Hearing at the European Parliament’s Economic and Monetary Affairs Committee
Introductory statement by Andrea Enria, Chair of the Supervisory Board of the ECB
Brussels, 31 March 2022
The war in Ukraine dominates our thoughts these days. The awful images of death and destruction close to our borders, in a country that had expressed its democratic wish to join the European Union, remind us of the core values driving European integration. The war triggered a second exogenous shock to our economy, and as a consequence to our banking sector, in less than two years. The international financial sanctions in response to the Russian aggression against Ukraine call for rigorous compliance by banks and other players, while generating challenges for multinational firms. The ECB is closely monitoring the impacts of current developments on the banking sector. We of course also remain committed to pursuing our supervisory priorities and to meeting our accountability obligations, and today we present you with our 2021 annual report on supervisory activities.
Banking sector preparedness for the impact of the Russia-Ukraine war
I would like to underline that the banking sector is well prepared for the impact of the Russia-Ukraine war, thanks to its strong capital and liquidity position.
Direct exposures of European banks to Russian counterparties appear manageable, which means the first-order impact on the euro area’s financial stability is contained. These exposures amount to approximately €100 billion, with sanctioned entities making up only a minor part of this total. Direct exposures are concentrated in a few banks operating in Russia, Ukraine or Belarus via subsidiaries that are predominantly locally funded. Even in the extreme scenario in which European banks were to write down cross-border exposures and decide or be forced to walk away from their establishments in the region, the overall capital impact would not jeopardise their continued compliance with supervisory requirements and buffers. The immediate consequence of the sanctions placed on Russia was a liquidity crisis at Sberbank Europe AG, whose ultimate majority shareholder is the Russian Federation. This led to our assessment of the bank and its subsidiaries in Croatia and Slovenia as failing or likely to fail. More recently, RCB Bank, which has Russian customers and is a former subsidiary of the Russian VTB Bank, decided to voluntarily phase out its banking operations and transform itself into a non-bank financial institution. A temporary administrator appointed by the ECB is working with management to oversee the orderly repayment of depositors, fully covered by the liquid assets available at the bank.
Regarding the implementation of the sanctions, ECB Banking Supervision does not have a mandate to assess and enforce banks’ adherence to the different regimes. Nevertheless, we are monitoring and evaluating the prudential implications of the sanctions very seriously. Effectively implementing the sanctions is a challenging task for banks, as they constantly need to adjust their operations to adapt to the multifaceted and evolving nature of the sanction framework. Our supervisory teams have daily exchanges with the banks to discuss the prudential implications of sanction regimes and to assess the measures taken. In particular, we are assessing whether banks have implemented adequate internal governance arrangements and controls to adhere to the sanctions. We are committed to a smooth cooperation with the industry and other European bodies to ensure clarity around the sanction framework.
Beyond the direct impact of the war, the ECB is also monitoring possible second-round effects on banks. At this stage, these indirect effects are more difficult to estimate. They could run through concentrated exposures towards sectors or individual customers indirectly hit by the sanctions, through the spike and volatility in energy and commodity markets, through heightened volatility in financial markets, and through the general deterioration of the macroeconomic outlook in the European Union. We are closely monitoring European banks’ risk profiles and are asking the banks to enhance their internal defences against cyberattacks and improve their operational resilience. We stand ready to implement swift supervisory actions should the risk situation of individual banks deteriorate.
A snapshot of the European banking sector taken at the end of 2021 provided a positive, improved picture. Capital and liquidity ratios had stabilised at levels well above those prevailing before the pandemic. There was continued improvement in asset quality, also thanks to banks’ ongoing efforts to securitise and dispose of legacy portfolios of non-performing assets. And profitability had rebounded to the highest level since the start of the banking union. Although these results were mainly driven by reduced provisions, several banks started projecting a return on equity at or above the cost of equity in their multi-year plans. A more positive sentiment had developed among investors, with market valuations steadily improving, supported by more ambitious distribution plans. This positive momentum has been severely disrupted by the headwinds to the near-term outlook following the escalation of the Russia-Ukraine war. This has translated into significant downside risks to economic activity in Europe and increased challenges to the banking sector. Market valuations have significantly deteriorated since the first days of the war.
