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Kerstin af Jochnick
Board Member

Banking stability amid macroeconomic uncertainty

Speech by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, at the annual conference of the European Society for Banking and Financial Law

Milan, 25 November 2022


It is a pleasure to be here in Milan today and introduce our discussions on credit perspectives for a sustainable recovery. In order to set the stage for the discussions that you will be having over the rest of the day, I would first like to talk about the performance of the euro area banking sector in the wake of the COVID-19 pandemic and the altered risk outlook brought about by the war in Ukraine. I will then outline the issues related to the banking business which will warrant the attention of both supervisors and bankers in the near to medium term.

To anticipate the thrust of my remarks, I would like to highlight three key messages.

First, euro area banks have proven themselves to be resilient to adverse and severe macroeconomic shocks characterised by high uncertainty in recent years, unlike during the global financial crisis. This shows, among other things, that the reforms enacted in the aftermath of the global financial crisis are working, and that the elements of those reforms that are still pending should be implemented without further delay.

Second, in a collective sense, bankers and supervisors need to carefully monitor the risks stemming from the current macroeconomic and financial environment and manage them accordingly. Banks need to be proactive in the early recognition and management of credit risk. They need to incorporate downside scenarios into their capital planning and be mindful of both the risks and benefits of rising interest rates. Banks would also be ill-advised to incorporate their expectations of future public sector interventions into their balance sheet management strategies, especially because these will necessarily have to be more targeted in nature than was the case during the pandemic.

Third, in the medium term, previously existing vulnerabilities, some of which have also been put in the spotlight due to the pandemic and the war in Ukraine, will continue to demand the attention of bankers and supervisors. In this context, addressing the challenges posed by digitalisation and making progress in preparing for the green transition are “must-haves” for banks, regardless of their business model.

Let me elaborate on these messages.

The impact of macroeconomic shocks on banking dynamics

The euro area banking sector proved to be resilient throughout the pandemic, with banks supervised by the ECB exhibiting capital and liquidity buffers which remained broadly unchanged at comfortable levels.[1] Banks were therefore able to support the economy in spite of the severe negative fallout brought about by the COVID-19 shock. In contrast, during the 2008 global financial crisis, euro area banks were caught wrong-footed and forced to deleverage in a bid to repair their balance sheets, thereby exacerbating the magnitude of the economic downturn.

It is undeniable that the scale of the countercyclical policy response to the pandemic by both European and national authorities, which was significantly larger than the response by the same parties during the global financial crisis, was a key contributing factor to maintaining financial stability. However, it is also hard to argue against the notion that the differentiated scope of the policy response to the COVID-19 crisis – aiming to stabilise the real economy rather than just the banking sector – also stemmed from the fact that the banking sector was in comparatively better shape to begin with. Had this not been the case, banks would not have been able to fulfil their critical role of keeping the lending channel afloat as a lifeline for economic activity during the pandemic.

The banking sector’s differentiated response to these two crises therefore suggests that the Basel III reforms agreed by supervisors to enhance banking resilience in the aftermath of the global financial crisis have paid off. However, my experience with crisis management also suggests that no two crises are the same and that past successes are not necessarily reliable predictors of continued sound performance. This is why the elements of those global reforms that are still pending should be implemented in Europe without further delay.

As the banking sector emerged from the COVID-19 crisis, its stability was again put to the test with the outbreak of the war in Ukraine. Thus far, banks have coped well. In direct terms, the impact of the war seems to have been manageable, including for those banks with large direct exposures to Russia. In indirect terms, the macroeconomic shock provoked by the war, which is still ongoing, is yet to have any discernible effects on banks’ balance sheets. In aggregate terms, capital and liquidity ratios mildly edged down from the end of 2021 to the second quarter of 2022. However, they were still robust, in both cases remaining above pre-pandemic levels and close to their historic highs.[2] Over the same period, the total non-performing loan ratio of banks supervised by the ECB continued to edge down to an all-time low of 1.9%. Banking profitability as measured by the return on equity metric was already on the mend amid the initial rebound in economic activity in the latter stages of the pandemic. It has been further buttressed by the positive effect on net interest margins associated with the turning of the interest rate cycle. As a result, most banks have posted profits in recent quarters that were above market expectations. Overall, the return on equity of banks supervised by the ECB edged up to 7.6% in the second quarter of 2022, the highest recorded value since the operational start of ECB Banking Supervision.[3]

