Hearing of the Committee on Economic and Monetary Affairs of the European Parliament
Introductory statement by Andrea Enria, Chair of the Supervisory Board of the ECB
Brussels, 21 March 2023
2022 was in many ways a turbulent year. As the EU economy and its banking sector were moving along a path of steady recovery from the pandemic, the Russian invasion of Ukraine, at the beginning of the year, proved to be the root cause of yet another important exogenous shock. However, banks remained resilient and managed to smoothly navigate the changing geopolitical and macroeconomic environment. While the fast-paced adjustment of interest rates allowed the banking sector to reach record levels of profitability and improve its market valuations, it also gave rise to the need to proactively manage interest rate risk, funding and liquidity risk. The strength of banks’ balance sheets has been a crucial factor for weathering the turbulence which has materialised on banking and financial markets over the past few weeks. I would now like to elaborate on the supervisory developments over the past year, given that the more recent turbulent events will be discussed in a separate session later on this afternoon.
Supervisory activities in 2022
Banks’ capital and liquidity positions remained solid and well above minimum requirements, with the aggregated Common Equity Tier 1 ratio standing at 15.3% and the liquidity coverage ratio at 161% at the end of the fourth quarter of 2022. In addition, the volume of non-performing loans continued to decline, with the non-performing loans ratio standing at 1.8% in the fourth quarter. Return on equity reached its highest level since the start of the banking union, to stand at 7.7% in the fourth quarter of 2022.
Supervisory work first and foremost focused on monitoring the activities and the risk reduction efforts made by banks with direct exposures to Russia and, in particular, those established in the Russian market. This work is still ongoing, for while total euro area banks’ direct exposures to Russia had declined by around 20% as at the third quarter of 2022, the exit strategy used by some banking groups still present in Russia has not thus far delivered the results expected.
Against the backdrop of energy price inflation and heightened volatility of commodity prices, we used available granular credit risk data to monitor banks’ credit exposures to energy-intensive sectors, such as metal and chemical products, commodity goods and energy utilities. In the light of the lessons drawn from the collapse of Archegos in 2021, we also turned our attention to possible risks arising from financial market dislocations, which could primarily affect non-bank financial counterparties. By reviewing the governance and risk management practices of those significant institutions most exposed to counterparty credit risk and risks related to prime brokerage, supervisors were able to identify and tackle those deficiencies which, if left unaddressed, would overly expose banks dealing in derivatives and offering clearing, securities and investment banking services to other banks and non-bank financial institutions.
Finally, we focused on the risks arising from the upward shift in interest rates. In particular, we carried out a targeted review of interest rate risk and credit spread risk in the banking book and we looked closely at exposures to sectors especially sensitive to interest rates, such as commercial and residential real estate lending and leveraged finance. Leveraged finance also became the object of a dedicated Pillar 2 capital requirement add-on as a result of the Supervisory Review and Evaluation Process (SREP) decision, which was targeted at a handful of highly exposed banks.
Strong internal governance and effective steering by management bodies are key for banks to continue developing adequate strategies and face the challenges ahead. That is why ensuring the effectiveness and diversity of banks’ management bodies remains one of the current priorities for ECB Banking Supervision, making it important for us to perform our targeted reviews and on-site inspection campaigns whenever we consider it necessary. Governance arrangements are also key to instigating the appropriate strategic steering towards digital transformation. Last year, we conducted an extensive survey to better understand the state of play of digital transformation and to better plan our supervisory activities around this.
Our supervisors also intend to follow up on the results of the reviews of climate-related and environmental risks that were conducted in 2022. While clear progress was made compared with 2021, banks still have significant blind spots in terms of identifying climate-related and environmental risks. As part of their monitoring efforts, supervisors will focus on banks’ ability to capture these risks in their risk management frameworks. We are also urging banks to further develop their stress-testing frameworks and reduce data gaps. Banks have now received individual letters setting out the steps to be taken in order to be fully compliant with our supervisory expectations by the end of 2024.
Work to improve supervisory processes
The experience gained around two exogenous shocks in the space of only two years illustrates the invaluable benefits of a flexible and fully risk-based supervisory approach. Moving away from the start-up phase of the Single Supervisory Mechanism and taking stock of the more equal level playing field achieved by building harmonised supervisory practices and processes, we now need to look at ways of enhancing the efficiency of our work, lightening the administrative burden and making supervision even more effective and impactful.
We are therefore gradually working to improve our supervisory processes. We are introducing a supervisory risk tolerance framework, which will allow supervisors to better adjust to bank-specific needs and avoid tick-the-box exercises. We also intend to enable our supervisors to better calibrate the intensity and frequency of their analyses over time by introducing what we call a multi-year SREP approach.
With our supervisory processes benefiting from more discretion, we also need to be more accountable and hence transparent to the banks we supervise as well as the wider public. We are therefore taking steps to better explain our methodologies and individual supervisory expectations. In this vein, we now summarise our key concerns and findings in the executive letters that we send to individual banks at the end of each SREP exercise – a means for setting forth what we want the banks to treat as a priority. In the near future, we intend to increase transparency regarding our methodology for setting Pillar 2 requirements.
Effective supervision and the soundness of our banking sector have, of course, also been made possible by the rules that you, the EU legislators, put in place. Let me recall three key legislative initiatives that you are currently working on and which are particularly relevant for us supervisors.
First, there is the banking package. It needs to be put into force by the beginning of 2025, at the same time minimising any deviations from the Basel III final standards. As part of this package, you need to be as ambitious as possible regarding the requirements you introduce for banks’ governance. This is the only way to achieve the solidity and success of the bank business that we truly need. It is crucial that we conduct fit-and-proper assessments of banks’ managers before they take up their positions. Supervisors must be able to ensure that candidates meet the high standards of professional competence required of them. Also, banks’ boards need to be sufficiently independent and diverse in terms of their professional and educational background, gender, age and geographical origin.
Second, it is important that the new anti-money laundering authority is set up without undue delay, with adequate supervisory capacity to perform its tasks, as well as being responsible for the direct supervision of a sufficient number of institutions to have an EU-wide impact.
Finally, there is the reform of the crisis management framework. The banking union has more than once demonstrated its ability to swiftly manage banking crisis scenarios, taking complex decisions by means of smooth and intense cooperation between the ECB and the Single Resolution Board, as well as with several national authorities. Our last case in this respect was the successful management of the Sberbank Group failure following the Russian invasion of Ukraine. However, we are still working under the assumption that the resolution framework would only apply to a narrow set of banks and we face very heterogenous national liquidation frameworks and different roles for deposit guarantee schemes across the Member States. It is important to reflect on what we learned during the first few years in which we applied this new framework and move towards targeted improvements in legislation and practices. This would also help us to move one step closer to completing the banking union.
Thank you very much for your attention, I now look forward to your questions.