Exchange of views of the Committee on Economic and Monetary Affairs of the European Parliament
Opening remarks by Andrea Enria, Chair of the Supervisory Board of the ECB on the failure of Silicon Valley Bank and its implications for financial stability in Europe
Brussels, 21 March 2023Jump to the transcript of the questions and answers
Monitoring the euro area banking sector in the aftermath of the March 2023 US bank failures
The failure of some mid-sized US institutions earlier this month reminds us that specific features of a bank’s business model can make its balance sheet particularly vulnerable to interest rate risk. In extreme cases, this can turn rising interest rates from a boost to profits into an existential threat. In this context, the case of Silicon Valley Bank is particularly illuminating. The institution concentrated both its lending activities and its deposit-taking activities among venture capital firms, fintechs and start-ups. More than 80% of its deposit base consisted of uninsured corporate deposits, which tend to be more mobile than other deposit types. Most of the bank’s assets consisted of fixed income securities, which typically lose value when interest rates rise. As deposit outflows started mounting, Silicon Valley Bank liquidated fixed income securities at a loss, further exacerbating the run on its deposits and the strain on its liquidity. This happened in a US regulatory context where mid-sized banks, like Silicon Valley Bank, are exempted from, or treated preferentially under, relevant prudential standards such as liquidity requirements − the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) − and capital requirements; such banks are subject to less frequent stress tests than larger ones and they can be allowed not to reflect in their regulatory capital the unrealised losses on securities held in the balance sheet as “available for sale”.
The episodes under consideration have been contained also by the prompt and forceful intervention of the US authorities, which have (i) committed to protect all uninsured deposits of the banks involved, under what is known as the “systemic risk exception”; and (ii) set up a central bank liquidity facility accepting from banks fixed income securities valued at par.
There is no direct read-across of the US events to euro area significant banks. First and foremost, this is because the banks we supervise do not exhibit the outlier features of extreme interest rate risk and predominant reliance on a concentrated, uninsured deposit base – what might be termed the “SVB business model”. Our banks generally operate with a more diversified customer base. Although uninsured deposits are an important source of funding in the euro area as well, they tend to be more relevant for business models which are well diversified on both the asset side and the liability side, including their depositor base. Importantly, all our banks are subject to LCR and NSFR requirements. Liquidity coverage ratios have only decreased marginally since the monetary policy normalisation process began, and they averaged in excess of 160% towards the end of last year. More than half of the existing buffers of highly liquid assets are made up of cash and central bank reserves, which sensibly mitigates the risk of mark-to-market losses when liquidity needs arise. In fact, recent data indicate that those banks that have experienced some deposit outflows appear to have succeeded in maintaining their levels of excess liquidity. They have done so mostly by issuing debt securities and reducing interbank lending, and only to a minimal extent by liquidating securities. The sector’s overall liquidity resilience also results from the overhaul of the regulatory framework implemented in the aftermath of the global financial crisis and the choice, made by the European Union, to apply the international standards to all the banks operating in its jurisdiction.
We are well aware that the ongoing, fast-paced normalisation of monetary policy conditions is increasing our banks’ exposure to interest rate risk. We started assessing interest rate risk and credit spread risk as early as the second half of 2021, when the first signs of inflationary pressure emerged, and in 2022 we included those risks in our supervisory priorities. Last year, we repeatedly measured the sector’s response to standard 200 basis point shocks to interest rates, highlighting that the net effect on bank profitability and capital is expected to remain positive under baseline macroeconomic scenarios. The boost interest margins give to net interest income has a positive impact on banks’ earnings capacity. The effect of this is expected to outweigh the costs associated with worsening asset quality, as borrowers find it more difficult to pay back their loans. At the same time, we also reviewed the interest rate and credit spread risk management practices of the most exposed banks and instructed them to improve the way they monitor and manage the negative impact that rising rates typically have on their economic value of equity, i.e. the net present value of their balance sheet. When interest rates rise, the economic value of equity falls due, among other factors, to the reduction in value of fixed income securities, including sovereign debt securities. This happens irrespective of whether banks measure the value of such securities at amortised cost or at market prices for reporting purposes. If not appropriately managed and hedged, unrealised losses on securities that banks hold at amortised cost might become a concern, particularly because investors and sophisticated depositors tend to focus on market values when their level of confidence dwindles on the back of changes in fundamentals or even mere rumours.
During this review of risk management practices, we asked some banks to be more conservative in the assumptions they apply when stress testing credit spreads on financial securities. We also encouraged them to improve the calibration, validation and back-testing of their asset and liability management models, to make sure that these models properly reflect loan repayment and deposit withdrawal behaviours by customers, in line with the new interest rate environment.
Liquidity and funding risks have also been upgraded in our set of supervisory priorities. As the normalisation of monetary policy started and the phasing-out of the extraordinary central bank funding facilities came closer, our supervisors began in the second half of last year to devote significant attention to the sustainability of banks’ funding plans.
Both euro area banks and supervisors are therefore focusing on the risks and risk management practices that are most relevant, given the fast pace of change in the interest rate environment.
The market turmoil triggered by the failure of the US banks has been further aggravated by the significant drop in share prices and spike in credit default swap spreads experienced by Credit Suisse last week. While euro area banks saw their share prices tumble, their funding and liquidity positions were not materially affected, reflecting the continued resilience of the sector. Credit Suisse, a global systemically important bank engaged in a complex refocusing of its business model, was already subject to significant liquidity outflows in the last quarter of 2022. In order to restore trust, the Swiss authorities provided Credit Suisse with a large volume of liquidity support, and the details of the bank’s acquisition by UBS were finalised over the weekend. The ECB has issued a statement welcoming this outcome. We have clarified, in a joint statement with the Single Resolution Board and the European Banking Authority, that the hierarchy of claims is clearly defined in our resolution framework, and CET1 capital would always be first to absorb losses and would be fully written down before Additional Tier 1 instruments could be written down. This approach has been consistently applied in past cases and will continue to guide the actions of the Single Resolution Board and European banking supervision in all crisis interventions.
