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Kerstin af Jochnick
Board Member

The single supervisor ten years on: experience and way forward

Speech by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, at the LBBW Fixed Income Forum

Frankfurt, 13 March 2024


It is a pleasure to be here today and I would like to thank the organisers for their kind invitation. In my speech today I will outline the risks we see for the banking sector and the supervisory actions we intend to take to keep those risks in check. I will touch on a number of issues that will be tackled in the individual sessions of today’s conference, including the macroeconomic outlook, sustainable and green finance, and the digital transformation. So I hope that my remarks set the stage for your discussions later on.

The overall message I would like to convey to you is both optimistic and cautious.

The optimistic part is that the banking sector remains resilient overall, as proven in recent years by its ability to withstand large and sudden external shocks. This resilience has been built over time, and, although not the only factor, the active role played by the single supervisor should be recognised. Thus far, European banking supervision is fulfilling the promise on which it was established ten years ago, which is to ensure that banks remain safe and sound.

However, while banks are generally well positioned to deal with external shocks thanks to solid capital and liquidity buffers for the system as a whole, we also know that they will continue to face headwinds. The current environment of high interest rates and sluggish economic growth means that banks need to pay close attention to credit risk, particularly in vulnerable and leveraged sectors. The fact that some banks still show weaknesses in risk controls and internal governance may compound such vulnerabilities by complicating risk identification and mitigation. Shortcomings in these areas need to be remedied in a timely manner. And while banks grapple with these near-term risks, they need to continue to prepare for challenges related to the green and digital transitions, which are bound to affect their business models further down the road.

This is where the cautious element of my message comes in. While we can be pleased with how the banking system has evolved in recent years, we should also keep in mind that past success is not a reliable predictor of future performance. As we mark the tenth anniversary of the banking union, we should celebrate its achievements but also recognise that it is still incomplete. The fact that single supervisory and resolution mechanisms have been established in a short amount of time has certainly made our banking system stronger. But in order to cement its resilience even further, we need to create a truly integrated banking market, fine-tune our crisis management framework and address the gaps in our macroprudential framework.

Let me now elaborate on this message. I will first look at the health of the banking sector at the moment.

Resilient banks amid a stronger regulatory framework

Standard indicators for our supervised banks show that, in aggregate terms, they are now in much better shape than when they first came under ECB supervision in November 2014. The weighted average Common Equity Tier 1 ratio for banks supervised by the ECB increased by 4.7 percentage points between the fourth quarter of 2014 and the third quarter of 2023, while their liquidity coverage ratio rose by almost 29 percentage points, to 159%. Over the same period, their non-performing loan (NPL) ratio dropped by 6.1 percentage points, to 1.9% in the third quarter of 2023, the latest quarter for which data are available. Profitability, which had long been the Achilles heel of the European banking sector, has also been on the mend recently, with bank profits boosted by the turning of the interest rate cycle. Banks’ return on equity stood at 10% in the third quarter of 2023, which was more than 4 percentage points higher than in the fourth quarter of 2014.

The fact that this improvement has taken place in spite of the large negative shocks that have hit the banking sector in recent years, including a global pandemic and the fallout from Russia’s war in Ukraine, makes it all the more notable.

In my view, the resilience of the banking sector in recent years has been due to two main factors.

First, ECB Banking Supervision deserves credit for raising the common standard for the entire system. Various initiatives were instrumental in restoring confidence in the banking sector, including progressively lifting the capital bar faced by banks, focusing on legacy non-performing asset reduction and reviewing banks’ internal models. It is also important to recognise that these higher supervisory standards were made possible by overhauling the Basel framework after the great financial crisis. This is why I believe that the revised framework has proven its worth – and also why it is crucial that the remaining Basel III standards are fully integrated into European law.

Second, when confronted with challenges on an unprecedented scale, both European and national policymakers have shown that they can act quickly and work together to respond appropriately. Banks have also indirectly benefited from the support that was provided to the real economy, as it shielded their balance sheets from the full impact of adverse shocks to growth.

