EBA director says there has never been so much good-quality capital in system
BANKS need to prepare for tougher times ahead including taking a hard look at both lending for customers and pay-outs to shareholders, a top EU regulator has warned.
Francois-Louis Michaud, the Frenchman in charge of day-to-day management at the Paris-based European Banking Authority (EBA), says that market jitters are a warning sign for lenders.
His advice: “Be careful” with dividends and loan decisions and keep cash buffers “high”. The outlook is clearly deteriorating,” he told the Irish Independent in a video call ahead of a visit to Ireland next week. Banks are definitely revising down their expectations for the quality of their portfolios. They start increasing provisions. We don’t see a massive shift yet, but we see signs that the situation is getting a little bit more tense. It’s very important, in that context, that, indeed, banks take the right internal decisions in terms of extending credit, also keeping their buffers high, be careful with distributions, things like that. They need to prepare for – possibly and probably very likely – more adverse times.”
With eurozone inflation almost in double digits, the European Central Bank (ECB) is expected to hike interest rates again today and signal how it intends to deal with the trillions of euros in low-cost loans it has extended to banks during the pandemic.
"I think they are very well aware that all eyes are on them, and I think this is like other central banks around the world," Michaud says.
"We believe banks are in a good position to withstand all those challenges"
“I think they are trying to navigate – to walk a thin line – and keep supporting the economy.”
Recent ECB rate hikes have bumped up banks’ net interest margins and Michaud expects third-quarter results to be “positive”. A decade-long rebuilding of capital buffers, which now amount to around 15pc of risk-weighted assets, has left banks in a better position to withstand the coming economic slowdown, Michaud believes.
“We’ve never had so much capital – and good quality capital – in the system. The liquidity ratios are also extremely high. We believe banks are in a good position to withstand all those challenges, but of course we will see what happens.”
Irish banks are required to hold more high-quality capital – the first to be called on in case of losses – than their European counterparts because of their history of risky mortgage lending. But analysts say the rules have also dampened profitability and competition here.
While Michaud won’t be drawn on whether that fed into recent decisions by KBC and Ulster Bank to leave the Irish market, he admits the 2008 banking crisis “has had a sort of long-lasting impact on the Irish financial sector”.
He “can’t really comment”, either, on the Central Bank of Ireland’s decision last week to ease mortgage-lending rules.
Economists fear the move could fuel household debt and push house prices even higher, as housing supply is still not meeting demand.
The Central Bank admits it could put average home buyers at an increased risk of “financial distress” if interest rates continue to rise, and could lead to “moderate” house price hikes.
In general, increasing mortgage lending when house prices are already high “could be conducive to risks” for banks, Michaud says.
“Much depends on the creditworthiness of the borrowers, much depends on the economic cycle, and also on the level of capital that the bank holds. The assessment needs to be done based on the bank’s situation.”
Earlier this month, the EBA warned in a note about “higher risks in banks’ mortgage portfolios” due to overheating in residential real estate markets across the EU. It name checked the Netherlands and the Czech Republic in its report. The European Systemic Risk Board (ESRB) – the EU watchdog whose job it is to spot potential crises - said earlier this year that Ireland’s housing market was at a “medium” risk level. But that was before the war in Ukraine and the ECB’s rate hikes.
The ESRB said this summer that financial stability risks are on the rise, including the risk of an “abrupt and broad-based fall in asset prices” – real estate included.
But Michaud points to generalised market jitters rather than specific asset price bubbles.
"It's clear that certain valuations are high. It's not for us to say whether there are bubbles or not. What we are probably now faced with is not so much a big bubble in itself, but more like a sort of nervousness that we could see in markets; a lot of volatility, people getting a little bit more nervous, a bit more responsive to anything that might happen. And then it might be more a combination of triggers that might result in a difficult situation for financial sector players in general."
UK investors were triggered into a government bond sell-off last month following the former chancellor's unfunded mini-budget of tax cuts.
The episode laid bare the exposure of defined benefit pension schemes to UK gilts, but Michaud does not fear a similar episode in Europe.
"The situation in the UK is also very specific. We don't see necessarily the same developments occurring in Europe. We tend to link that to market volatility and markets being supersensitive about what's coming from governments regarding their fiscal stances, what's coming from central banks regarding the speed at which they fight inflation, and also the interest rate differentials across jurisdictions. So there is market volatility, potentially, and that needs to be taken into account."
EU banks' ability to with-stand potential volatility will become evident next year, when the EBA conducts a new round of stress tests - starting in January, with the results due in July.
This round will bring 76 banks into the net, up from 50 in 2021, and will test them â€œvery carefully, very strongly against potential shocks, including a real estate crash.
“For us, the jury is still out, and we will see with the stress test whether banks are able to cope or not, but there is no indication so far that they aren’t,” Michaud says. “Banks stayed very well capitalised in the previous EBA stress test in 2021. That was, of course, a different world.”
Michaud, a former ECB and French banking supervisor, took up his role in 2020, after the Central Bank of Ireland’s Gerry Cross failed to garner enough support from MEPs.
The EBA was set up in 2011 in the midst of the last financial crisis, along with two sister institutions that monitor financial markets and insurance. Its job is to make sure banks are applying EU rules consistently – and to stress test them every couple of years. In the last decade the regulator has undergone a major reorganisation, adding new units on data analytics, anti-money laundering, environmental, social and governance risks and digital finance.
Michaud travels to Dublin next week to speak at a Central Bank conference on the topic of financial innovation.
He says Ireland is a “very dynamic market” for fintech, and that the growth of non-bank lenders is a sign of “vitality”.
But not all innovation is cre-ated equal.
The growth of non-bank lenders is a sign of 'vitality'
The EBA was the first global regulator to warn consumers against investing in crypto-currencies, almost a decade ago now, Michaud says.
“We’ve continued issuing warnings and we’ve said very explicitly that this is not suited for most retail consumers as an investment, or as a means of payment, or as an exchange. Consumers risk losing everything.”
He says new EU rules to protect consumers that use crypto trading platforms – agreed this year and due to come into force in 2024 – will create a “much, much safer environment”.
A “fluid dialogue about current challenges for the financial sector” between private firms and regulators is essential to keep the system functioning, he says.
The Central Bank’s Financial System Conference 2022 takes place at the Aviva Stadium next Wednesday and Thursday.
The interview was conducted by Sarah Collins