Second ordinary hearing in 2018 at the European Parliament’s Economic and Monetary Affairs Committee
Introductory statement by Danièle Nouy, Chair of the Supervisory Board of the ECB, Brussels, 20 November 2018
As this is my last hearing at the European Parliament as Chair of the Supervisory Board, let me express my gratitude and appreciation for the good cooperation between the Parliament and ECB Banking Supervision over the past five years marking the establishment of the SSM.
In my introductory remarks I will focus on four areas: key developments and risks in the euro area banking sector; our supervisory activities, including work on non-performing loans, NPLs for short; the results of the 2018 EU-wide stress test; and, finally, the legislative steps that I deem crucial for the banking union, including action to tackle money laundering.
Key developments and risks in the euro area banking sector
Let me start with a short overview of the situation in the euro area banking sector from a supervisory perspective. Euro area significant institutions have further increased their resilience throughout 2018. Supported by the euro area’s cyclical momentum, banks directly supervised by the ECB maintained strong capital positions, with a Common Equity Tier 1 (CET1) ratio of around 14%, while using part of their capital buffers to further strengthen their balance sheets.
Banks continued to make progress in reducing their stock of NPLs, which, as you know, was and still is a priority for us. In mid-2018 the gross NPL ratio for banks under ECB supervision fell to 4.4%, down from 7.5% in early 2015.
Notwithstanding the robust economic recovery and the mature business cycle, the profitability of euro area significant institutions remains subdued. Their average return on equity stood at 6.8% in the second quarter of 2018, down from 7.1% a year earlier. On average, euro area banks continue to be less profitable than their US peers, reflecting, among other things, incomplete business model adjustments, remaining cost inefficiencies and overcapacity in some euro area banking sectors.
Looking at the euro area banks’ current operating environment, geopolitical risks have intensified, including political risks in Europe. Trade protectionism is on the rise and we observe worrying developments in some emerging market economies. A sudden repricing in global financial markets or an escalation of international trade tensions would negatively affect euro area economic activity, thereby hitting banks too.
Of course, we also face genuinely European challenges. In this respect, the recent increase in sovereign bond yields in one country is an unwelcome development. ECB Banking Supervision will continue to monitor all developments that could undermine banks’ capital positions.
Let me now report on some of our key supervisory activities.
We have made considerable progress in the area of credit risk. We carried out a thematic review on banks’ implementation of the accounting standard IFRS 9 and worked with banks on further reducing NPLs. To that end, banks with high levels of NPLs have submitted their NPL reduction strategies to the ECB. Having now assessed these strategies, Joint Supervisory Teams are engaging in intensive and ongoing dialogue with the banks on their implementation and giving updated guidance.
Several other risk dimensions also feature strongly in our work. For one, we have made progress on banks’ risk management. Our activities in this area include the targeted review of internal models (or TRIM for short). The first phase of on-site missions was successfully completed and, by October this year, more than half of the banks covered by TRIM had received their first supervisory decisions. We will also continue our dialogue with banks around trading risk and asset valuations, including level 2 and level 3 asset exposures. ECB Banking Supervision will undertake dedicated on-site missions and Joint Supervisory Teams will conduct deep dives at selected significant institutions. In addition, ECB Banking Supervision will continue to assess the impact of IT and cyber risks. Moreover, we will conduct a focused stress test in 2019 to assess banks’ resilience against liquidity shocks.
Outcome of 2018 EU-wide stress tests
Let me now report on the outcome of the 2018 EU-wide stress test.
On Friday 2 November, the European Banking Authority published the results of the EU-wide stress test representing 70% of banking assets in the EU. The results show that the 33 largest banks directly supervised by the ECB have become more resilient to financial shocks over the past two years. In parallel to the EU-wide EBA stress test, the ECB conducted its own stress test for additional banks that are also under its direct supervision but are not part of the EBA sample. The results of both stress tests will inform the upcoming Supervisory Review and Evaluation Processes.
Thanks to a fairly significant build-up of capital and to banks’ ongoing efforts to address legacy assets, as required by ECB Banking Supervision, ECB supervised banks in the EBA sample entered the exercise with a much stronger capital base than they had two years ago: their CET1 ratio stood at 13.7% in 2018, up from 12.2% in 2016. The euro area banking system’s overall higher capacity to absorb macroeconomic shocks is also reflected in the end results. Although a more severe adverse scenario was applied, the average CET1 capital ratio of all 33 banks, after a three-year stress period, would be 9.9%, up by 1.1 percentage point from 8.8% two years ago. These capital figures reflect the fully-loaded basis, which assumes a full implementation of regulatory requirements that are currently subject to transitional arrangements.
This reassuring outcome should not hide the fact that challenges remain. There is still work to be done on business models and on legacy issues, including NPL levels that remain a significant concern for a large number of euro area institutions. We will of course carefully monitor progress and developments in these areas.
In addition, we will look closely at the challenges encountered during this year’s stress test with a view to improving future exercises.
Let me now conclude by reiterating some points which I see as crucial for ensuring a well-functioning banking union and for which we greatly depend on the support of Parliament both before and after the European elections. While we have come a long way since the establishment of ECB Banking Supervision, there is still more to be done before the banking union is completed.
First, on the banking package, it is important to finalise the review in the course of this legislature. We see room for improvement in some areas, in particular the Pillar 2 framework, where we need to preserve supervisory discretion when addressing banks’ risks as well as the ability to require banks to use the best loss-absorbing capital for Pillar 2 across the board. We are also concerned about the proposal on the treatment of the so-called “massive disposals of NPLs” in banks’ internal models, as this would undermine the ECB’s efforts to address the unwarranted variability in banks’ internal models. Moreover, it is not even needed, as the current legislation already permits some flexibility, when it makes sense, as demonstrated in some supervisory decisions. Finally, we think it is important to align the conditions for declaring a bank failing or likely to fail and the initiation of national insolvency procedures.
Second, on investment firms, we fully support entrusting the ECB with the supervision of systemic investment firms. This is an important and urgent issue, given the plans of large firms to relocate to the euro area due to Brexit.
Third, looking ahead, as we have discussed before, we need to take a more European approach to combatting money laundering. We need to consider a higher level of harmonisation of the applicable rules in the form of a regulation. We are also working on intensifying our prudential work on this topic, by creating a coordination function for SSM related AML issues within ECB Banking Supervision, in full respect of the allocation of anti-money laundering responsibilities within the current legal framework. This “AML office” is intended to fulfil three roles. First, it will act as a single point of entry with respect to the direct exchange of AML information between the ECB and AML authorities. Second, the AML Office will set-up and chair “an AML Network” among Joint Supervisory Teams in charge of the banks whose business model leads to a high level of money laundering risks. Third, it will act as a centre of expertise on the SSM related AML/CTF issues. On this basis, the AML Office will contribute to the development of ECB positions on AML topics.
Finally, making progress on risk reduction should pave the way for more risk sharing, such as through a common backstop to the Single Resolution Fund and a European deposit insurance scheme. And looking ahead, a genuine banking union needs further regulatory harmonisation to address unwarranted national options and discretions and to rely more on regulations rather than directives, for example for rules on fit and proper assessments.
I am now happy to answer any questions you may have.