The profitability outlook for the remainder of 2022 remains optimistic on account of the positive contributions by lending volumes and margins to net interest income growth. Market participants seem to anticipate that the dynamic momentum in this regard will extend well into 2023.[4] However, it is striking that this confident sentiment seems to have taken hold in spite of the fact that, since the outbreak of the war in Ukraine, real growth expectations by both public and private sector analysts have been revised down significantly. This is particularly true for 2023, with private sector forecasters now expecting the euro area economy to grind to a halt next year[5]. And although the September 2022 ECB staff macroeconomic projections still foresaw a modestly positive real GDP expansion as a baseline scenario for the euro area in 2023, a recession scenario caused by euro area energy supply disruptions was also considered a possibility, should downside risks materialise.[6] In this context, the ECB further warned in October that “the likelihood of [a] recession [was] looming much more on the horizon and the probability of it [had] increased”, and this assessment was also echoed in its November 2022 Financial Stability Review.[7]

Rising interest rates, weaker growth and risks for banks

Markets therefore seem to be reconciling the competing trends concerning banking profitability and real economic activity in the euro area. Markets are betting that, in a context of still high inflation, the beneficial effect of higher interest rates will more than compensate for the drag stemming from increasing loan loss provisions, lower loan volumes and higher operating costs amid a weaker economy. However, I would argue that there are at least three important reasons to take this wager with a degree of caution.

The first is that the benefits of interest rate increases are not evenly distributed across our supervised banks. The relative “payoff” matrix in this regard is dependent on factors such as business model and balance sheet structure, as well as on the sensitivity of those variables to the underlying strength of the economic cycle. The speed with which banks can adjust the assets side of their balance sheet largely determines banks’ ability to benefit from rising rates in the near term. This adjustment is contingent on higher repricing and constraining the potential downsides of other elements stemming from losses in bond portfolios, increases in risk-weighted assets, and increases in the cost of risk. Insofar as the repricing adjustment in liabilities tends to lag behind that of the assets in their balance sheets, banks tend to benefit from the increase in interest rates as the positive effect in earnings more than compensates for any deterioration in capital adequacy.

In this regard, analyses conducted by ECB Banking Supervision staff suggests that the euro area banking sector as a whole would be able to cope with a 200 basis point interest rate shock in a baseline scenario of sluggish growth comparable to the scenario outlined in the September 2022 ECB staff projections. This analysis shows that bank profitability would increase overall and total capital adequacy would only deteriorate mildly.[8] However, the distributional effects of such relative gains and losses may still matter. For example, promotional and development banks[9] would tend to see higher capital depletion compared with other banks. This is because longer-dated exposures would partly stand in the way of a quick repricing on the asset side of their balance sheet, while reliance on wholesale markets would negatively impact their cost of funding. For the latter reason as well as the impact of the increased cost of risk on their balance sheets, banks primarily engaged in consumer lending would be in a similar position. From a supervisory perspective, it is therefore important to understand that even if the system-wide effects associated with rising interest rates are presumed to be positive, idiosyncratic factors may influence outcomes across individual banks.

The second reason to be cautious about market expectations for future bank profitability is that the current risks to the outlook are clearly tilted to the downside. This means that any deviations of actual growth relative to the baseline may further affect the “winners and losers” associated with rising interest rates that I have just described. The main concern in this regard is a potential deterioration in asset quality. As mentioned earlier, the stock of non-performing loans for banks under ECB supervision has kept going down in 2022, but there are signs that the tide might be turning if interest rates keep going up and the macroeconomic outlook continues to deteriorate. In this regard, bad loans in certain market segments have recently been on the rise, as has the share of loans subject to impairment review in total loans.[10] The ECB’s latest bank lending survey also shows that, in response to the deteriorated outlook, credit standards applied for lending to households and firms have tightened substantially.[11]