Thank you for your attention.
Exchange of views in the Committee on Economic and Monetary Affairs of the European Parliament with Andrea Enria, Chair of the Supervisory Board of the ECB, and José Manuel Campa, Chair of the EBA
Irene Tinagli: Thank you very much. Now let’s start our Q&A session, and we start with Markus Ferber for the EPP.
Markus Ferber: The rapid increase in interest rates can be a problem for banks. You’ve just explained that as well. But we’ve often talked about interest rates in a different connotation with a different approach. Because in the stress test in the past, it was at the lower-for-longer scenario, so what would happen if the interest rates were low for the long term. Now we have exactly the opposite happening. And because the ECB increased by 350 basis points and then a further 50 basis points as announced by President Lagarde. So I think the question is whether or not you were looking at the wrong risk, and to what extent are you looking at interest risk? And there was a very rapid reaction to Silicon Valley Bank to calm the markets. It was agreed to set the guarantee in the US at USD 250,000 so that no one would have to be worried about their deposit. So I have two questions. Do you think that the way that the American authorities’ proceeded is correct, are there risks with this moral hazard, for instance, and are they going beyond the limits? And, secondly, would that be possible in the EU? Or do you think that goes against the no creditor worse off principle? The question is to both of course.
José Manuel Campa: I’ll start first on the issue of the stress tests. You are absolutely right that this is the first scenario in a long time in which we are considering a macro environment of increased interest rates, increased spreads, which has also happened in the past, and the impact that that scenario of increased interest rates has on higher persistent inflation and lower economic growth. I think that would provide us with good insight going forward. I think that the scenario is qualitatively different from all the previous ones, but at the same time it’s been – I was going to say accused – but it’s been referenced by many of the observers and the banks involved as the toughest scenario ever by the EBA. And I think that’s probably right when we measure in terms of the GDP drop in the adverse scenario relative to the baseline. It’s a difficult scenario. I think that that will help us in providing more robustness on the situation of the banks. Most of the impacts come, obviously, through the deterioration of credit portfolios, from the deterioration of the economic outlook and higher cost of lending, and from the deterioration of the market portfolio as adjustments are taking place as a result of the increased interest rate. Those valuation effects, which are part of what we are seeing right now, are actually quite large in our stress test, so we are confident that that stress test should be helpful in providing some input.
On the extension of the deposit insurance in the US beyond USD 250,000 to all depositors, this is a clause, and I think Andrea Enria explained this in his opening remarks as well, that can be called upon by the US authorities, and a specific provision for preserving financial stability. In the current context of the EU, we do not have that clause. And obviously, as you said, there are concerns about that type of action going forward in terms of moral hazard and other aspects, about what it means to provide some “skin in the game” for people participating in the different banks and market monitoring?
Andrea Enria: Very quickly, because you’ve covered it all. The first point I want to say is that the fact that we didn’t have in the past the stress test focus on increasing interest rates, and it was more a low-for-longer scenario, doesn’t mean that, from the supervisory perspective, interest rate risk was not covered. We already started in 2021 to look into interest rate risk in the banking book. In particular, we have been regularly applying these standard shocks, which are also dictated by the EBA guidelines and by the Basel standards, of 200 basis points in all possible directions. So, parallel shifts, the tilting of the yield curve, the steepening of the yield curve. And we always identified banks that were performing worse under these scenarios and thus told them to strengthen their hedging and their risk management capacity. So there has been quite a lot of focus on interest rate risk.
On the point on the guarantee of deposits, I would say that the issue is sometimes that we always have the impression that we have to map what is being done in other countries in our jurisdiction. I would argue that the best protection against these types of events is to prevent the types of extreme business models that we have seen being very fragile in this situation, with a concentrated uninsured deposit base, homogeneous in terms of business lines, all fintech venture capital investors, crypto-asset providers that also behaved in a coordinated manner in this case, and extreme interest rate risk also in terms of the asset and liability management. So this I think, in terms of supervision, is the most important priority.
Irene Tinagli: Thank you very much. Now I give the floor to Paul Tang for S&D.
Paul Tang: Thank you, Irene. Thank you, Chair, and thank you, Mr Enria and Mr Campa, for being here, and also for your fast-spoken contribution. That’s very impressive – so dense. It’s good to hear that you are very serious in addressing the risks, including the interest rate risk, and, among other things, doing the stress testing. That’s good to hear. I also hope that the deposit holders of the banks will find your story as impressive as I do, because what I find striking in this situation is that it’s mainly revolving around unsecured deposits. If you look at Silicon Valley Bank, but also Credit Suisse, they have very diversified business models, very different business models.
Whereas Silicon Valley Bank had tech companies, Credit Suisse has high wealth individuals, but they started to run because unsecured deposits are the most mobile, right? So this is what they have in common. So I was wondering what is the situation then in Europe, because I can learn that in the US about 40% of the deposits at the bank are unsecured. But I see that the guarantee in the US is higher, and the US relies less on banks. So, could it then be true to conclude that unsecured deposits in Europe are higher than, for example, in the US? Is that the situation? And do you see this as a vulnerability in the system, because we can refer to the European deposit insurance scheme (EDIS), but that’s up to €100,000? In the US there’s a guarantee up to $250,000, and even then you see bank runs appearing. So how do you see the situation? Is this a phenomenon that we need to address as well, the fact that there are unsecured deposits and the deposit holders tried to run?
Andrea Enria: Thank you very much for your question. The first point I want to make is that, even in this period of turmoil, the liability side of the European significant institutions has remained very stable. This means that, at the moment, we do have strong trust of depositors in European banks, which we think is well placed. This is also an issue of the structure of the liabilities of European banks. As I mentioned, we do have quite some reliance on uninsured deposits also in the EU. But the business models, especially the business models which have more reliance on uninsured deposits, are also more diversified, so they do not have the concentrated uninsured depositors. They have more spread, different types – corporate, financial institutions, public administrations – and they also have better diversification on the asset side. And the smaller mid-size banks in general see a higher weight of stickier retail insured deposits in their deposit base. So these are important features. Another important element is that, traditionally, the United States is a market in which capital market activities are more developed, and where money market funds have also been very aggressive in their competition for bank deposits.
