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Strengthening banks’ resilience in the banking union

Speech by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, at the Financial Stability Conference 2021

Berlin, 19 November 2021


It is a pleasure to be here and I would like to thank the organisers for inviting me. As you might expect from a banking supervisor speaking at a conference on financial stability, my remarks today will focus on the topic of banking sector resilience. In particular, I will be discussing the factors that have underpinned the resilient behaviour of the banking sector during the pandemic thus far and the ways in which we could collectively strengthen this resilience even more going forward.

In doing so, I hope to impress on you three enduring propositions. The first is that the swift and comprehensive policy response to the COVID-19 crisis by the public sector at large would have been unthinkable without the banking union. The second is that the economic shock brought about by the pandemic has also shown that the Basel III reforms enacted to articulate banking activity in the aftermath of the great financial crisis are paying off. Together with the high degree of adaptability to rapidly changing circumstances displayed by banks themselves, these factors help to explain why banks have reinforced financial stability during the pandemic. Thus far, banks have emerged relatively unscathed from one of the worst crises on record while helping to sow the seeds of a future recovery.

However, it is worth noting that the institutional and regulatory processes underpinning such an encouraging outcome remain incomplete. The full implementation of some Basel III standards is still pending and important elements in the banking union architecture related to crisis management are still missing. Therefore, my third and most important proposition is that work to bridge the remaining gaps on these fronts should proceed as a matter of priority, so that we are better equipped to deal with future challenges related to the pandemic itself and further beyond. Throughout this process, banks will need to continue to show a high degree of adaptability so that the benefits of the banking union may be reaped in full by banks and their customers.

In the remainder of my remarks, I will elaborate on each of these three propositions.

Banks and financial stability: this time is different

Let us start by looking at the role of banks in financial stability. The ECB defines financial stability as “a condition in which the financial system – which comprises financial intermediaries, markets and market infrastructures – is capable of withstanding shocks and the unravelling of financial imbalances”[1]. Banks are a type of financial intermediary. Although since the great financial crisis the financial structure of the euro area has shown a medium-term movement away from strong bank dominance and towards a more balanced composition in terms of financial intermediaries, banks are still the most important actors in this context[2]. In other words, what happens to banks is of great significance for financial stability in the euro area, also because of their unique role as deposit-takers from the general public.

The fact that the banks have often acted as either sources or amplifiers of shocks that subsequently spread to the rest of the economy has been well documented in economic literature. For example, in historical terms, there is evidence to support the notion that crises have frequently emanated from the financial centres, transmitted through interest rate shocks and commodity price collapses[3]. And in the specific context of the great financial crisis, there is also evidence to suggest that banks with weaker core capital positions and greater dependence on market funding and on non-interest sources of income restricted their loan supply more sharply than their peers during the crisis period[4].

However, in contrast to the previous crisis, data suggest that euro area banks have remained resilient and capable of supporting the economy since the outbreak of the pandemic. In this regard, ECB data show that lending to non-financial corporations and households increased by an average of 2.4% and 2.6% respectively over the 6 quarters ranging from the beginning of 2020 to the first half of 2021. It is also worth noting that credit growth to the private sector remained robust even when 2020 is seen in isolation, in spite of an annual real GDP contraction of 6.4% for the euro area economy as a whole over the same period[5]. Banks have also started to release loan loss provisions, which should continue to support lending going forward. In this regard, the results of the latest ECB bank lending survey[6] suggest that banks’ lower risk perceptions due to the improved economic outlook are already supporting credit conditions, with banks expecting a net easing impact on terms and conditions for commercial and housing loans, as well as a positive impact on lending volumes to firms and households, in the period ahead.

