‘Banks must pay for talent but without jeopardising costs’
The French executive believes that Europe has progressed in harmonising its banking rules and that banks should not shy away from proposing cross-border mergers. Though stress tests are considered to be a very useful tool, the Authority will be proposing changes for forthcoming tests on the EU banking sector
The European Banking Authority (EBA) is celebrating its tenth anniversary; 10 years in which it has had to tackle two economic crises, move its headquarters from London to Paris on account of Brexit, subject the biggest European banks to stress tests and lead the adaptation of the financial regulation to the EU framework, apart from its other responsibilities. Its executive director, François-Louis Michaud, gives an interview to EXPANSIÓN to take stock and comment on the challenges facing the sector at present, such as the lack of profitability and climate change.
What are the conclusions of the report that the EBA has just published on banks and climate change?
I think it is a report that tries to throw some light on what we know and what we don’t know, which was its initial purpose. There are a lot of green initiatives underway in the climate sector. Everybody has something to say, but they are all using different metrics. We focus on a number of recommendations to use information better and a European taxonomy. We feel that this is going to be important, but we also criticise where we are at in terms of climate exposure. And we can work with banks on this, because they have access to privileged information. That’s what we have done in the exercise with 29 banks from 11 countries, which represent 50% of EU banking sector assets. It has enabled us to learn a lot about the exposure of banks as well as their practices, about how they assess their exposure. We decided to restrict the target to non-SMEs in the EU because we feel that is the population on which we have better information. It is an important tool for anyone that wants to analyse risk in this area. For supervisors doing a stress test it is important to know the quality of the information on which it is to be based. With this report we can tell them how far they can go and what they can expect to find in banks. We will continue analysing the situation to see how things develop and to see if any progress is made.
‘Banks have to bear in mind that the public accepts that they have to manage talent and reputation’
‘It is important that banks use common methodologies in the fight against climate change’
However, the main message is not only that we have a low green asset ratio, which stands at about 8%. But that at present there are different bank practices and that there is a part of their portfolios about which we have little information, or even none.
It is also important that banks use common methodologies. Everybody is convinced that actions have to be taken, but they are all using different metrics and that makes comparison difficult. Nothing can be compared and that is quite dangerous. It is very uncomfortable when it comes making policy decisions.
We believe the EU has a good benchmark in its EU taxonomy and it is important to start using it now. It’s not too late. Banks have invested in their methodologies and I understand how attached they are to them. The longer it takes us, the more difficult convergence will become.
What are the biggest threats to the European banking sector?
That’s a very important question. Banks can help with the climate change issue, but they are also game players.
What has been done also has consequences. There are two types of risks or consequences: direct and indirect ones.
Potentially direct ones mean that the change will have an economic cost. There will be changes in the real economy that will affect the sector; there will be new competitors, some more profitable, others less so ... and this will affect banks’ portfolios and their income. This will not be a neutral transformation.
As regards indirect risks, I’d say that if there are disorderly changes, such as prices swiftly changing on account of changes in investor or user preferences, they may affect banks if the transition is not smooth enough. Reputational risks also have to be dealt with from two directions, because depending on what customers do or don’t do, banks can suffer from these effects. And they may also suffer if they are perceived as not doing enough. It’s a risk, but an opportunity as well. If they play their cards right it can also be seen as an opportunity to become an important and reliable contributing player.
[Banks] can be a marvellous source of information owing to their privileged position in the economy. But they must also responsible in how they share this information, because there may be consequences in the short term that affect the transition in the long term.
It is important that banks facilitate this transition for their customers. There are lots of opportunities. In the last crisis their reputation took a blow, but they have picked up the pieces and done a lot to restore it. They are seen as an aid in the pandemic and a key to recovery.
With respect to reputation, a debate has arisen in Spain as regards senior executive salaries.
That’s a delicate issue. It has become an important matter in a lot of European countries. In the Netherlands, for example, they have put a cap on salaries. It's not something for supervisors to get involved in. We’re in a capitalist market, so it’s a matter for shareholders not supervisors. Nonetheless, supervisors and regulators have to look closely at the balance between what can better serve a bank or harm it.
Banks need talent and pay for it. But, at the same time, they can’t jeopardise their structure or operating costs, which are very high in some countries. They have to hold on to talent, but without overly affecting structures. Neither can you drain talent from other sectors, a risk that may arise if they pay too much.
What is acceptable to the public must be taken into account. Banks have to manage talent, but protect their reputation as well.
We try to publish annual remuneration reports and compare them across the EU. This produces a lot of information, and we believe it is a useful tool. At present, the general public is particularly sensitive to the remuneration issue.
Banks need to be careful about their reputation. It’s important to show self-restraint.
What can banks do to tackle their lack of profitability?
This is a critical issue for the banking sector. Low profitability has been an ongoing problem since the last crisis.