Managing risks in leveraged sectors

So the good news is that, in general, banks are well positioned to deal with external shocks when they materialise. This conclusion is also borne out by the results of the stress test conducted by the ECB in 2023, which showed that the euro area banking system could withstand a very severe economic downturn, largely because banks were in better shape going into the exercise.[1]

However, there is also less positive news. The macroeconomic outlook has deteriorated in recent months[2] as the European economy has lost momentum, while many banks still show weaknesses in risk controls and internal governance. This was one of the main conclusions from our latest assessment of banks’ health, the Supervisory Review and Evaluation Process (SREP), which we conduct on an annual basis.[3] And we must also keep in mind that the effects of the period of high interest rates have yet to fully feed through to banks’ balance sheets.

The combination of these factors means that we remain concerned about credit risk in banks’ balance sheets materialising in the near term. To gauge the likelihood of this happening, the first port of call for us as supervisors is to look at the incidence of bad loans in the banking sector. As I mentioned earlier, the headline NPL ratio for the banks we supervise has remained low and relatively stable in recent months. However, once we move past this headline figure, a more nuanced picture appears, as NPL volumes have been picking up from low levels in certain market segments, especially in banks’ consumer credit and commercial real estate portfolios. In addition, the share of loans in early arrears (i.e. from 30 to 90 days past due), which tends to be a reliable leading indicator of rising NPLs in the future, has been on an upward trend in recent quarters. And corporate bankruptcies and default rates have increased from the record low levels which we saw during the pandemic, though still remain at relatively low levels in historical terms.

Taking all these different elements together, we think that some deterioration in bank asset quality is to be expected going forward amid a more sluggish economy. To the extent that banks need to increase their provisions as a result, this will further negatively weigh on their profitability, in a context in which the relative contribution of net interest margins to banks’ financial bottom line is also expected to fall. This is why we think it is key for banks to manage their distressed debtors and exposures early on. We are asking banks to be proactive in detection and recognition of credit risks in their balance sheet, keeping a close eye on vulnerable sectors, as well as in proposing workable solutions to their customers.

Within this overall credit risk picture, developments in certain markets warrant particular attention from a supervisory point of view. One of them is real estate, because price corrections in this segment have been a major headache for banks in past crises, and, through the banking sector, a source of contagion to the real economy too.

Residential real estate and commercial real estate markets are both in a downturn, with borrowers facing higher debt servicing costs due to higher interest rates. It is worth noting that, in aggregate terms, euro area banks’ exposures to such markets differ significantly. While residential mortgages account for almost 30% of euro area banks’ total loans, only around 10% of total bank loans are exposed to commercial real estate[4]. But whereas mortgage borrowers’ debt servicing capacity has been supported by relatively robust labour markets to date, commercial real estate borrowers have faced declining profitability, with higher interest rates reducing the income of specialised firms operating in this market and the value of their properties. The commercial real estate market is also adjusting to lower demand on account of structural changes that were reinforced by the pandemic, notably shifts towards online shopping and working from home. This means that firms and agents operating in this sector are facing challenges on both the financing and income side.

Taken together, these factors suggest that portfolios in the commercial real estate market segment have a higher likelihood of facing debt servicing challenges than those in other market segments. In the current cycle, borrowers in this sector are facing increased refinancing risk, particularly for bullet or balloon loans, which have a large balance that will fall due at maturity. This is a development that we, as supervisors, are monitoring closely because banks could be exposed either directly, via the credit channel (through loans for construction and purchasing commercial real estate), or indirectly, via the collateral channel (through borrowers using commercial real estate as collateral). This is why we are engaging closely with those banks under our supervision that are most exposed to this risk, to ensure that they manage it appropriately.

Other areas that warrant particular supervisory scrutiny in the current environment are leveraged finance and counterparty risk.

