European banks in the post-COVID-19 world

Speech by Andrea Enria, Chair of the Supervisory Board of the ECB, at the Morgan Stanley Virtual European Financials Conference

Frankfurt am Main, 16 March 2021

In April 1815 the Mount Tambora volcano erupted on the Indonesian island of Sumbawa. One year later, the effects of the eruption hit Europe with full force. Spring and summer arrived, but temperatures dropped and precipitation increased, with snow even falling in some places. Harvests were decimated and crop prices increased fourfold.

But from this hardship also came resilience and creativity. At dawn and dusk, the particles lingering in the air coloured the sky, inspiring some of the most famous works of William Turner and Caspar David Friedrich. Mary Shelley drew on the prevailing sense of doom for her most famous work: Frankenstein. And the memory of the famine in 1816 drove Justus Liebig to investigate the preconditions for plant growth, which led to the development of mineral fertilisers, raising harvest yields significantly.

The current pandemic is also inflicting massive hardship. But we have to focus on the conditions that can support a strong and fast rebound after the crisis, possibly even fostering structural change in important areas of our economies.

It was at the end of January this year when I last provided the wider public with a comprehensive update on the health of the banks under our supervision. You may remember that, based on the data available from the third quarter of 2020, we considered that the euro area banking sector had, on the whole, responded to the coronavirus (COVID-19) pandemic with resilience. We highlighted that credit risk management standards and cost-efficiency policies would be at the forefront of our supervisory strategy moving into 2021, and that the ECB remained committed to allowing for continued flexibility in relation to capital.

In a fast-changing environment, both in the areas of health and economic policy, the priorities we laid out at the beginning of the year are now even more attuned to the risks and opportunities of the delicate recovery phase that lies ahead. With various sources of market analysis portraying a decidedly positive medium-term outlook, year-end data suggest we should adopt an overall cautious stance for 2021. I will take this opportunity to update you on how the ECB is following up on the strategy and priorities announced earlier this year, with a particular focus on credit risk developments.

Banks have shown resilience during the pandemic

European banks absorbed the first economic shock of the pandemic well as a result of both the regulatory reforms put in place following the great financial crisis and the achievements of the first six years of single supervision within the banking union. Banks entered this crisis with much stronger capital positions, and additional capital space has been generated by the relief measures issued promptly by the ECB and the national macroprudential authorities. Based on the data available at present, we expect to see only a slight fall in the Common Equity Tier 1 capital ratio in the last quarter of 2020 (compared with the third quarter of the same year) to levels still above those prevailing at the start of the year.

Capital conservation has also been aided by our recommendation on dividend distributions. Banks followed our guidance and suspended the payment of dividends throughout 2020. Following the revision of our recommendation on 15 December, with the resumption of payments within prudent parameters, banks under ECB supervision communicated distribution plans of around €10 billion system-wide, in line with the envelope envisaged by the recommendation and one-third the size of the initial distribution plans from September 2020. Only a few banks have distribution plans that are somewhat greater than the thresholds foreseen by the recommendation. In these cases, the supervisory dialogue with the banks is ongoing. We have clearly communicated that in the absence of unexpected, materially adverse developments in the coming months, we plan to repeal our recommendation at the end of the third quarter and go back to the ordinary vetting of bank distribution targets on the basis of the forward-looking assessment of each bank’s individual capital planning. I would like to reiterate that this recommendation has been an exceptional policy response to the unprecedented uncertainty regarding the depth and length of the recession generated by the pandemic.

When the COVID-19 crisis hit, ECB Banking Supervision swiftly made capital buffers available to banks to enable them to absorb losses and keep lending to the real economy. In tandem with monetary and fiscal policy actions, the measures had the desired effect. Compared with what happened during the great financial crisis, banks reported a much more moderate tightening of credit standards in reaction to the outbreak of the pandemic. Lending to firms and households continued to grow in 2020, even though we saw a slowdown during the second half of the year.

