European banks: Opportunities and challenges
Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, Delphi Economic Forum, Delphi, 1 March 2018
Giving a speech here in Delphi might raise false expectations. People might think of the famous oracle of Delphi and expect far-reaching prophecies. Well, I am not the Pythia, and I will certainly be less prophetic, but hopefully a bit clearer.
The first point I will make is this: we need banks. I know that many people are suspicious of banks because of their role in the crisis. But still, we need them. Banks form the hub of Europe’s economy, for better or for worse. Who do you turn to when you need money to buy a house? Who do you turn to when you want to build a factory? Here in Europe, you would probably turn to a bank.
Banks play a critical role for all of us and thus for the entire economy. If the banks don’t function, neither does the economy. That’s the lesson we have learnt from the financial crisis, and at great cost. What we need are stable and profitable banks, managed by responsible and capable bankers.
Regarding the stability of banks, we have come a long way. Just at the end of last year, the final piece of the global regulatory reform was put into place –Basel III was finalised. In respect of Europe, you can include all the progress made with the banking union. The result is a regulatory and institutional framework that will make the banking sector much safer.
That is a necessary condition, but it is not sufficient. Banks need to be both stable and profitable. They need to follow the rules and succeed in the market. And in that regard, European banks face many challenges these days. But these challenges are also opportunities. Let’s consider the full picture and, in doing so, take a closer look at Greek banks.
Opportunities and challenges – the euro area…
When discussing banks, the first thing to keep in mind is that no two banks are alike and each bank faces its own challenges. That said, there are challenges which affect so many banks that they can be seen as universal challenges. And “universal”, in this case, means “European”.
Some of these challenges stem from the financial crisis. In many countries, banks are still weighed down by legacy assets on their balance sheets. Non-performing loans are certainly the most obvious example. Then there is the long period of low interest rates. Given that interest income makes up a large part of banks’ operating income, low rates are a major challenge. And there is a challenge which many banks would rank first, but I don’t: stronger regulation. Yes, complying with stricter rules puts pressure on banks. But compared with the heavy burden that the crisis imposed on people and the economy across Europe, this is an acceptable price.
In addition to these crisis-related challenges, there are new ones, such as technological change, which many people would put at the top of their list. The business of banking is not immune to the digital transformation. And the banks weren’t the first to realise this. It seems that new competitors were quicker to see how new technologies could be applied to banking. These fintechs now pose a challenge to the incumbents. It remains to be seen how all this plays out, but one thing is certain: it is another challenge banks have to deal with.
Taken together, all these trials and tribulations are reflected in the profits – or losses – of banks. That is the overarching issue. Banks in the euro area are still struggling to earn their cost of capital. And I would go as far as to say that profitability is the number one challenge for European banks.
And before all of this becomes too depressing, let us look on the bright side of life for European banks. Although they indeed face many challenges, now is the ideal time to tackle them, for several reasons.
First, the euro area economy is growing. It has been doing so for almost five years, and it will most likely continue to do so in 2018. Second, technological change is both a challenge and an opportunity. It offers new sources of income for those banks that act quickly. Third, there is regulatory certainty. As I said before, the regulatory reform has been finalised. On that basis, banks can plan for the future. And fourth, there is supervisory certainty. We are in the fourth year of European banking supervision. Banks have got used to their new supervisors, and to their methods and policies. European banking supervision has become “business as usual”.
Ladies and gentlemen, this is, in a nutshell, the situation of European banks. Now let’s focus on Greek banks. What we see is that Greek banks face many of the challenges – and opportunities – of their counterparts elsewhere in Europe. Yet, at the same time, they are in a special situation.
The economic and sovereign debt crises in Greece were deeper than in most other countries; a stability support programme is still in place, and so are capital controls. All this affects the banks, of course. They were hit hard by the crisis: some failed; some needed to be recapitalised; and some needed emergency liquidity assistance from the central bank, ELA for short, to keep going.
However, change is under way as conditions are improving. The Greek economy is recovering; the stability support programme is scheduled to end in August; and capital controls will be gradually eased and eventually lifted. But it’s not just the conditions that are improving. Greek banks have come a long way, too.
For one thing, they have built up their capital buffers, and they have stabilised their funding. ELA was, for a long time, the defining characteristic of the Greek crisis. But the banks have become less and less dependent on it. In 2017, the volume of emergency liquidity declined by more than 50%. The banks are turning away from the central bank for funding and towards the markets. Depositors, for instance, have started to come back. And once the capital controls are lifted, they might have even more incentive to deposit their money with Greek banks.
In addition to stabilising their capital and funding, Greek banks have carried out structural reforms. In particular, they have overhauled their boards of directors. They have brought in new managers who are independent and experienced. That was an important first step towards better governance. But the new boards still have to deliver, which is not all that easy. They need to initiate a change in culture; they need to further improve governance; they need to put the banks on the right track.
So, challenges remain. And the biggest one for Greek banks is not theirs alone, but one they share with many banks elsewhere in the euro area: non-performing loans, NPLs for short. Given that NPLs affect so many banks across the euro area, I will discuss them in more detail.
Non-performing loans – an issue for many stakeholders
At close to 50%, Greece has the highest ratio of non-performing loans in the euro area. And this is a huge problem. NPLs are a drag on profits and they cause staff and other resources to be diverted from more productive activities. Greek banks exemplify this dilemma. In the aggregate, their pre-provisioning profits look quite reasonable, but once provisions for NPLs are taken into account, profits turn into losses.