Concerning leveraged finance, we remain concerned about high levels of risk associated with such transactions, and we have found that banks’ risk control measures in this area are sometimes weaker than they should be. It is fair to say that we have not been satisfied with how far banks have progressed towards reducing risks from leveraged finance. Indeed, many banks have appeared complacent about following our supervisory guidance on this matter, which we issued in 2017.[5] This is why, over the last couple of years, we have introduced a targeted capital add-on in the capital requirements for some banks, which is intended to address individual cases of persistent deviation from our supervisory expectations.[6]

Turning to counterparty risk, the main focus is on the banks under European banking supervision that offer prime brokerage services to non-bank financial institutions, especially if the latter are highly leveraged. In these cases, we have seen shortcomings in areas such as risk management and stress-testing. We have recently issued supervisory expectations in this area, also on the basis of the thematic reviews which we have conducted, and, going forward, we will be monitoring whether banks comply with them.[7]

Overall, credit risk will remain an area of heightened supervisory focus for us in the near term, particularly in those market segments that are more sensitive to changes in the interest rate cycle. In this regard, it is important to address deficiencies in the frameworks that banks have in place for internal governance and for managing credit risk. Banks’ weaknesses in this area are often long-standing, for example as regards risk data aggregation and reporting capabilities, which we have been flagging through dedicated letters[8]. However, as banks’ progress to remediate these weaknesses has often been slow, many of them have continued to score poorly on governance in their annual SREP assessments even though their risk profile has improved in other areas. This also explains why, during their latest SREP assessment, almost three quarters of our banks received measures to address deficiencies in governance. Looking ahead, to address this shortcoming, supervisors will stand ready to use enforcement measures, which can range from issuing qualitative measures with clear remediation deadlines to imposing capital add-ons or periodic penalty payments if deadlines are not met.

Managing the green and digital transitions

Looking further ahead, there are two areas that will be crucial for the viability of banks regardless of their business model, and which will consequently deserve continued supervisory attention in the medium term.

The first is climate-related and environmental risks, or C&E risks for short. We have made it clear that it is not up to the ECB to tell supervised banks how green their lending policies should be. Nevertheless, we expect them to manage C&E risks in the future in the same way they manage any other material risk today. The good news is that there is broad awareness amongst our supervised banks about the relevance of such risks. For example, over 80% of euro area banks have already concluded that transition risks have a material impact on their strategies and risk profiles[9]. However, the results of the various initiatives we have taken on C&E risks in recent years suggest that, while banks have made progress in their treatment of these risks, they still have some way to go to properly incorporate them into their risk management frameworks.[10]

This is why we set intermediate and bank-specific deadlines for aligning frameworks with our supervisory expectations in this area by the end of 2024. Some banks did not comply with our first intermediate deadline of March 2023, which focused on the materiality assessment of the impact of C&E risks on banking activities. We responded by issuing binding decisions that impose periodic penalty payments if the affected banks fail to comply with the requirements by a certain date. We will be taking a similar approach to the rest of our implementation deadlines. Our supervisory efforts in this area will also be helped by the fact that EU legislation will soon stipulate for banks to have mandatory transition plans, because this legal proviso will also mandate supervisors to check such plans and assess banks’ progress in addressing their C&E risks.

The second area that will continue to be important for banks in the medium term is digitalisation. Our prudential approach in this field is similar to the one we have taken for C&E risks. We want to ensure that banks are in a good position to manage risks from digital transformation, including the related implications for the sustainability of their business models. The results of the digital transformation survey we conducted last year paint a mixed picture.[11] While almost all banks have a digital transformation strategy, their degree of maturity differs. And, while banks spend on average a fifth of their IT budget on digitalisation, most of them do not yet have a dedicated digital transformation budget. We are now following up on these results with on-site inspections and targeted reviews, which will help to shape our supervisory expectations on digital transformation in the future.