The results of the January 2021 euro area bank lending survey indicate a tightening of credit standards against the backdrop of the winter lockdown restrictions. However, this does not necessarily suggest an overly procyclical development. While it is essential that banks are ready to support the recovery, especially when public support measures are lifted, it is equally crucial that their lending policies are appropriately selective and correctly reflect developments in the risk environment. The supportive lending environment created by monetary policy should lead banks to accommodate the demand for credit coming from viable businesses and to look beyond any temporary stress in the liquidity position of borrowers. But they should also strive to identify at an early stage more fundamental solvency problems and proactively manage exposures towards distressed customers, approaching them with a view to finding workable solutions and bringing them back on to a sustainable path or triggering an early exit from the market when no other option is available. The strength and the quality of the post-pandemic recovery depends not only on the amounts of credit available but also on the ability of banks to channel financing to sustainable businesses via accurate risk management and pricing policies. One of the key lessons of the great financial crisis is that the deterioration in asset quality, if not actively managed at the early stages of a crisis, leads to a serious impairment of the banking sector’s lending capacity, with severe adverse macroeconomic effects.

These considerations motivated our letters to banks’ CEOs sent in July and December of last year to strongly emphasise the importance of accurately and proactively managing credit risk. Twelve years after the default of Lehman Brothers and nine years after the first private sector involvement during the Greek sovereign debt crisis, asset quality at euro area banks still remains below the levels prevailing before the 2008 crisis. The pandemic hit some of our banks when they were still making tremendous efforts to resolve legacy risk. Year-end data for 2020 point to a decline in the NPL ratio, which shows that banks have effectively remained focused on the need to address the existing stock of impaired assets, especially via intense NPL sale and securitisation activities. This progress must be praised, and serves as a reminder to us all that we cannot afford to lose control of asset quality again.

Our supervisory work is now centred on a very granular analysis of credit quality: we are carefully reviewing the banks’ responses to our Dear CEO letters; we are conducting in-depth analyses of the classification of assets to different stages under IFRS9; we are assessing the drivers of the different approaches adopted by European banks in their provisioning choices; and we are focusing on exposures to sectors hit hard by the pandemic. The added value of European supervision is that we can compare behaviours across a large number of banks competing in the same markets.

Preliminary results from our examination of credit risk that we started in 2020 are becoming available. Some banks have not yet met the expectations set out in our letters on credit management and some gaps still need to be addressed. The fallout from the pandemic is still far from being fully reflected in indicators of distress, but the clouds of uncertainty surrounding credit risk are beginning to clear and signs of increased credit risk are becoming apparent. From the second to the fourth quarter of 2020, the share of EBA-compliant moratoria fell from 6.8% to 2.3%. Forborne exposures increased slightly, and there was a moderate increase in the share of exposures classified as unlikely to pay among those ongoing and expired moratoria. There are also significant differences in how banks flag their exposures as forborne, which raises concerns that some of them are not taking an adequate approach in this area. Particularly worrisome is the large share of exposures that have been directly transferred from stage one (performing) to stage three (non-performing), without passing through stage two (underperforming). This could suggest that early-warning systems are ineffective.

It is crucial that banks recognise credit impairments without delay. Ample room for loss absorption is available to all banks under our supervision, especially considering that the buffer flexibility we have granted includes the capital conservation buffer and remains valid until at least the end of 2022. In any case, the rebuild process will only start once the peak in capital depletion is behind us. In the coming months we will closely watch developments and stand ready to postpone the timeline to rebuild buffers if doing so would help the sector to quickly process the expected increase in NPLs.

In the United States, the improved outlook resulting from vaccine availability and the large fiscal stimulus led banks to release provisions in the fourth quarter of 2020. This approach differs from that of banks under European banking supervision, which continued to build up provisions in the final quarter, albeit at a slower pace than during the first two quarters of 2020. Credit impairments for US banks have been materially higher for the full year 2020. Although the figures are not directly comparable owing to differences in asset composition, accounting rules and write-off practices, European banks need to make sure that provisioning decisions are not unduly postponed as this might negatively affect their profitability and lending capacity when the demand for credit picks up. Provisioning levels in the banking union have so far been below the levels predicted by historical elasticities to macroeconomic developments[1], but this could be explained by the unprecedented public support measures. The specific role of savings and disposable income during pandemics, as well as the negative impact of COVID-19 being concentrated in specific vulnerable sectors, could also be contributing factors. Nevertheless, our supervisors are actively discussing provisioning policies with banks and will also deploy in a virtual setting methodologies commonly used in on-site inspections to delve deeper in cases where there are concerns about the prudence of banks’ practices.