Beyond a weakening of economic activity in general, there is also concern about the potential effect of rising interest rates on specific market segments where banks may be particularly exposed. This includes risks for banks that are active in residential and commercial real estate markets, consumer and leveraged finance and energy-intensive corporate sectors.[12] More broadly, the combination of low growth, higher inflation and tighter financial conditions also renders banks vulnerable to corrections in asset prices, including through heightened counterparty risk. Meanwhile, rising mortgage rates and worsening debt servicing capacity by households could also affect banks’ balance sheets indirectly. The potential materialisation of these and other vulnerabilities prompted the European Systemic Risk Board to issue its first ever general warning in September 2022 on risks to financial stability in the European Union.[13] This is why, at the ECB, we are emphasising the need for banks to monitor the downside risks to the macroeconomic and financial outlook and to proactively manage the associated risks.

A third factor affecting the market assessment of future bank profitability is the response which may be reasonably expected from the public sector should downside risks to the outlook materialise. While the degree of macroeconomic uncertainty unleashed by the war in Ukraine and the associated volatility in financial markets bears some resemblance to that which characterised the initial phase of the pandemic, the repercussions of each shock on global energy and commodity markets, and hence on inflation, constitute a key difference. Whereas the initial impact of the pandemic was deflationary in nature (by weighing on economic activity), the outbreak of the war in Ukraine has been inflationary (with the energy and commodity crisis adding to price pressures from pandemic-related bottlenecks in supply chains). This has meant that, while the pandemic postponed the exit from a low interest rate environment, the war in Ukraine has hastened it.

The fight against inflation, and in particular the need to bring it back to levels consistent with the ECB’s primary objective to maintain price stability, is therefore a limiting factor to the policy measures which the public sector may deploy to support economic activity. From a supervisory perspective, the main implication of this is that banks should not incorporate their expectations of the public sector’s future interventions into their balance sheet management strategies, as these will necessarily have to be more targeted in nature than was the case during the pandemic.[14]

Points of attention for bankers and their supervisors

I will now turn to the salient issues that should be high on the agenda for bankers and supervisors.

In the near term, we face the key task of keeping a close eye on the risks stemming from the current environment and managing them accordingly. I would like to highlight three areas in this regard.

First, as regards credit risk, ECB Banking Supervision has been regularly monitoring banks’ exposures to vulnerable sectors since the outbreak of the pandemic, and the tools we developed to this end are being used to assess the potential fallout from the war in Ukraine. For example, we engaged in an on-site inspection campaign and an off-site targeted review of banks’ activities in commercial real estate. We thereby identified lending standards, collateral valuation and monitoring processes as areas for improvement.[15] In addition, earlier this year we conducted a deep dive analysis of banks’ exposures to energy utility companies, as well as of their credit and derivative exposures to the largest energy commodity traders. We have also observed that, notwithstanding a recent slowdown amid an uncertain macroeconomic environment, there is still a significant proportion of riskier leveraged loans despite the supervisory guidance we gave to banks in 2017.[16] More broadly, we have continued our work on banks’ credit risk management frameworks to ensure that deficiencies in this area are addressed. This process was launched during the pandemic and remains fully relevant in light of the war in Ukraine. We will keep engaging with banks on these and other aspects, and we will continue asking them to be proactive to guard against the materialisation of credit risk and bridge any gaps with our supervisory expectations.

Second, concerning sensitivity to the interest rate cycle, ECB Banking Supervision is finalising a targeted review of banks’ risk management capabilities to deal with interest rate and credit spread shocks. Our preliminary results suggest that many banks lack an adequate framework for assessing the most important second-round effects and structural shifts, such as changes in consumer behaviour. These could be associated with a rise in interest rates, including on account of limitations in the models used by banks.[17] Here again, we will follow up with banks in due course.

Third, as regards capital adequacy, ECB Banking Supervision has asked banks to provide us with their updated capital trajectories in light of the adverse macroeconomic scenarios highlighted by the ECB staff projections. This will allow us to better understand how our supervised banks expect to be affected by the downside risks to the outlook and the potential implications for their individual capital planning. We will assess banks’ capital trajectories on a case-by-case basis as part of our normal supervisory process.

In the medium term, the main task is to tackle challenges which, while predating the pandemic and the war in Ukraine, have risen to the forefront of the supervisory agenda as a result of these crises. Chief among these challenges are banks’ digitalisation strategies and addressing climate-related and environmental (or C&E) risks. The fact that these are precisely the topics of the two focused sessions that you will be having later today is a good indication of this.