Digitalisation also affects the operational resilience frameworks of banks because they increasingly depend on a few third-party service providers. And we have noticed an increase in the number of cyber incidents reported to supervisors in recent months. We will therefore continue assessing banks on their outsourcing practices and cybersecurity management, and will also conduct a system-wide cyber resilience stress test later this year.


Let me conclude. In its standard dictionary definition, “resilience” is “the capacity to withstand or to recover quickly from difficulties”. On this basis, we can say that the European banking system has proven resilient over the last decade. Better regulation, more efficient supervision, well-capitalised banks and strong institutions have all helped to make the banking sector more stable.

However, it is important to acknowledge that resilience also has a temporal and adaptational element to it. If a system is unable to persist over long periods of time, it is by definition unsustainable. In the socio-ecological literature, resilience is often defined as “the capacity to deal with change and continue to develop”.[12] Keeping this definition in mind is also useful in a prudential sense, because while we should be pleased with the evolution of the banking sector in recent years, we know from experience that no two crises are likely to be the same. The fact that the banking system has proven to be resilient to the challenges of yesteryear does not necessarily imply that it will continue to thrive going forward.

So to further cement the resilience of our banking system, we need to foster the creation of a truly integrated banking market, refine our crisis management framework and address the gaps in our macroprudential framework.

First, we should complete the banking union as originally envisaged. Advances in supervision and resolution under the first two pillars have helped weaken the links between banks and their sovereigns. However, as long as the third pillar – a common deposit insurance scheme at European level – is missing, it is possible that the “doom loop” between governments and banks could resurface. Progress in setting up the third pillar should also foster bank mergers across national boundaries, which have so far failed to materialise to a significant extent. Advances in setting up a capital markets union in the European Union, which have also remained lacklustre thus far, should also be associated with increased bank integration[13].

Second, the process for unviable banks exiting the market could be improved. The scope of resolution can be expanded to ensure that the failure of small and medium-sized banks can be addressed in a harmonised manner, and deposit guarantee schemes can be empowered to provide a wider range of crisis management options for addressing potential, or actual, bank failures. The European Commission’s recent proposals are a welcome step in this direction.[14]

Finally, recent experience also suggests that policymakers will continue to be confronted with the question of how to ensure banks can use their buffers more effectively during a crisis, including by adjusting macroprudential frameworks to make these buffers buildable and releasable in a countercyclical manner.

  1. European Central Bank (2023), 2023 stress test of euro area banks – final results, July.

  2. European Central Bank (2024), Macroeconomic projections, March.

  3. Enria, A. (2023), Introductory statement at the press conference on the 2023 SREP results and the supervisory priorities for 2024-26, December.

  4. ECB (2023), Financial Stability Review, November.

  5. European Central Bank (2017), Guidance on leveraged transactions, May.

  6. The number of banks to receivethat received such an ‘add-on’ in their ‘Pillar 2’ capital requirement increased to eight in following our SREP 2023 assessment in 2023, (which is an increase from three in the previous year).

  7. European Central Bank (2023), Sound practices in counterparty credit risk governance and management, October.

  8. European Central Bank, Letters to banks.

  9. Elderson, F. (2024), 'Failing to plan is planning to fail’ – why transition planning is essential for banks, ECB Supervision Blog, January.

  10. European Central Bank (2022), Walking the talk – Banks gearing up to manage risks from climate change and environmental degradation, November.

  11. European Central Bank (2023), Take-aways from the horizontal assessment of the survey on digital transformation and the use of fintech, Frankfurt am Main, 15 February.

  12. Stockholm Resilience Center, Resilience dictionary, Stockholm University.

  13. European Central Bank (2024), Statement by the ECB Governing Council on advancing the Capital Markets Union, March.

  14. European Commission (2023), Banking Union: Commission proposes reform of bank crisis management and deposit insurance framework, press release, 18 April.


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