Moreover, while the lending channel has been kept open amid the COVID-19 shock, the capitalisation position of the banking system as a whole has remained robust, with euro area banks’ Common Equity Tier 1 (CET1) ratio in the second quarter of 2021 standing at 15.6% – near its all-time high – or about 300 basis points higher than at the start of the banking union. Indicators of banks’ leverage ratios and liquidity buffers show a similar trend. While the effects of the pandemic on banks’ credit risk metrics have yet to be fully revealed on account of the ongoing government support measures, the non-performing loan ratio for euro area banks edged down to a low level of 2.3% in the second quarter of 2021, or over 5 percentage points less than at the start of the banking union.[7] The resilience of the euro area banking sector as a whole has also been confirmed by the recent stress tests conducted by the ECB and the European Banking Authority, which showed that banks’ average CET1 ratio would remain close to 10% even under a three-year adverse scenario.

Taken together, this suggests that banks should be in an optimal position to benefit from the benign macroeconomic scenario which they have helped to engineer in the first place. Although the pandemic is still ongoing and macroeconomic projections should be taken with a greater degree of caution than may be the case during normal times, we can safely say that an economic recovery is underway, with real GDP in the euro area forecast to exceed pre-pandemic levels already by the end of this year. However, banks should also remain mindful that, with government support measures still in place, the full impact of the COVID-19 shock has yet to materialise on their balance sheets. This implies that proactive risk management tools will be crucial to keeping asset quality deterioration risks in check and thereby safeguarding the bank lending channel’s ability to continue to support the real economy in the future.

Factors supporting banks’ resilience

Overall, I would argue that the resilience of the euro area banking sector which we have observed during the pandemic has two sources. The first is the policy response to the economic fallout of the COVID-19 shock from different authorities – monetary, supervisory, regulatory and fiscal – which has been unprecedented in both its scope and scale. The contrast with the previous crisis is very telling. In terms of scope, whereas policy measures during the great financial crisis primarily aimed to stabilise the euro area banking sector itself, those enacted in response to the pandemic have sought to mitigate the broader impact on the euro area real economy instead. The banking sector was a key conduit to achieving this objective, given its critical role in lending to firms and households as a lifeline supporting economic activity.

Perhaps the clearest indicator of this change in policy emphasis is in the use of loan guarantees. While the total amount announced by euro area governments during the pandemic is comparable to that during the great financial crisis (16% of euro area GDP now versus 18% then), such guarantees are now targeted at non-financial corporations rather than banks themselves[8]. Banks were able to continue to fulfil their critical intermediation role because, unlike during the great financial crisis, governments have so far not had to intervene to directly support euro area banks as a result of the pandemic itself.[9] Therefore, it is fair to say that in this crisis, the euro area banking sector has been part of the solution rather than part of the problem.

In terms of the scale of the policy response, the broader objective of mitigating the pandemic fallout for the real economy has meant that the measures taken have been larger, and the number of stakeholders involved higher, than during the great financial crisis. To mention just a few examples, discretionary fiscal support from euro area governments is estimated at 4.1% of GDP in 2020, as compared with 1.5% for all EU Member States in 2009.[10] Well over half of this amount, which excludes the potential impact from state guarantees on loans and related payment moratoria, has been directed to non-financial corporations in the form of direct transfers and subsidies, among other measures. This fiscal effort in the national domain has been complemented by a number of initiatives at the European level, including the establishment of safety nets to support measures for workers and businesses in Member States and to safeguard countries’ access to financing (totalling €540 billion), as well as the landmark Next Generation EU recovery package, which offers a mix of grants and loans to Member States, totalling €750 billion.

Closer to the banking sphere, the ECB’s pandemic emergency purchase programme, which seeks to lower borrowing costs and increase lending in the euro area, has provided €1,850 billion of financial resources alone, equivalent to around 16% of euro area GDP[11]. This compares with the €220 billion set aside for asset purchases under the Securities Markets Programme (activated in 2010) during the great financial crisis. Through its monetary policy arm, the ECB has also offered support via targeted lending operations at favourable interest rates for banks that lend to the real economy – known as targeted longer-term refinancing operations. On the supervision side, the ECB took a number of measures to grant temporary relief to banks, including by allowing them flexibility to make use of capital and liquidity buffers. This capital relief, estimated at €120 billion, could be used to absorb losses or to potentially finance up to €1,800 billion of lending. To keep precious capital resources in the system and enhance loss absorption by banks, in March 2020 the ECB asked banks to refrain from distributing dividends or engaging in share buy-backs – a recommendation which was withdrawn as of October 2021, as banks’ capital trajectories have become more reliable in recent months. Actions by other stakeholders which have directly or indirectly benefited the banking system have included the release of countercyclical buffers by some national macroprudential authorities and measures by European legislators to facilitate bank lending and support households and businesses during the pandemic (through the COVID-19 banking package, also known as the “CRR quick fix”).