The pandemic highlighted the need for banks to embrace digitalisation. Apart from responding to customers’ demands, digitalisation could be one way of improving efficiency, offering banks new possibilities for revenue growth while also allowing them to keep pace with competitors like fintechs. However, investing in digitalisation entails short-term costs for banks before they can reap the benefits of such technologies. However, greater reliance on IT systems and other technologies opens the door more permanently to operational and cyber risks. ECB Banking Supervision is therefore engaging with banks regarding their digital transformation activities through several initiatives, including dedicated surveys, targeted reviews and on-site inspections.

As regards C&E risks, the repercussions of the war in Ukraine for global energy markets will likely hasten the collective momentum towards the green transition. At the ECB, we do not regard climate change as a long-term risk – as its impact is already visible and is expected to grow materially in the years to come. Banks therefore need to address this challenge and grasp the opportunities that the climate transition also offers.

ECB Banking Supervision conducted a stress test in 2022 to understand banks’ exposure to C&E risks, as well as a thematic review to assess whether banks are aligned with our supervisory expectations in this domain.[18] The common message that emerges from these initiatives is that, while banks are making progress in their management of C&E risks, this trend is not uniform and laggards remain in all areas. For example, in the stress test[19] we found that many banks do not have robust climate risk stress-testing frameworks and lack accurate data and insights into their clients’ transition plans. The thematic review[20] showed that, while most banks have at least basic practices in most areas, they are still lacking more sophisticated methodologies and granular information on climate-related and environmental risks.

At the same time, these exercises also revealed that some banks have already adopted state-of-the-art governance and risk management practices for C&E risks. We have therefore issued a compendium of such practices to foster convergence among our supervised banks in this domain.[21] We have set institution-specific deadlines for achieving full alignment with our expectations by the end of 2024. Our goal is to fully integrate climate-related and environmental risks into the regular supervisory cycle and treat them in the same way as any other material risks that may affect banks’ capital requirements.[22]


Let me conclude. As supervisors we always have to look around the corner to make sure that banks remain resilient and able to support the real economy through the financial cycle. Walter Bagehot, the 19th century economist known for his observations on how modern central banks should behave in times of crisis, once noted that “adventure is the life of commerce, but caution is the life of banking”.[23] I hope to have persuaded you that the current circumstances unleashed by the war in Ukraine, quite different from the confluence of risks which we faced during the pandemic, call for vigilance and prudence from all of us, bankers and supervisors alike. And although the turning of the interest rate cycle has been beneficial for banks thus far, they need to know that this would be insufficient to offset any structural weaknesses that would re-emerge if and when downside risks to the economic outlook materialise.

At the same time, the fact that our banking system has thus far withstood the test of two large and unexpected external shocks over the last three years in quick succession – of the kind that had almost sunk it in the past – is a testament to the validity of well-capitalised banks, prudent supervisors and strong institutions. But this should not lull us into a false sense of security, also because the second of these shocks is still on-going. In order to further strengthen our collective resilience to potentially adverse developments in the future, the ECB is calling for the prompt implementation of the Basel III regulation and the completion of the European banking union project.

  1. In fact, standard indicators of banking health tended to improve during the pandemic. In aggregate terms, the Common Equity Tier 1 (CET1) capital level of banks supervised by the ECB rose from 14.9% in the second quarter of 2020 to 15.6% in the fourth quarter of 2021. Banks’ liquidity coverage ratio rose from 165% to 173% over the same period, while the total non-performing loans ratio for banks supervised by the ECB dropped from 2.9% in the second quarter of 2020 to 2.1% in the fourth quarter of 2021.

  2. The CET1 capital level of banks supervised by the ECB dropped from 15.6% in the fourth quarter of 2021 to 15% in the second quarter of 2022; this compares to a ratio of 14.4% in the first quarter of 2020. Banks’ liquidity coverage ratio dropped to 165% from 173% over the same period, as compared to a ratio of 146% in the first quarter of 2020. In both cases, the highest ratios recorded since the operational start of ECB Banking Supervision were posted in the second quarter of 2021 (with a 15.6% CET1 ratio and a 174% liquidity coverage ratio).