There are two developments recently in the United States which have driven this volatility of deposits. The first one is that the Federal Reserve has reintroduced the supplementary leverage ratio for the largest banks, which means that banks started to avoid gathering additional deposits because that inflated their balance sheet excessively. At the same time, the Federal Reserve has provided very favourable conditions on an overnight reverse repo facility that made it very easy for money market funds to invest without counterparty credit risk at very good returns. So the money market funds have become very competitive and there has been a major acceleration of the outflows from deposits to money market funds. This is not something which at the moment we are seeing in the European Union. So, in general, there are different structures in the markets and different structures in the bank’s liabilities that I think make these types of events less likely. But in any case, I think that our institutional setup is fit for purpose. That’s my assessment at least.
José Manuel Campa: I agree with all the assessment that Andrea has made on the structure of the banking sector, and also very much with his analogy to the US situation with the money market funds. I think something that has potentially changed, and that we’re monitoring very carefully as we’re moving into this high interest rate environment, is that over the last decade of low interest rates there has been digitalisation, there’s been social media, there’s been other means by which information can be spread. And within the information that is spread, part of the experience over the last weeks is that it’s also a potential lack of confidence, a potential elasticity of deposits to move away. That’s one area of sensitivity where in the regulatory framework we have always been prudent in Europe about what the assumptions are about potential withdrawal of deposits in terms of the calculation of liquidity ratios at the corporate level, at the retail level. That’s an area in which we need to continue to be prudent.
For instance, we assumed in the stress tests that the pass-through of interest rates to deposits is 75% for corporate deposits and 50% for retail deposits, which is much higher than what the evidence suggests. But it’s another prudent measure. So I think on that part we need to be vigilant.
Irene Tinagli. Thank you very much. Now I give the floor to Stéphanie Yon-Courtin for Renew.
Stéphanie Yon-Courtin: Thank you very much Madam Chair. Thank you, Mr Enria and Mr Campa. The collapse of Silicon Valley Bank raises a number of questions about the stability of our banking system in Europe. We are aware that a number of public authorities – and you repeated this – including the ECB, have already come out to make clear statements about the resilience of our banking sector. Nevertheless, this bankruptcy will have effects on other banks in the United States. As you say, we need to stay very vigilant when it comes to any potential contagion effect when it comes to our European banks. If this contagion were to take place in the EU, to what extent are European national supervisors ready to react? How does that fit together with your roles as the European Banking Authority and the ECB in terms of responding? As for the important financial institutions, what are the points that you’re looking at? Of course, they will be similar to the ones of the medium-sized banks, but I’d be interested to hear about that. And then what about the European national supervisors’ efforts to maintain the competitiveness of certain sectors, particularly small and medium-sized companies and tech companies? The case of Silicon Valley Bank affected European tech companies as well. Is the European response sufficient to preserve these sectors?
Andrea Enria: Thank you for your question. On your first point, we know that banking institutions are, by construction, highly leveraged. They rely on and carry out transformation of liquid liabilities into more illiquid long-term assets. So, by construction, there is liquidity risk and interest rate risk in the banking sector that might also generate contagion. This is something that we know. How do we react? In general, of course, the best reaction is to prevent these being triggered in the first place, to make sure that these risks – liquidity risk and interest rate risk – are managed effectively by the banks. So that’s the first thing we look at. As I was saying before, we started very early, looking into the interest rate risk management of the banks, and into the funding plans of the banks.
The focus on funding plans is particularly important when the interest rate environment shifts, because banks were accustomed, basically, to relying on very cheap funding from central banking facilities. And now, of course, this source of funding is drying up, so they need to develop their funding plans. They need to do so conservatively, and we have been very challenging in this respect.
Let me say also that being in the banking union helps because this enables us, whenever there are banks with similar business models, to read across and do peer comparisons across banks which are facing the same types of risk, identify strengths and weaknesses and push the banks to adopt the best practices in the market.
On the effect on tech companies, we are aware – we’ve also heard – that some tech companies actually had exposures, for instance, to Silicon Valley Bank. They had deposits in Silicon Valley Bank. Should there have been a channel in the European banking sector via exposures to these tech companies? I think that the European banks have been able to easily support these tech companies in facing this liquidity strain.
Irene Tinagli: Thank you very much. Now I give the floor to Claude Gruffat for the Greens.
Claude Gruffat: Thank you, Chair. Good afternoon to both our speakers. Thank you for coming and sharing your analysis of the potential consequences of the failure of Silicon Valley Bank and the other two banks for the European financial sector. In order to avoid such a situation in Europe, we have to avoid this happening here. And we have known that since 2008. Now a couple of questions, the SVB vulnerabilities weren’t anticipated by the bank or its supervisors, largely because of the regulatory exemptions that it benefited from due to the previous President Trump’s reforms. It seems that it wasn’t subject to a stress test, and the ECB recently launched its stress tests for 2023. And it seems that the tests are less strong than some of those that are currently underway. Do you think that the scenario that’s been envisaged is sufficiently demanding, and do you plan to carry out additional tests to ensure the resilience of the European banking sector? Secondly, a lot of commentators have said that if SVB had been subjected to Basel III requirements it wouldn’t have gone under. Do you think that this event should lead us to reconsider deviations that we’re currently seeing in the transposition of Basel III agreements in Europe? And finally, what lessons should we be learning from this case and also that of Credit Suisse, where the principle of no creditor worse off was not respected because the bondholders are undergoing more debt than shareholders? Are you going to take that into consideration in your upcoming risk management system?
