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Kerstin af Jochnick
Board Member
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Business models, bank funding and market value in a changing environment

Introductory remarks by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, at the 6th European Banking Federation Boardroom Dialogue

Frankfurt am Main, 7 July 2022

It is a pleasure to be here and to be speaking to you in person after two years of meeting almost exclusively online.

In my remarks today, I will discuss how banks can refocus their business in the medium term in order to remain attractive to investors. But first, let me set the scene. The European banking sector as a whole has emerged from the pandemic in a robust position and has coped well with the fallout from the war in Ukraine. However, the period ahead – marked by a new phase in the interest rate cycle – is likely to be just as challenging. Therefore, banks must continue to adapt to a changing environment. To remain attractive to investors, they need to consider a medium-term perspective when adjusting their business models.

The euro area banking sector in the wake of the pandemic

Let me start by looking at banks’ performance to date. As already highlighted by our Chair Andrea Enria earlier today, European banks have emerged from the pandemic in a solid position, with the Common Equity Tier 1 ratio for significant banks directly supervised by the ECB edging up to 15.5% in the fourth quarter of 2021, from 14.9% in the second quarter of 2020. During this period, the aggregate non-performing loan ratio for such banks has continued on the downward trend observed since 2014 to stand at 2.1% in the final quarter of 2021. And profitability has also been on the mend, with significant banks’ return on equity rising to 6.7% in the fourth quarter of 2021, from zero in the second quarter of 2020. At the same time, the fallout from the war in Ukraine seems to have been manageable, including for those banks with large direct exposures to Russia.

However, while the direct impact on banks from the war has been contained, the indirect effects on the broader macroeconomic environment have been all too evident in the form of higher inflation, weakening growth prospects and a turn in the interest rate cycle. Markets anticipate that the adverse macroeconomic developments may weigh on banks’ profitability and asset quality in the future, and this has already led to an upward revision in loan loss provisions. The latest Eurosystem staff macroeconomic projections introduce, for the first time, a downside scenario entailing a possible recession in 2023 as a result of disruptions to euro area energy supplies.

Therefore, banks will need to be ready to confront a challenging period marked by higher inflation and a gradual exit from the low interest rate environment. Interest rate normalisation should be beneficial for banks on the whole. We have seen that, in the first quarter of 2022, increasing yields together with continued lending growth supported positive levels of net interest income. However, the boost to earnings provided by higher net interest margins would be insufficient to offset the structural weaknesses that would re-emerge if and when downside risks to the outlook materialise.

Bank business models in a changing macroeconomic environment

It is therefore crucial that banks continue to adapt their business models because, to remain viable, they cannot rely on higher interest rate margins alone. Moreover, while interest rate normalisation should seemingly be consistent with higher profitability and costs associated to credit risk and asset valuations should remain contained, banks’ sensitivity to the interest rate cycle may also differ depending on their size or business model. And evidently, higher interest rates in themselves will not do much to support bank profitability unless overall economic activity remains strong.

Three areas will be particularly important for banks as they adapt their business models.

The first is digitalisation. Low profitability has long been a challenge for the euro area banking sector, often rooted in structural vulnerabilities related to excess capacity and cost inefficiencies. Digital technologies could be a key lever to improve efficiency, offering banks new avenues for revenue growth. By taking advantage of digital innovation, banks can also keep pace with competitors like fintechs, big techs and other digital natives. Of course, investing in digitalisation entails short-term costs for banks before they can reap the benefits of such technologies. And as noted by our Chair Andrea Enria earlier today, investment in digital technologies also entails operational risks to banks. But I would say that, in this day and age, banks can’t afford not to follow this path.

The second area concerns climate-related and environmental risks. The sharp rise in the price of fossil fuels resulting from the war in Ukraine has made the need for alternative sources of energy even more urgent. While the war may hinder the transition to net zero in the short term, the quest for energy independence from Russia may accelerate the green transition in the medium term. As a result, transition risks could materialise much sooner, requiring banks to step up their climate risk management efforts. Investment in green technologies is also likely to outstrip divestment from carbon-intensive ones. On the supervisory side, at the ECB we are doing everything we can to ensure that banks are well placed to address the challenges posed by the green transition. Supervisors and banks are on this journey together. And the banks have already taken some steps, but most need to be more ambitious if they are to meet our supervisory expectations on incorporating climate-related and environmental risks into their practices by the end of 2024 at the latest.

The third area is bank funding. In the debate on how to make banks’ business models more sustainable, the level of central bank policy rates and their broader impact on the financial bottom line of banks tend to capture the headlines. This means that the issue of banks’ funding costs, which are also sensitive to the interest rate cycle, often receives much less attention. In recent years the ECB’s exceptional measures, such as its targeted longer-term refinancing operations, have provided stable and dependable funding in times of market uncertainty, increasing banks’ reliance on central bank funding. In addition, deposit volumes have continued to increase despite the low remuneration rates available to customers. The low and stable deposit funding rates have also protected banks from the increase in funding costs associated with the notable rise in bank bond yields since the end of 2021. However, the expected reduction in banks’ Eurosystem funding is likely to return the size of banks’ balance sheets and the composition of their liquid assets to pre-pandemic levels.[1] This may cause banks to rely more heavily on market-based funding than before, and this wholesale funding may also come at a higher price, thereby affecting interest margins. Banks should therefore take this into account when considering their funding plans in the period ahead, as well as its potential implications for business model viability.

Overall, perhaps the greatest risk facing banks during this new phase of the interest rate cycle is that of complacency, with banks erroneously believing that higher interest margins make the need to adapt their business models less pressing than before. Spurning the opportunities offered by digitalisation and the green transition will only widen the gap between profitability leaders and laggards, and banks that do so may leave themselves vulnerable. Markets and investors will likely favour banks which develop viable business models that carefully take these factors into account. This should be reflected in the (lower) cost of funding available to them.


To sum up, while the macroeconomic environment has changed considerably in recent months, the need for banks to continue to refocus their business models – and with that remain attractive to investors – has not.

Thank you for your attention.

  1. Based on the median estimate obtained from the ECB Survey of Monetary Analysts, €700 billion of repayments of targeted longer-term refinancing operations are expected to be made by the end of December 2022. See ECB (2022), Financial Stability Review, May.


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