The second factor contributing to banks’ resilience during the pandemic was that the euro area banking system as a whole was in a much better position going into this crisis than it was in past instances, like in the run-up to the great financial crisis. At the beginning of my speech, I noted the progress made in recent years across a number of standard metrics of banking sector health. And I think that, as supervisor, the ECB deserves credit for bringing the entire system to a higher common standard. But I would also emphasise that this standard was largely established in the aftermath of the great financial crisis, through the Basel III reforms to overhaul banking activity at a global level.

As a policymaker in the field of banking supervision, I have drawn two main conclusions from the events leading up to and during the COVID-19 shock. First, the efforts to impose higher capital requirements after the great financial crisis were clearly appropriate. Second, the Basel III framework, devised by global regulators during the previous crisis, is working largely as intended – the higher capital and liquidity buffers enabled banks to absorb losses in response to a large and unexpected external shock, and the prudential stance could still be adjusted when needed to avoid a procyclical reaction to the crisis by the banking system.

Basel III: the importance of full, timely and faithful implementation

The response to the COVID-19 shock has therefore shown that a well-capitalised banking system is a precondition for implementing public policies aimed at reducing business cycle volatility. This experience – which is consistent with previous studies showing that higher bank capital is associated with greater lending owing to a lower cost of funding[12] – should strengthen the case for fully implementing the Basel III standards. Let me explain why this is such an important topic for supervisors.

First, I would like to recall that the implementation of the pending Basel III standards is a necessary improvement to the prudential framework which dates back to the great financial crisis, when European banks’ use of internal models was viewed with suspicion by many in the financial markets. Reflecting these standards in European legislation should thus be seen as a structural reform that seeks to restore the credibility of banks’ internal models and the level playing field across the European banking market. Therefore, postponing or watering down these standards in European implementation would only prolong a situation in which some banks receive undue regulatory benefit at the expense of others and risk further denting financial markets’ trust in internal models in the event of future crises.

Second, I would highlight that, unlike other Basel III reforms drawn up in the aftermath of the great financial crisis, the aim of the pending standards is not to raise capital requirements per se – the implementation of these standards is expected to have a diverse impact across banks. However, some banks will need to make adjustments, as their use of internal models to calculate capital requirements has made them outliers in the distribution in terms of risk-weighted assets. This has contributed to excessive variability in this regard and, as a result, to a lack of comparability in the system.

Third, as confirmed by analysis conducted by the European Banking Authority and the ECB, the short-term transitory costs of implementing Basel III pale in comparison with the long-term benefits of strengthening the resilience of the financial system[13]. As I said earlier, this highlights the importance of a sound banking system that is able to support the economy through the cycle.

As you may be aware, the European Commission has recently unveiled its proposals for the implementation of the pending Basel standards in European legislation[14]. We consider this is an important step towards implementing the Basel agreement. The Commission’s proposals also introduce a number of positive elements going beyond Basel III, including as regards bank governance and environmental sustainability, which will remain important areas of attention for supervisors going forward. However, we also believe that there are transitory and permanent adjustments in the details of the Basel III implementation proposals which raise concerns from a prudential perspective.

Strengthening the crisis management framework

There is another pending legislative process at the European level which will be important in the years ahead and influence the resilience of the banking sector – the review of the crisis management and deposit insurance framework. Similar to the implementation of Basel III, this is a task that has been on policymakers’ collective to-do list since before the pandemic. However, unlike Basel III, the lessons learned about crisis management do not stem from the events of the great financial crisis, but from cases of individual bank failures during the early years of the banking union.