‘It is important that we have strong banks and scale can help to reduce costs and face the digital challenge’
‘Banking is an information business and we are seeing how it is failing to compete as well as others’
This is due to a combination of factors: interest rates have negatively impacted of course, but this has also helped to create cheaper sources of financing. Which is not necessarily a bad thing. The bank income mix is the question. Interest rates are not high enough if you are too margin dependent. This is a problem for some banks in Spain. As far as I know, interest accounts for 70% of their operational income. If you don’t have other sources of income, such as charges, to balance it out, the impact is greater.
The economy is behind this, because it lacks the dynamism of other regions. There are too many competitors, which is causing strong price competition. Some very weak banks have been affected by the competition.
Moreover, costs are also quite high, though this differs depending on the country. Northern European banks have pushed ahead with digitalisation and reduced branch networks. There are ways to reduce costs, but they have not been implemented in all countries. Spain is on the path to consolidation. It managed to do so after the crisis, and is doing so again. It is important that we have strong and resilient banks. Scale can also help to cut high costs and tackle the technology challenge.
Technology is still a sector problem. We know that the information systems are not as advanced as they should be and that sections of the public are crying out for this digitalisation, which is very expensive.
Banking is an information business and we are seeing how it doesn’t know how to compete as well as new market players.
New market players seem to be cleverer.
It is very important that banks invest in new technologies and information services and maintain franchises, but they can also prioritise in which countries and sectors they want to operate.
Consolidation is helping in this regard and we feel that trans-European consolidation will help diversify their portfolios. Market obstacles still exist, but the framework has greatly levelled the playing field in recent years. There has been great improvement and banks should not shy away from using these more harmonised markets. The consumer segment is another one that has experienced this consolidation. It is possible.
Why are there no pan-European mergers?
For a long time it was because the idea was to focus on and prepare for the new regulatory framework. Financial institutions busied themselves with calculating the impact of all the regulatory measures on their activities. There was excessive concern out there. So they preferred to wait and rebuild. Wait and see.
Positive signs have come from all directions: EBA, BCE, national authorities ... They are taking a positive approach in this matter, to help in the creation of bigger groups if they bring a better and more solvent business model. What’s more, to enable banks cover their financing cost.
Insolvency schemes are not helping either. We have drafted a report on this and feel that regulatory convergence would help a potential consolidation. The market is quite fragmented.
Some banks are competing well, there are big and profitable entities out there. Some are suffering more and some are just not viable. It’s important that those in a better condition be able to lead the rest. It’s also important that they study the markets they want to enter and can serve as an inspiration for others.
With only 10 banks in Spain, do you think competition is at risk?
No, I don’t. We have seen that competition was not negatively affected either in the United States or in other countries. A small number of very active competitors can suffice. We are not worried, but are watchful. I think that in spite of the consolidation, competition is thriving with entities active in many segments. New entrants will help competition and banks will also find themselves having to innovate.
Regulatory obstacles are indicated in the risk report we publish periodically.
‘There are still obstacles to European mergers, but the situation has improved a lot in recent years’
‘The market is calling for more transparency in more banks, so we should study broadening the sample’
Most banks see execution as the biggest challenge, others believe there is a lack of opportunities, while regulatory obstacles are cited as the third cause, but I honestly feel this is not the case, simply an excuse.
Maybe they are referring to national regulators.
That’s true, because banks are important for economies. Authorities may have genuine concerns. But I think that the market is sufficiently integrated for it not to be a problem.
Mergers and consolidation are cases in which managers and execution are key factors. Which leads us to the question of whether or not governance and management are in the right hands. We spoke of talent earlier. This has a lot to do with organisation transformation. I think it's interesting, because banks are not thinking hard enough about how to transform themselves.
The EBA is known for its stress tests. Do these need a reform?
We started stress testing after the last crisis as a way to restore confidence and throw some light on banks to be able to render their risks and exposures transparent. That’s why we publish so much detailed information.
Proving useful in itself, it has become a recurrent tool. A more institutional one. Originally a tool for a crisis, it has now become an important one in the hands of regulators and supervisors because it affords us a magnificent insight into all bank activities using the same methodology and scenarios.
It's important for investors to know how European banks are compared to each other. We get a marvellous snapshot that makes things easier.
We think it’s a very powerful tool and are happy with it.
Particularly this year, we feel that the stress tests are very important after postponing them last year to allow banks to concentrate on their customers during the pandemic. But this also means that the tests are very important to get information on the situation of banks.
That’s why we are going to publish tests that will be very useful in a year in which the information was affected by measures like grace periods. These stress tests will enable us to see where we stand. The best scenario will resemble reality, while the worst case will give us an idea of the situation if there are problems.
Do we need to change the tests? There’s a lot of work involved for banks and supervisors because so many resources are mobilised for such long periods. We are looking into how we can simplify in the future to adjust the cost and benefits of these exercises. Working top-down instead of bottom-up in some areas and rebalancing these models. The top-down approach is not easy because it tends to be less realistic, which makes it a challenge.
We will be proposing a few changes for the next rounds of tests, which will be implemented in 2023.
The interview was conducted by Nicolás M. Sarriés.
Expansión, 7 June 2021.