José Manuel Campa: On the issue of the adverse scenario for the stress test that we’re running right now, as I mentioned in my initial remarks, beyond the narrative of higher interest rates and higher spreads and the impact that those higher interest rates will have on economic growth and economic activity, on the level of interest rates themselves, I think we’re confident that the level of interest rates is sufficiently stressed to test beyond the current economic outlook for interest rates. The numbers of the baseline scenario are using the projections that the ECB had at the time of the launch of the scenario, which was at the end of last year, but in the adverse scenario it’s significantly larger than what now looks to be the outlook going forward and the swap rates are very demanding. On top of that, there’s also an increase in credit spreads on a number of other securities, particularly on fixed income securities. And, as I mentioned before, there is also a significant adjustment on the evolution of certain asset prices, particularly commercial real estate, residential real estate and equities. So I am confident that the scenario would be sufficiently severe in that aspect.
In terms of your question about deviations from Basel III, as I mentioned in my initial remarks, the EBA has been consistently saying that we want to stick to international rules, that we should remain loyal to the implementation of Basel rules within the European Union, and not just loyal in its content, but also in its timing. So I think it’s important that we go forward with a timely implementation, as close as possible to the Basel agreement. We stated in the past our concerns with some of the deviations, and particularly with the possibility that some transitional arrangements may become more temporary. So I think, in that sense, the current episode and, as you mentioned, the fact that the rules are applied to a large number of banks have also shown the value that that has in terms of strength and robustness.
A last point regarding the issue of “no creditor worse off”, the situation of Credit Suisse. As was explained by Andrea and in our joint communication with the Single Resolution Board yesterday, we believe that, under the current regulatory regime in Europe, Additional Tier 1 (AT1) should bear losses after Common Equity Tier 1 (CET1).
Andrea Enria: I need to be careful here because I don’t want to say that this happened in the case of the specific banks we are talking about, but there could sometimes be the temptation to look favourably on banks and financial institutions which are investing, particularly in new technologies, in new instruments and experimenting with these sort of new, innovative instruments. And there could be the temptation to say “okay, to let these models flourish, let’s maybe make the regulatory or supervisory requirements for these banks a little bit less demanding”. I think I’m very supportive. I think that we need to let our banks also invest in new technologies. They need to do so. I want to have new fintech companies becoming banks and maybe challenging the incumbents. But if you’re a bank, you need to be regulated and supervised as a bank and you need to be strict in the application of the requirements. And I think this is an important principle that we need to keep in our attitude towards supervision going forward.
Irene Tinagli: Thank you. Thank you very much. Now I give the floor to Gunnar Beck for ID.
Gunnar Beck: Again, thank you very much, Mr Campa, Mr Enria. I’ve got two questions to both of you. First of all, SVB failed and it was one of the most important lenders to tech starters. Now, through Next Generation EU (NGEU), billions are being invested in tech companies as a future market. But what happens if the tech bubble bursts? SVB does not seem to have been one of the most profitable and successful banks in the world. So how do the ECB and the EBA model the kind of risks of the bursting of a technology bubble? Secondly, SVB and Credit Suisse were run by political correctness and incompetence. The SVB’s Chief Administrative Officer, Joseph Gentile, was CFO at Lehman Brothers until it went down in 2008. He was also involved in Arthur Andersen, which is the accounting firm that was wound up after the Enron crisis. The CEO rushed off in his private jet to Hawaii after having sold off all of his SVB shares just before the bank went under. So we urgently need a discussion on the impunity of these “banksters”, so that this does not repeat itself in Europe. What have you done specifically since the financial crisis and the eurozone crisis to ensure that our savers, pensioners and investors are safe from incompetent managers and ensure that they are ultimately accountable for their actions?
José Manuel Campa: I think part of the regulatory framework that has been built over the last decade has made a fair amount of progress in trying to enhance both the methodologies that we have and the regulation that we have on governance, on fit and proper assessments, on making sure that the members of the management body and the executive body are assessed properly. There are challenges that are still there, and I think that, as we go through the revision of the Capital Requirements Directive (CRD), we might want to have that process a little bit. But, beyond that, to also align risk objectives in a better manner and go with compensation of managers going for assessments. So now we have compensation requirements in the European Union that put limits on the rate of fixed remuneration versus variable remuneration, on the amount of variable remuneration that should be received, also linked to, or aligned with, shareholder incentives, maybe linked to stock performance, on delayed payment of some of the variable remuneration over a number of years, depending on the seniority of the institutions, and on the possibility of having clawbacks or maluses to be applied in situations in which ex post there are bad outcomes for the institutions that they manage, so that for some of that delayed remuneration there can be clawbacks.
Those are mechanisms that are in place, and actually have already been imposed in some cases in the European Union in the past. When I think, for instance, of the resolution of Popular, I think there was some clawback of some of the compensation that was taken there. So we do have some mechanisms that, hopefully, will help align incentives and enhance better governance of the institutions.
Andrea Enria: You mentioned the tech bubble. I don’t know whether we have a tech bubble, but, in general, the main contribution that we can make to any development of bubbles is to make sure that the credit risk controls are in the proper place at the banks and that banks do not inflate these types of bubbles by relaxing lending standards for certain types of counterparties. And they can tell you that in the last years in particular, starting during the pandemic, we’ve been very alert to look at the sectors that were particularly risky, perhaps because they were hit by the pandemic or because they were hit by the energy shock or any other type of event, and we have done quite granular and in-depth analysis of the risk controls of the banks vis-à-vis these exposures.
On governance, as Manuel said already, how can we be safe from incompetent managers? The most important protection, the safeguard, that we have is the fit and proper regime, and this is the vetting by the supervisor of the professional capacity, the skills, the knowledge, but also the ethical compass of bankers. You have the banking package on your table. We have strongly argued in favour of a strong and fully harmonised framework for fit and proper that could enable supervisors in all the Member States, in the whole banking union, to conduct demanding ex ante assessments of the managers and members of the board and ensure competence and professional skills across the board, also with diversity of professional regimes. We need to have robust challenge on the board. This year we are conducting a review of board effectiveness, which means the ability of the board to really challenge the management and have checks and balances within the work of the banks. I think that’s the most important safeguard.
Irene Tinagli: Okay, thank you very much. Now I give the floor to Michiel Hoogeveen for ECR.