Seizing opportunities in times of crisis

Notwithstanding the challenges to credit management, banks have been integral to keeping the economy afloat during the pandemic. However, for banks to not only survive but also thrive in a post-pandemic world, they will have to fully embrace the changes we have witnessed over the past year. The reduction in SSM banks’ operating expenses seen last year has been in line with a trend that goes back to the great financial crisis; but there has been no acceleration in cost savings. At the same time, the pandemic has forced banks to acknowledge the untapped potential of digitalisation, with large numbers of employees working remotely, services provided digitally, and no extensive branch network. In future banks will have to apply the lessons learned from being more digital during the pandemic. As the supervisor, we will duly consider these elements as part of our supervisory approach to the analysis of business models in our supervisory review and evaluation process.

In the quest to increase cost efficiency, banks should also consider the possible benefits of business combinations. We have recently seen some movement here. With our Guide on the supervisory approach to consolidation in the banking sector[2], we set out to clarify our approach and show that it is supportive of well-designed and well-executed business combinations. Consolidation could allow banks to fully exploit the opportunities for economies of scale linked to digitalisation. It could also facilitate the orderly exit from the market of players that do not have a sustainable business model, thus helping to reduce overcapacity and unhealthy competition. Too often recently, banks have waited for a change in the interest rate environment to solve their problems and restore profitability to sustainable levels. It should be clear by now that banks need to take more radical self-help measures to restore profitability. The pandemic could be a catalyst for change as it has put additional pressure on bank profitability but also revealed paths that could lead to more profitable and resilient business models.

Looking back to see the future

Looking back to 1816, the year without summer, we are not only reminded of our capacity for resilience in times of hardship, but we can also see what might lie ahead of us if we do not take decisive action. The change in climate triggered by the eruption of Mount Tambora is a stark reminder of what could be in store if global warming were to continue unabated.

We know that the challenge of climate change is a severe and potentially existential one. But this knowledge also allows us to prepare. The physical impact of climate change and environmental degradation, as well as the transition to a low-carbon economy, will have wide-ranging effects on many sectors and regions. As lenders to the real economy, banks will see the risks reflected on their balance sheets. Although we don’t know exactly what level of transition and physical risks banks will face, we do know that they will be confronted with a combination of these risks and that the risks will most likely worsen over time. In our view, it is therefore critical for banks to fully develop their capacity to manage climate-related and environmental risks.

To this end, last November we published our final and amended Guide on climate-related and environmental risks following a public consultation. The Guide explains how the ECB expects banks to prudently manage and transparently disclose such risks under current prudential rules. Banks now need to conduct a self-assessment in the light of the supervisory expectations outlined in the Guide and draw up action plans on that basis. We will then benchmark the banks’ self-assessments and plans and challenge them in the supervisory dialogue. In 2022 we will also carry out a climate risk stress test for banks.

Our mission is to ensure the safety and soundness of the banking sector now and in the future. Adequately representing climate risks in bank balance sheets is a prerequisite not only for the sector’s resilience, but also for the accurate pricing of these risks. This, in turn, will contribute to an efficient and orderly transition to a low-carbon economy.


Let me conclude. The pandemic has had devastating consequences for lives and livelihoods. The challenge for the economy has been daunting and is still ongoing, and the banking union is facing its hardest test since its inception. But, as in previous times of hardship, the pressures to act and to innovate also hold the potential to bring about more efficient ways of working. Just as the year without summer ushered in creative achievements and new agricultural methods, embracing the lessons learned during the pandemic could pave the way for improved cost efficiency and more sustainable business models. And by heeding the warnings of past climate disruptions, we can contribute to an orderly transition to a low-carbon economy.

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