As you may know, the European Commission concluded a public consultation on this topic earlier this year, to which the ECB also contributed[15]. I imagine that this issue may be of great interest to today’s audience, particularly given the subject of the panel discussion scheduled right after my speech. I would therefore like to take a few minutes to outline the main areas for improvement in the framework from a supervisory perspective.

First, the introduction of a common European deposit insurance scheme (EDIS) is a key element to strengthen the crisis management framework and complete the architecture of the banking union as it was initially conceived. Progress on this third pillar of the banking union has been lacklustre in recent years. Meanwhile, differences in national legal regimes for dealing with bank failures continue to stand in the way of a fully integrated market and do not allow a uniform level of protection for the same category of investors and depositors across participating EU Member States. This means that the intrinsic value of a deposit in one country could differ from that in another, even within the banking union. It is therefore important to realise that EDIS would not only be a useful tool to manage a crisis in case of bank failure, but also that establishing it would make a crisis less likely to occur in the first place. Moreover, progress on EDIS would also allow for asset transfers in resolution and liquidation and may help to foster progress in European banking integration by overcoming host countries’ reluctance to allow cross-border capital and liquidity waivers.

Second, the risk of banks remaining in “limbo” situations needs to be addressed. Banks that are declared failing or likely to fail but not subject to resolution should enter a procedure that eventually leads to their exit from the banking market. The situation where a bank is declared failing or likely to fail with no alternatives to prevent failure and no public interest in resolution should be added to the grounds for the withdrawal of a bank licence. This is not currently the case. On this point, the proviso in the Bank Recovery and Resolution Directive that such banks need to be wound up should also be clarified. More broadly, introducing a harmonised administrative liquidation framework for banks would address this issue. Such a framework could be established at European level and be supported by EDIS, with the Single Resolution Board being granted powers to liquidate banks under its remit whose resolution is not found to be in the public interest.

Third, the framework whereby the supervisor can impose certain measures on a bank under “early intervention” should be clarified to make its practical implementation easier. There is currently an overlap in the existing legislation in this regard since some of the same measures could be taken either under the early intervention umbrella or under the remit of normal supervisory engagement. Removing this duplication and aligning the conditions for early intervention with those for imposing supervisory measures would make it easier to apply the early intervention framework.

Fourth, preventive measures undertaken by national deposit guarantee schemes have proven to be a useful crisis management tool which should be kept and extended across the European banking market in a harmonised way. Pending the agreement on EDIS, and also in the preparation phase, it would be desirable to harmonise and thus increase the availability of this type of intervention.


Let me conclude. As you are well aware, one of the lessons from the great financial crisis was that the set-up which saw monetary policy managed at the supranational (European) level while supervision and resolution remained in national hands was untenable. The need to overcome the fragmentation of the financial system along national lines – which threatened to bring down the entire construct of European monetary union – was the main reason why political leaders decided to establish a banking union.

I would argue that the presence of a single banking supervisor has allowed for a quicker and more efficient response to the challenges brought about by the pandemic, especially as it has managed to resolve many of the home/host issues in the banking market that came to the fore during the great financial crisis. More broadly, the forceful response to the pandemic crisis has also shown how policies implemented by different stakeholders, within their respective mandates, can be mutually reinforcing. And while the counterfactual is hard to gauge[16], there is little doubt in my mind that the recession suffered by the euro area economy in 2020 would have been deeper, and the recovery we are seeing in 2021 shallower, had these measures not been put in place.

As well as challenging the banking union’s crisis response capabilities, the COVID-19 shock has also seriously tested the Basel III regulatory framework devised in the aftermath of the great financial crisis. Here too, I believe that we can be relatively pleased with the results so far, because while improvements could be considered over the medium term[17], the system has largely worked as intended.

However, we also know that there are outstanding regulatory and institutional issues predating the pandemic which have yet to be addressed, and these may affect the future resilience of the euro area banking sector. In such circumstances, thinking that past success is a reliable bellwether for future performance could be tempting, but it is ultimately foolish. This is why work to bridge the remaining gaps should proceed in earnest.