Michiel Hoogeveen: Thank you Chair and thank you, Mr Enria and Mr Campa, for coming to the European Parliament. Things have moved on very quickly from the failure of Silicon Valley Bank. I initially thought I would ask you some questions specific to the failure of SVB, but then we were all concerned about Credit Suisse last week and over the weekend. While SVB and Credit Suisse are not directly compared or related to each other, I do think we see some overlap. The key reasons why both ultimately failed includes three main reasons, and the first is the failure on the boards of these companies: incompetent and failed leadership, where SVB was guessing too long on these low interest rates, while there were clear indications that these interest rates were going to rise, and obviously Credit Suisse was involved in multiple scandals. And the second reason is multiple missions and failures by the regulators. SVB was already on the list of many analysts as a potential risk. And Credit Suisse was already seen for a long time as a car crash moving in slow motion. And the third item I would like to address, and I think this is also very important to address at this hearing, is the failure at the top of our own policymakers and public institutions. We’ve continued to pursue free money and reckless spending policies for more than a decade. That is the root cause for the 40-year high inflation we’re facing right now, and the sharpest rise in interest rates we have seen in more than 30 years. And we know that tackling inflation seldom goes with a soft landing. So, in a matter of a couple of short weeks, we have gone from a US bank catering to start-ups to a threat of a potential financial crisis in the EU. And my question is then relating to that potential crisis. My question to you is, given the information available today, what risks do you imagine the failure of SVB and the acquisition of Credit Suisse will have for the European housing market? How will this news affect European citizens’ ability to obtain loans? And what about the willingness of banks to open credit lines to businesses and consumers? Do you foresee potential underlying inflation caused by this crisis hurting potential homeowners in the short or medium term?
José Manuel Campa: I think that our assessment so far – I know it has been two weeks since the turmoil of the last two, but in terms of what the impact has been on lending activity and availability of credit across the board in the European Union – is that we have not seen really at this stage any significant concerns. So when you’re concerned about what the impact of this is in terms of lending to households or to small and medium-sized enterprises (SMEs), I would say that, at this stage, maybe it’s too early to judge, but I would be prudent on saying that there is any evidence right now that there is any impact. On that aspect, it is fair to say that within our risk assessment when we think about the European Union and credit markets right now, one of the areas of risk concern as we’re going forward and we have been monitoring is real estate markets overall, mortgage markets, particularly commercial real estate, and household real estate in some parts of the Union. But in terms of additional provision or a potential credit crunch – and, here, obviously, the supervisor has much more intense up-to-date daily information – my impression is that there’s no significant impact on credit provision.
Andrea Enria: In terms of the tightening of monetary policy, what we are seeing is that developments so far are according to the expectations. As the tightening started, we saw a continued growth of loans until, basically, the third quarter of last year. Then in the fourth quarter the ECB bank lending survey started highlighting a tightening of lending standards. So banks were expecting to tighten lending standards, apply higher interest rates to customers and be more selective, which is what the transmission channel of monetary policy is about. At the moment, this is proceeding in an orderly way. As José Manuel said, in terms of the impact on the housing market, we’ve been conducting already last year a targeted review and then on-site inspection campaigns on exposures to commercial real estate, identifying where there were problems in terms of valuation of the collateral, in terms of origination standards, in terms of credit risk management, and we are now repeating the same campaign of on-site inspections, the same targeted review, on residential real estate. It is clear that when you are moving from a low interest rate environment to higher interest rates, these are markets that could come under greater pressure. So you need to make sure that banks have their credit risk monitoring in the right place, that when they see signs of deterioration on the side of the customers, they pre-emptively get in touch with the customers, trying to restructure the loan, trying to address the problems as early as possible. This is also the lesson of the last crisis and we are trying to apply all the best practices that we have identified in order to closely follow the development of credit risk in these markets.
Irene Tinagli: Now I give the floor to Chris MacManus for the Left.
Chris MacManus: Thank you Chair, and I suppose an awful lot of this talk about bank collapses worries us all. And it does really concern many people who remember how talk about banks far, far away being in a difficulty turned into very real and brutal austerity for millions of people. And, of course, we all hope that what we’re dealing with here is to some extent an isolated incident, but we do need to be vigilant. I recently became aware of what I would call, in hindsight now, a particularly badly timed report that was commissioned by the European Banking Federation (EBF) from earlier this year. In their forward, the EBF states, when they were looking at why US banks are so much more profitable, and I quote, “the regulatory and supervisory pressure EU banks are exposed to play important roles” and “financial regulation has a direct impact on the banking sector’s ability to support the real economy”. So it was all basically saying that regulation was bad. Now, my question to our two contributors, or rather an invite to comment is, is it their opinion that the Eurosystem and the EBA should prioritise financial stability and protection of the taxpayer above any other political agenda? And would they agree that to even suggest rolling back regulations should be given quite short shrift and that any loosening of regulation most certainly should not be on the agenda? And a second query, not immediately related. SVB was a lender to many tech companies and it was also connected to the world of crypto-assets. And I’d ask what analysis our contributors have got or are considering carrying out into how vulnerable European banks might be to any further crypto collapses, and what would be your advice to any EU bank tempted to invest in such assets?
José Manuel Campa: On the inter-relationship that some of the failures, particularly in the United States, have had with the crypto markets, I think that’s an interesting part that we need to assess, and assess carefully, because it is true that, because of their specialisation with high-tech firms, there was a large exposure of some of these banks to the crypto industry. I think there are lessons there to be learned, and, fortunately, in Europe we have the Markets in Crypto-Assets (MiCA) Regulation that we are now in the process of starting to implement. Once it has been approved by the co-legislators, I hope we will implement that properly. We are assessing precisely what is the inter-relationship of these, particularly when we think about some of these crypto-assets as being payment devices, similar to e-money institutions, and what are the proper regulations that should be considered for them in terms of the reserve requirements, whether those reserve requirements should be put forward, and where’s the prudential supervision? We’re in the early stages of developing the relative technical standard jointly with the European Securities and Markets Authority (ESMA) in this process. I think there’s actually some lessons that we need to assess going forward. It’s an important aspect.