And NPLs are not just a problem for banks. They also keep banks from providing new loans to the economy, and this in turn keeps the economy from growing. This is of particular concern to the Greek economy, which is still recovering.
While Greece is in a special situation, the problems caused by NPLs are widespread. It is true that the level of NPLs in the euro area has gone down over the past few years, but at €760 billion, it is still very high. That’s why it is a top priority for European banking supervision – in Greece and across the rest of the euro area.
Our approach is made up of three elements. The first one is qualitative guidance to banks, which we published in March 2017. This guidance brings together best practices and sets out how we expect banks to deal with NPLs. It thus serves as a basis for the banks to devise their own NPL strategies. And it serves as a basis for supervisors to assess the banks’ strategies.
These assessments feed into the second element of our approach: a dialogue between supervisors and banks. This dialogue has been going on for some time now and, at the end of 2017, we provided banks with formal feedback on their strategies. But this is not the end, of course; the dialogue will continue in 2018.
The third element, finally, is an addendum to our guidance. We published a draft version for public consultation back in October. And it seems fair to say that it sparked a heated debate. So let me expand on why we think we need the addendum and what it is intended to achieve.
The addendum sets out how we expect banks to provision new NPLs. And here, two things are important but sometimes misunderstood. First, the addendum is about new non-performing exposures. Second, banks will not have to fully provision these loans right away. Unsecured loans that become non-performing will need to be fully provisioned after two years; secured loans after seven years.
The general purpose of the addendum is to prevent a recurrence of the NPL problem. Given the scale of the current problem, everyone should subscribe to this goal. Yet, as I said, the draft addendum sparked a heated debate. This debate is reflected in the large number of comments we received during the public consultation – around 450 altogether.
We have assessed all these comments and will adapt the addendum accordingly. Among other things, we will take into account the legal concerns that were raised, and we will shift the cut-off date. We expect to publish the final addendum later this month; so it is coming, and banks should get ready for it.
We supervisors support the banks in their efforts to reduce NPLs. At the end of the day, however, it is the banks themselves that have to take action. As for Greek banks, they have made progress, but some more so than others. There’s a catch, however. In their plans, the banks envisage reducing their NPLs by a greater amount each year. So they have to step up their efforts as well.
But NPLs are not just an issue for banks and supervisors. The legal and judicial frameworks should also be enhanced in order to facilitate a more rapid resolution of NPLs. This includes action in areas such as insolvency regimes, debt enforcement and out-of-court restructuring. In these areas, Greece has passed new laws, which is encouraging. However, passing laws is just the first step; they also need to be implemented and applied. And here, it seems that things could move faster.
One example concerns the framework for repossessing or liquidating collateral. How easily can banks make use of the collateral posted by their debtors? Until recently, banks could only conduct physical auctions of collateral. And these were often cancelled due to strikes or obstruction by activist groups. Thus, the Greek Parliament decided to phase out physical auctions and replace them with electronic ones. This was a sensible step. However, the new system needs to be swiftly implemented, and it needs to cover the whole of Greece, not just some regions. Moreover, the Greek authorities need to better protect notaries involved in electronic auctions as they have become the targets of violent attacks in recent weeks.
Once electronic auctions work properly, they should prompt defaulting debtors to talk to their banks and hopefully find mutually acceptable solutions. And here, I am thinking of “strategic defaulters” in particular – people or corporates that could service their debt but adopt a “wait and see policy” in the hope that, in the end, they can avoid paying at least part of their debt. More generally, the new system will help to change the culture of servicing and repaying loans. Such a cultural shift will take time, but it is absolutely necessary.
Non-performing loans are the weakest link in the Greek banking system, there’s no doubt about that. It is crucial that Greek banks clean up their balance sheets.
The upcoming stress test for banks will also play a role here. To give you some background: this year, the European Banking Authority, the EBA, will conduct a stress test on European banks. The aim of this test is to check how resilient banks are to economic and financial shocks. Altogether, the EBA stress test covers 37 banks in the euro area: the 33 banks in the EBA sample plus the four significant Greek banks. But there is a slight difference in respect of the Greek banks. For them, the stress test will be conducted earlier than for the other banks. While the results of the EBA sample will be published in November, we will publish the results for the Greek banks in May, before the end of the stability support programme.
Capital shortfalls in the baseline scenario need to be covered in any case – one way or the other. With regard to shortfalls in the adverse scenario, we will decide on a case-by-case basis. So for banks across the euro area, the stress test will be a moment of truth, no doubt about that. But it will also be an opportunity to clean up balance sheets, increase resilience and prepare for the future.
Ladies and gentlemen,
These are not easy times to be a banker in Europe. The entire sector faces a number of challenges. At the same time, however, conditions are very promising for dealing with all these challenges. That is also true for Greek banks. They fell very sick during the crisis and spent quite some time in intensive care. But since then, their condition has stabilised; all the metrics are gradually returning to normal levels.
However, just like someone who was sick for a long time, Greek banks are still a bit weak. It will take time and determination for them to make a full recovery. But as in the rest of the euro area, the conditions in Greece are good. And as we are in Delphi, it seems appropriate to say that the omens are favourable.
Thank you for your attention.
Evropska centralna banka
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