  1. See the ECB website.
  2. See ECB (2020), Financial Integration and Structure in the Euro Area, March.
  3. See Reinhart, C.M. and Rogoff, K.S. (2008), “This time is different: a panoramic view of eight centuries of financial crisis”, NBER Working Paper Series, No 13882, March.
  4. See Gambacorta, L. and Marqués-Ibañez, D. (2011), “The bank lending channel: lessons from the crisis”, ECB Working Paper Series, No 1335, May.
  5. Lending to non-financial corporations and households increased by an average of 3.9% and 2.2% in 2020. Data refer to domestic banking groups and stand-alone banks in the euro area. While a similar breakdown is not available in the consolidated banking data for the period covering the great financial crisis (taking 2009 as a proxy year in that regard), the following comparison may give a crude approximation: ECB data also show that loans by monetary financial institutions (MFIs, which also include money market funds and credit institutions) to non-financial corporations and households increased by 6.5% and 3.5% in 2020, respectively, in spite of a contraction of 6.4% in euro area real GDP. By contrast, loans by MFIs to non-financial corporations declined by 2.2% in 2009 as a whole, and loans to households rose by a modest 1.3% over the same period, at a time when euro area real GDP contracted by 4.4%. Sources: ECB and Eurostat.
  6. See the results of the euro area bank lending survey for the third quarter of 2021.
  7. See Enria, A. (2021), “Banking sector resilience – the post-pandemic outlook”, presentation at the 9th “EU financial markets today and in the future” conference organised by the Finnish Financial Supervisory Authority, 2 November; see also the ECB’s supervisory banking statistics.
  8. See ECB (2021), “The initial fiscal policy responses of euro area countries to the COVID-19 crisis”, Economic Bulletin, Issue 1.
  9. According to the European Commission, government interventions to support financial institutions amounted to almost €240 billion in the 2008-20 period, or roughly 2% of euro area GDP. While disbursed amounts in this regard picked up in 2020 in a few countries relative to preceding years, these were largely related to legacy (pre-pandemic) issues. For more information, see European Commission (2021), “Eurostat supplementary table for reporting government interventions to support financial institutions”, Background Note, October.
  10. See ECB (2021), “The role of government for the non-financial corporate sector during the COVID-19 crisis”, Economic Bulletin, Issue 5; and European Commission (2010), “Public finances in EMU – 2010”, European Economy, Issue 4.
  11. For more details on the measures taken by the ECB to mitigate the crisis, see Our response to the coronavirus pandemic.
  12. See Gambacorta, L. and Shin, H.S. (2016), “Why bank capital matters for monetary policy”, BIS Working Papers, No 558, BIS, April.
  13. See Budnik, K., Dimitrov, I., Groß, J., Lampe, M. and Volk, M. (2021), “Macroeconomic impact of Basel III finalisation on the euro area”, Macroprudential Bulletin, Issue 14, ECB, Frankfurt am Main, July; European Banking Authority (2021), “EBA Report on Basel III Monitoring (data as of 31 December 2020)”, September.
  14. See European Commission (2021), “Banking Package 2021: new EU rules to strengthen banks’ resilience and better prepare for the future”, press release, 27 October.
  15. See ECB (2021), “ECB contribution to the European Commission’s targeted consultation on the review of the crisis management and deposit insurance framework”, May.
  16. See Schnabel, I. (2021), “Asset purchases: from crisis to recovery”, speech at the Annual Conference of Latvijas Banka on “Sustainable Economy in Times of Change”, September; Dautovic, E., Ponte Marques, A., Reghezza, A., Rodriguez d’Acri, C., Vila Martín, D. and Wildmann, N. (2021), “Evaluating the benefits of euro area dividend distribution recommendations on lending and provisioning”, Macroprudential Bulletin, Issue 13, ECB, Frankfurt am Main, June.
  17. See af Jochnick, K. (2020), “COVID-19: recovery and regulatory response”, conversation with Tim Adams at the IIF 7th Annual European Banking Union Colloquium, November.

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