As I said, I think we are in a better starting position than the United States, because we have the MiCA Regulation in place, and, overall, I think that’s a better position. I should note, in terms of the second part of your question, what should be the attitude that we have, or the approach that we have, to banks holding this type of assets? Our approach so far has always been that these are assets that are difficult to understand in terms of their underlying business model, for many of them, that they are highly volatile, so the banks should be very prudent. We recommended not to hold them and at the same time also not to market them to potential customers in their advisory work. Basel has moved forward with some principles and standards of how to include some of these crypto-assets in the banks’ balance sheet and prudential standards. There was some agreement that was reached in December, and, as we go forward, we need to distinguish between two types of crypto-assets: crypto-assets that are backed by good assets, and which we broadly define as stable currencies or stable crypto-assets, and the other ones that are not backed up and that are more speculative.
In the second case, the treatment overall should be, basically, a deduction from capital if banks want to invest on those assets. In the first case, depending on the characteristics of the assets and qualities, the treatment may be somewhat more favourable, but that’s the progress that has been made in that part.
Andrea Enria: If I may, a couple of words on the European Banking Federation report.
I would like to take more time, but it is interesting because basically what the European Banking Federation report did was to compare the capital ratios of European banks and US banks, and the conclusion was that we are tougher than our US colleagues. And this was basically a competitive disadvantage for our banks. So that was in a nutshell the main point.
When I first read it, I thought, this doesn’t resonate with me. We meet frequently with our colleagues at the Federal Reserve and we compare the capital ratios, the treatment of our large banks, and my perception has always been that we are in the same ballpark in terms of capital ratios, the United Kingdom being a bit higher because they rely more on the countercyclical macroprudential buffers than we do.
Then digging a bit deeper into the analysis, you understand that they take all the euro area significant institutions, so 113 banks right now, and a larger sample of US banks. So, while indeed on the global systemically important banks (G-SIBs) we are basically in the same ballpark as our US colleagues, or maybe even a bit lighter than our US colleagues, it is true that we are much more demanding in terms of capital for banks of smaller size. So the United States has a very dichotomic approach. They were very demanding in terms of buffers, especially through the stress tests, for the largest banks, but much less so for the smaller banks. To some extent, what we’ve been discussing today is also reflecting this bifurcated approach that they adopted.
On the other points in the report, that we are excessively heavy-handed as a supervisor, I tend to disagree with these comments. But, of course, we also have to take some positives, and it might be true that, in terms of procedures, we can be a bit lighter sometimes. We are also thinking of how to become lighter on procedures, but definitely not on standards, and not on the intrusiveness, on the rigour, of our supervision. On these, I don’t think that there is anything that we need to change.
Irene Tinagli: Thank you very much. I’ll give the floor to Isabel Benjumea for the EPP.
Isabel Benjumea: Thank you to Mr Campa, Mr Enria for being here today. As I said previously, on 10 March we saw the biggest banking failure since the global financial crisis in the United States. Now, fortunately, the repercussions for our markets have not been similar to those that we saw with Lehman Brothers. Nonetheless, the intangible effect that it might have on our continent is that we have finally realised that the banking union hasn’t been completed 11 years after it was started. Only two out of the three pillars would be ready to act if something similar were to happen to what happened in America. If there were to be a parallel banking crisis, as well as national deposit systems, that would lead to stumbling blocks for Member States. And so I’d like to know, what more do we need to happen before we can make progress? Are there any technical issues that aren’t allowing us to complete the banking union beyond the political issues that we know? Is it going to take a crisis for us to finally solve this? Finally, European SMEs are ultimately more dependent on the banking system than the bigger companies. 70% of SMEs are dependent on their banking funds. Unlike 40% in America, where they’re much less dependent. The European SMEs have much worse conditions for their banking financing as well. So they have a certain number of tools that they need to be able to use. The Silicon Valley Bank case shows us that we have to ensure that our SMEs are no longer so dependent on a single source of financing. So I’d like to ask you what are the perspectives of the European Banking Authority in this area, and what can we do to ensure diversification of financing for our businesses from the perspective of your institution?
José Manuel Campa: I think that I share many of the comments that were made at the beginning, and I think I mentioned that in part of my points in the initial remarks. I think that we should remind ourselves that we have an incomplete banking union. We should remind ourselves that that incomplete banking union has implications in the short term for the functioning of the Single Market that is not integrated. The result of that leads to fragmentation. That fragmentation also leads to limits in risk sharing, and also to difficulties, obviously, in facilitating growth, potentially, in the medium and long term. We have put forward a number of suggestions in the area that the banking union should continue. I think it’s not just the banking union. As I said in my initial remarks, I think it is the complementarity of the capital markets union, as you mentioned as well in your question, regarding the availability of different alternative sources of funding for small and medium-sized enterprises, and for equity investments going forward, is an important aspect. I can only encourage that we continue to work in that direction.
Andrea Enria: Let me add one point to what José Manuel said. We do manage crises and we can continue managing crises without EDIS, without a complete banking union. So we don’t have a dysfunctional regime. The point is that the way in which we do that is very complicated. Every time, and this has been the experience in recent cases, as in Sberbank, or RCB in Cyprus, not a liquidation case, but still an exit from the market, we are confronted with different features of the national regime. So, if you compare the banking union with the United States, we do have the same amount of funds. If you take together the Single Resolution Fund and the national deposit guarantee schemes, we are in the same ballpark as the FDIC in the United States. But it’s very difficult for us to deploy this funding to actually ensure the smooth management of a crisis because we have, in any case, different regimes at the national level, different engagement of the deposit guarantee schemes. So what is crucial in a crisis is the funding, and having a more integrated system would make our life much easier and, I dare say, also the life of savers, depositors and citizens.
Irene Tinagli: Thank you very much. Now I give the floor to Marek Belka for S&D.