  3. ECB Banking Supervision (2022), “Supervisory Banking Statistics: Second quarter 2022”, October.

  4. ECB (2022), “Financial Stability Review”, November.

  5. ECB staff cut their 2022 real GDP growth projection for the euro area by 0.6 percentage points to 3.1% in the six-month period ranging from March to September 2022, but the downward revision over the equivalent period to its 2023 real GDP forecast (of 1.9 percentage points to 0.9%) was much larger in comparison. Similarly, the ECB Survey of Professional Forecasters shows that respondents cut their estimate of 2022 real GDP growth in the euro area by 1.2 percentage points to 3% between the surveys corresponding to the first and fourth quarter of 2022. Over the corresponding period, however, the forecast for real growth in 2023 was cut by 2.6 percentage points to 0.1%. See ECB (2022), “ECB staff macroeconomic projections for the euro area”, September; and ECB (2022), “The ECB Survey of Professional Forecasters: Fourth quarter of 2022”, October.

  6. ECB (2022), “A downside scenario related to the war in Ukraine and energy supply cuts”, ECB staff macroeconomic projections for the euro area, September.

  7. The November edition of the ECB’s Financial Stability Review noted that “one-year ahead recession probabilities [for the euro area] have increased markedly”. The ECB has also made it clear that further interest rate increases beyond those made in October 2022 are to be expected in order to ensure the timely return of inflation to the ECB’s medium-term target. See the ECB’s monetary policy statement of 27 October 2022.

  8. For a full discussion of the potential implications of rising interest rates for euro area banks, see Enria, A. (2022), “Monitoring and managing interest rate risk along the normalisation path”, speech at the Deutsche Bundesbank symposium “Bankenaufsicht im Dialog”, Frankfurt am Main, 8 November.

  9. These are banks that carry out financial, development and promotional activities on a professional basis commissioned by national, regional, or local authorities.

  10. Stage 2 loans rose to 9.7% in the second quarter of 2022 from 8.9% in the third quarter of 2021. See ECB Banking Supervision (2022), “ECB publishes supervisory banking statistics for the second quarter of 2022”, press release, 7 October.

  11. ECB (2022), “October 2022 euro area bank lending survey”, press release, 25 October.

  12. Enria, A. (2022), “The risk outlook for euro area banks”, presentation at the Cumberland Lodge Financial Services Summit, London, 4 November.

  13. ESRB (2022), “Warning of the European Systemic Risk Board of 22 September 2022 on vulnerabilities in the Union financial system”.

  14. Enria, A. (2022), “Better safe than sorry: banking supervision in the wake of exogenous shocks”, speech at the Austrian Financial Market Authority Supervisory Conference 2022, Vienna, 4 October.

  15. ECB Banking Supervision (2022), “Commercial real estate: connecting the dots”, Supervision Newsletter, 17 August.

  16. ECB Banking Supervision (2017), “Guidance on leveraged transactions”, May.

  17. ECB Banking Supervision (2022), “Written overview ahead of the exchange of views of the Chair of the Supervisory Board of the ECB with the Eurogroup on 7 November 2022”.

  18. ECB Banking Supervision (2020), “Guide on climate-related and environmental risks”, November.

  19. ECB Banking Supervision (2022), “2022 climate risk stress test”, July.

  20. ECB Banking Supervision (2022), “Thematic Review on Climate and Environmental Risks 2022: Final Results”, 2 November; and ECB Banking Supervision (2022), “Walking the talk: Banks gearing up to manage risks from climate change and environmental degradation”, November.

  21. ECB Banking Supervision (2022), “Good practices for climate-related and environmental risk management: Observations from the 2022 thematic review”, November.

  22. Elderson, F. (2022), “Delivering on the Glasgow Declaration: actions by the ECB on the road through Sharm El-Sheikh to a Paris-compatible path”, panel contribution at the Euro-Mediterranean Economists Association COP27 side event on “Investing in and financing the acceleration of sustainable development in a net zero scenario” in Sharm El-Sheikh, 9 November.

  23. Bagehot, W. (1873), Lombard Street: A Description of the Money Market, Henry S. King & Co, London.


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