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, 7 November 2023

As this is my last appearance before you as Chair of the ECB’s Supervisory Board, I would like to thank you for your close and fruitful cooperation during my five years in office − and indeed even before then, during my previous role at the European Banking Authority, when I also had the honour of working with this committee. Together we have weathered several crises and have strengthened the prudential regulation and supervision of banks, making the banking sector more resilient to risks and better equipped to support European households and firms. However, as our economies and financial markets continue to be tested by new developments, I will today outline the main risks and trends currently facing European banks rather than dwell on past achievements.

The state of the European banking sector

European banks have proven resilient and have been able to strengthen their balance sheets, notwithstanding the many abrupt shocks to the macroeconomic environment we have witnessed in recent years. In the second quarter of 2023, the Common Equity Tier 1 capital ratio of the banks under our direct supervision stood at 15.7%, while their leverage ratio was 5.4%. Despite the gradual reimbursement of extraordinary ECB financing, banks’ liquidity situation remained strong, with an average liquidity coverage ratio of 158%, well above regulatory requirements and pre-pandemic levels. In addition, banks improved their profitability, with their annualised return on equity reaching 10% in the first half of 2023 – a record level since the start of the banking union, but still below the cost of equity, which remains higher than 13%. Banks’ asset quality has also been steadily improving, as shown by the non-performing loan (NPL) ratio standing at 1.8% in the second quarter of 2023, slightly below its level one year earlier.

The results of the 2023 stress test also confirmed that the banking sector could withstand a very severe economic downturn. The adverse scenario for this exercise was much harsher than in previous stress tests, and included sharp interest rate hikes, high inflation and a significant decline in asset prices. In addition, it could be established on the basis of an ad hoc data collection that unrealised losses in the sector’s securities portfolios, stemming from increasing interest rates, are contained. Even under an adverse scenario, these unrealised losses would remain manageable.

European banking supervision is striving to become more risk-focused, leaner in its processes, and better able to adapt to rapidly changing circumstances. During the pandemic, we concentrated on risk control systems, capital planning and profit distribution plans. Following the Russian invasion of Ukraine, we shifted our focus towards sectoral analysis and risk assessments to evaluate risks linked to banks’ exposures to Russian counterparties, counterparty credit risk in a context of heightened financial markets volatility, and cybersecurity as well as energy price shocks. And well ahead of the normalisation of monetary policy and the turmoil of spring 2023, we had already started to zoom in on interest rate risk, the economic value of banks’ balance sheets and funding and liquidity risks − all while keeping an eye on increasing arrears and focusing on sectors that are particularly sensitive to higher interest rates.

European banking supervision work and priorities

To ensure that our banking sector remains resilient in an increasingly unstable external environment marked by macro-financial and geopolitical shocks, we will need to stay alert. Furthermore, in light of the lessons from the spring turmoil and the recommendations of an independent group of international experts which reviewed our supervisory processes, we must strive to become more effective in ensuring that banks remediate the weaknesses identified in our supervisory findings.

European banking supervision is urging banks to address shortcomings in their credit risk management. The exposures to the real estate sector deserve particular scrutiny. The current higher interest rate environment could put further downward pressure on office and house prices, making it harder for commercial property owners and households to service their debt. Banks should account for these risks in their provisioning practices and capital planning.

In addition, we are paying close attention to how banks structure their funding. This is particularly important given the more volatile behaviour of uninsured depositors seen during the banking sector turmoil in March 2023. Social media, digitalisation and attractive short-term investment instruments offered by non-bank competitors may also accelerate retail depositors’ reactions to price signals and market rumours. In response to these trends, we are closely scrutinising the funding plans and strategies of selected significant banks.

The management of climate-related and environmental (C&E) risks is also becoming ever more urgent for banks. We are conducting various on-site inspections and reviews, including targeted deep dives to follow up on shortcomings identified in the 2022 climate risk stress test and thematic review. Our supervisors are already including bank-specific climate and environmental findings in the Supervisory Review and Evaluation Process and have imposed binding qualitative requirements on a number of banks. We expect banks to be fully aligned with our supervisory expectations on C&E risks by the end of 2024, having set intermediate deadlines and required banks to reach specific milestones. Not addressing them will trigger an escalation to enforcement measures.

Furthermore, banks need to better address cyber risk by improving their operational frameworks. To check where banks stand in this regard, we will run a cyber resilience stress test for all supervised banks in 2024. The test will be the first of its kind and will focus on how banks’ response and recovery mechanisms would cope in the event of a severe but plausible cyberattack. Supervisors will scrutinise the results for any potential weaknesses and deficiencies and ensure that banks remediate them in order to withstand real attacks.

The market turmoil in both the United States and Switzerland in March 2023 has also sharpened the focus on banks’ internal governance. Each of the affected banks clearly had problems in terms of governance. As banks’ capacity to withstand risks hinges on strong internal governance, we will perform targeted reviews of the effectiveness of banks’ management bodies as well as targeted on-site inspections, and we will update our public supervisory expectations regarding banks’ governance arrangements and risk management.

The need for a robust regulatory framework

Turning to the regulatory framework, I welcome the political agreement on the banking package (Capital Requirements Regulation and Directive). The agreement should be fully finalised without delay. Swiftly implementing the internationally agreed standards will give the banking sector the legal and regulatory certainty it requires. Any deviations from these standards should be regularly reviewed to assess their impact and consider whether they could be phased out.

We hope to see swift progress on the reform of the crisis management and deposit insurance (CMDI) framework. Our existing crisis management framework has worked effectively in a number of cases. Indeed, Banco Popular and Sberbank banka were both resolved without the need for public funds. However, the framework may not be fully able to provide optimal solutions for mid-sized banks. The CMDI package offers an opportunity to achieve targeted and substantial improvements without changing the current institutional set-up, while making effective use of crisis management resources. I urge you to swiftly adopt this important package. For the ECB, it is crucial for policymakers to have an adequate set of crisis management tools, along with adequate funding for deploying them.

And of course, looking beyond my tenure and into the next legislative term, more work remains to be done, in particular on completing a fully integrated banking union. As the introduction of a European deposit insurance scheme has come to a political standstill, a dangerous fault line remains in our institutional framework. To my concern, most of those involved in the debate still fail to see that a more integrated banking sector would be a more resilient one, which would rely less, not more, on any collective safety nets.

Let me conclude by expressing my appreciation for your unwavering commitment and contributions to enhancing our legislative framework.

Thank you very much for your attention. I now look forward to your questions.