Marek Belka: High inflation, which is, in my opinion, increasingly home grown, requires higher interest rates, and higher interest rates have consequences for financial stability, something that we have overlooked so far, slightly at least. So, the question first to José Manuel Campa. The recent experience may prompt discussion about our regulatory regime. And what I have in mind is: number one, the eternal problem, the overdependence of commercial banks in Europe on domestic sovereign papers and, second, which surfaced in one of the cases in America, it’s the maturity mismatch between liabilities and assets. Do we need some kind of deepened discussion on this, maybe a strengthening of the regulatory regime, although I hesitate to propose anything like this? So, this was for José Manuel Campa.
Two short questions for Andrea Enria. Do the recent experience and the consequences of increasing interest rates have any impact on the functioning of the Transmission Protection Instrument (TPI)? It may be a surprising link, but, now, we may be forced to take into account financial stability risks in assessing euro member countries, which makes the whole process even more complicated. And the third question, also for Andrea Enria: do you see potential spillover effects of the rate hikes in the Eurozone for non-euro countries?
José Manuel Campa: So, on the question that you addressed to me on the issues, particularly on the high interest rate environment, and whether we need an enhancement of the regulatory framework, particularly in the area of interest rate risk in the banking book, and the whole bias of the sovereign exposures. Obviously, this is part of a long discussion, but on the interest rate risk in the banking book, as I said in the initial remarks – we’ve been monitoring as well, or we’ve been discussing some of the responses – this has been an area of enhanced monitoring. And we put forward a package of regulatory, of technical standards and guidelines in October that takes into account the supervisory outlier test, that takes into account prudent regulations in terms of what are the assumptions that we make about deposit outflow, like I mentioned earlier, and other aspects of the management of interest rate risk in the banking book for the banks. On top of that, we put forward a quantitative impact assessment. At the beginning of this year we had done an impact assessment before we put forward technical standards to assess the value, but, given that the interest rates are rising faster and maybe higher than expected, we had to do a new impact assessment, and we’re in the middle of doing that right now.
On the aspect of the sovereign holdings, I think that this, obviously, has been continuously an area of concern. Our view has always been that it’s better to have these portfolios managed according to the implicit risk that they have, not at face value. And beyond that, there are also probably some concentration concerns, concentration risks. It’s a concern, and some concentration charges and limits may be a good way forward, because in the end, when we think particularly about the banking union, it’s not the same to have a portfolio of a given size with sovereign bonds of a single member country and of all 27 member countries. The interest rate risk diversification of that is probably the same, because they’re all subject to the same interest rates and monetary policy, which is the ECB, but the diversification aspect of that portfolio is quite different, depending on whether it’s on one single national member state versus a diversified portfolio. So I think that encouraging that diversification would also be good for the banking union.
Andrea Enria: Well, of course, it is difficult for me to reply on TPI, which concerns the monetary policy arm of the ECB. What I noticed is that, in this very fast-paced increase of interest rates that we have had the since July last year, the spreads between different countries, between different sovereigns, have moved very little, even in the turmoil of recent days. This for me is a blessing because it enables me to focus on the interest rate risk of banks irrespective of the flag that they have on their headquarters, so, in a sense, to look into their internal risk controls more than at the more general macro environment. So I hope that this remains the case.
The point I want to make is that banks use government securities predominantly as high-quality liquid assets for their liquidity coverage ratio, as a liquidity buffer to be used in case of stress.
This liquidity buffer is correctly accounted for at market value, so you need to look at that market value. But banks might still have these assets in accounting books held at amortised cost, which means that if they actually sell them, they will need to take a capital hit if they are undervalued, if they lost value due to an increase in interest rates. So that’s a little bit of an issue as I see it. I’ve been arguing for a long time that, ideally, one should have, and this may be for you to consider, legislation that says that if you want to record something for high-quality liquid assets for the liquidity buffers, you need to be ready to sell this asset in the market any time you have liquidity stress, so, in my view, it should come from accounting books that are marked to market. And that, in my view, would be an important improvement in the framework. On the spillover effects between the Eurozone and non-Eurozone, I would say I don’t notice anything in particular. Unfortunately, to be honest, we have a banking market in the banking union which is still a bit segmented across national lines. So we don’t have a lot of pooling of liquidity or massive management across the whole banking union. So these dynamics remain a bit national. You see countries in which you have a huge spike in interest rates. You see a huge increase in interest margins and profitability. You would expect that, in a banking union, you would see dynamics by means of which maybe other banks start entering that market and there is more competition. These are actually dynamics that, unfortunately, we do not see. So, there is very much national dynamics, but I don’t see spillover effects. Of course, there could be some spillovers in terms of risk if the risk management is not done properly. But the interest rate risk in cross-border groups is deeply integrated, so I don’t see a problem from that side.
Irene Tinagli: Okay. Now, we have only five minutes left and I have three requests for catch the eye. So I suggest we collect the three questions and then I give you the floor for the answers otherwise we will not make it and I would like to give the opportunity to all three requests.
Luděk Niedermayer for the EPP: Thank you very much, Irene. And thanks to our guests for the very good discussion. I’m going back to interest rate risk, because Silicon Valley Bank was a kind of classical banking failure from old times, suffering with interest rate risk and refinancing risk. I’m grateful that you are talking about using stress tests quite a lot. I guess it’s a very helpful tool. Obviously, refinancing risk is more complicated. But, going to my question, I’m referring to what Marek Belka was talking about. Due to a really substantial increase in long-term rates, somewhere in the financial system there is substantial loss of mark-to-market value on long bonds because there are huge amounts of long bonds or fixed rate, long-term assets. So I wonder if we are really confident that we know how much is in the banking sector and how much is elsewhere, because, and I very much appreciate what Mr Enria said a few minutes ago, these are some of the concerns. There is a huge amount of mark-to-market losses, because the yield went up around 200 or, in the case of the United States, 300 basis points. So, if you multiply this by the duration of long-term bonds, these are substantial sums of money. So my question is, do we have this risk under control?
