working on them now.

Thank you for your attention.


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