At the end of last year, we published our supervisory priorities for the years 2022-24. These priorities reflect several objectives: first, that banks emerge from the pandemic healthy; second, that they seize the opportunity to address structural weaknesses through digitalisation strategies and enhanced governance; and third, that they tackle emerging risks, such as climate-related and environmental risks, and IT and cyber risks. Given the extreme uncertainty triggered by the war, on top of some pre-existing uncertainties stemming from the pandemic outlook, banks should be prepared to cope with potential asset quality deterioration and corrections in financial market valuations. The Russia-Ukraine conflict has reconfirmed and even reinforced our existing supervisory priorities. These include addressing shortcomings in banks’ credit risk management frameworks, monitoring exposures to vulnerable sectors and leveraged finance, and ensuring adequate management of interest rate and credit spread shocks.
In addition, structural challenges that predate the pandemic continue to weigh on banks. Addressing structural weaknesses in the area of the digital transformation and in the steering capabilities of banks’ management bodies is crucial to support the resilience and sustainability of banks’ business models. The constantly evolving risk landscape requires increased supervisory focus in order to address challenges stemming from climate-related and environmental risks, increasing counterparty credit risk towards riskier and less transparent non-bank financial institutions, and operational and IT resilience risks. The current situation further emphasises the relevance of cyber resilience, as banks might face a potential increase in cyber threats in retaliation to sanctions.
We welcome the Commission’s proposals, which reinforce the single European rulebook and enhance the prudential framework for credit institutions. We consider it paramount that the outstanding Basel III standards are implemented in a full, timely and faithful manner. One key element will be what is termed the “output floor”, which sets a lower limit on the capital requirements that banks calculate when using their own models. The Commission has proposed applying it at the highest level of consolidation, coupled with a re-distribution mechanism. However, this may still incentivise banking groups to reorganise activities so as to minimise the output floor impact on individual parts of the group in ways that could potentially be misaligned with sound risk management. In addition, it would freeze more capital at local level. A second option is to apply the output floor at both the highest consolidated level in the EU, and at the Member State sub-consolidated level. This would simplify the framework for banks compared to the Commission’s proposal and ensure proper capitalisation in each Member State, but it would also lock-in capital at this sub-consolidated level. A third option is to apply the output floor at the highest level of consolidation only. Importantly, this could be coupled with an obligation for banks and competent authorities to ensure that the capitalisation of standalone entities is adequate. This approach would not only be simpler and reduce fragmentation but also duly reflect the fact that the output floor was calibrated at the consolidated level. This last approach is preferred by the ECB.
The Basel III reforms would cater for a stronger and safer banking sector. That is why we urge a faithful implementation of Basel III in the EU. In this regard, we note with concern that the Commission proposals include some transitory and permanent deviations from the Basel standards. The transitory adjustments target a more gradual implementation of the output floor for very sizeable portfolios, such as residential real estate and unrated corporates. We question the wisdom of these proposals, especially at a time when the residential real estate market already shows clear signs of overheating in several Member States. Other permanent deviations from the Basel standards would concern less significant portfolios, but the cumulative impact of all these small adjustments could still hinder the effectiveness of the whole framework.
The proposals would also close the gaps identified in the current framework. First, the ECB welcomes the proposals to enhance the requirements with respect to environmental, social and governance, or ESG, risks for credit institutions and the respective mandate for competent authorities. ESG risks are present, acute and intensifying; they can have far-reaching implications for the stability of both individual institutions and the financial system as a whole. Second, we support the proposed harmonised provisions for the assessment of banks’ directors and key staff, as this will facilitate supervisory effectiveness and enhance sound governance. And finally, we welcome a new common set of rules for branches of third-country banks operating in Member States, since this will replace heterogeneous national approaches and strengthen the single market. The Commission has set out an ambitious and pragmatic approach for each of these three areas, which the ECB fully supports.
To conclude, I want to stress that the banking union has proven to be a real asset, also in this new crisis. Thanks also to the strong supervision carried out since the establishment of the Single Supervisory Mechanism, our banks entered the crisis in good health. The coordination and cooperation between the ECB, the Single Resolution Board and national authorities has proven very effective. That is why we are committed to pushing for more progress on completing the banking union.