Stasys Jakeliūnas for the Greens: Thank you, Chair. Let me go back to the problem. I see it as a problem. Variable interest rates, mortgage rates specifically. We talked about that with Mr Campa last year, I think, but in these times of stagflationary pressures and uncertainties related to the war in Ukraine, there could be developments in the markets. Collateral values, real estate values in some segments of the Union could be falling. Would you see, especially since Mr Enria is here, that this could be a problem not only for the mortgage takers but also for the banks, as was the case I think with the subprime mortgages back in the United States in the previous crisis? So, there is this asymmetry of prudential supervision, which is that there is the rulebook, the Single Supervisory Mechanism, etc., but there is nothing on the European level as far as business conduct supervision and, especially, consumer protection and mortgages are concerned. Would you think that this would require a more regulatory approach from us, from you, from others, that there will be no interest rate transfer to mortgage takers, because I think this is a problem, remains a problem, and could materialise in some problems for the banks as well.
Costas Mavrides for S&D: Thank you, Madam Chair. I find this discussion that we had today very interesting for one more reason, the fact that it’s taking place with some relief, but that is something on which I want to get your response. Completion of the banking union, and EDIS. Taking into consideration the fact that the decision of the US regulatory authorities to step in and safeguard all deposits, not only those covered by the FDIC, but all deposits, including the non-guaranteed deposits, which, by the way, are more than USD 250,000, my question is very simple: are there any lessons to be drawn for us in the Eurozone regarding the deposit system? And my second question: how would you respond to a Cypriot depositor who in 2013, unfortunately, suffered through a very vicious deposit haircut? Does the size of the banking union matter after all? Thank you, and I would expect your frank response.
Irene Tinagli: So thank you. Before giving back the floor to our speakers, let me remind you that we have 10 minutes extra interpretation, so we can allow you to conclude and have all the answers and I want to thank the interpreters for their availability.
José Manuel Campa: Mr Niedermayer, you are absolutely right that the way – and Andrea made a reference to this as well – the accounting is being done of the positions of fixed income portfolios in general in the banks is different depending on the business model, or the purpose of that. It’s also true that the banks need to manage interest rate risk in the books, and one way in which they manage interest rate risks is by acquiring fixed income securities. So it’s important to look at the assessment overall of the sensitivity of the banks’ business model, not just of their positions, to the interest rate movement, and that’s why there is so much that has been done on interest rate risk in the banking book. I think, and what is implied for liquidity, for banks in general, for many of the assets that they hold to maturity, their purpose is precisely to do the interest rate risk management, and to the extent that they will not need it for a liquidity stress it’s likely to remain in the books. So it’s likely to be good until the payments are due on those securities, and the mark-to-market performance is less relevant. But, nevertheless, it’s an area which we, and the supervisors as well, monitor very closely.
Mr Jakeliūnas, the area of consumer protection is an area which we can enhance overall in the European Union. We’re also doing a peer review on a particular area of consumer protection, which is how the consumer protection authorities assess the behaviour, the treatment, of customers on their arrears, and what action banks are taking in the different countries. We’ll have the outcome of that in the next months. I’ll be happy to share that with you, and I hope that’s a step forward. Our mandate in general concerning consumer protection, obviously, as the EBA, is much weaker than the mandate that we have on prudential purposes.
On the last question, as we discussed at the beginning, on the issue that the actions taken by the US authorities are possible within their tools, it’s an issue that raises significant concerns of moral hazard going forward. But at the same time it’s an issue that I think is less relevant for many business models in the European Union because of the extreme situation of the business model of the bank, where there was 94% of deposits that was unsecured. Such an extreme is not present – at least not across the significant institutions – in the current universe of European banks, so it’s unlikely that a similar situation would take place.
Andrea Enria: On the point of mark-to-market value, I said what I think on the liquidity buffers. Let me say also that in general I don’t like the term “unrealised losses” because it gives the impression that something is hidden under the carpet and is not visible. Actually banks are requested to do Pillar III disclosures. So, if you go to their books, you can see exactly how much the market valuations of these assets would be and how much the impact would be on their capital position. So this is something that is in the open. And indeed, if you take our banks, many of them have their liquidity buffer, which is composed more than 50% of cash and deposits/reserves at the central bank. In a sense, they could go a long way before having to realise these losses. And if they keep these assets on their balance sheets until maturity, there wouldn’t be any loss at the end of the day. So, we shouldn’t overemphasise the issue that there are huge market losses hidden in the bank’s balance sheets. This is not the case. First of all, they’re not hidden, and second the composition of the buffers is such that they can go quite a long way before having to sell assets and realise these losses. But still, I think you have a point in the sense that, as I mentioned before, we should make sure that at least what we asked them to hold to deal with market stress needs to be carried at market value, because they need to be ready to sell it at any moment without getting a capital hit.
On the point of mortgages and conduct, as José Manuel already replied, let me reiterate that we are conducting a specific thematic review on residential real estate, on mortgages, and again looking at the banks’ practices, their risk management. We don’t look at the conduct, but indeed we also see if there is improper refinancing or types of behaviour that are not compatible with sound risk management practices, and we would definitely raise these issues with our banks.
On the point of EDIS and the safeguard of deposits, again, as José Manuel was also saying, I think that, first of all, the best safeguard for depositors is to make sure that they have no reason to run, so that we don’t have business models which are extremely exposed to some risks.
And, in general, I don’t think that we should change the framework that we have right now. I know that the haircuts applied to Cypriot depositors in the past have been particularly harmful. We still see today, supervising Cypriot banks, how much inducing volatility in the potential behaviour of depositors can destabilise the banking sector. So I think that, when these tools are applied, you also need to always be very wary and careful about the consequences that these could cause in future, so that’s a very delicate topic and we are very much aware of this issue.
Irene Tinagli: Thank you very much. Now we have concluded our public hearing. I really want to thank all the participants, and in particular our guest speakers, for their availability, their frankness, and I think this is also an important signal that in situations like these, Parliament is the house also of transparency, and we let everybody know and we inform the citizens. Thank you very much. Have a nice evening.