Isabelle Vaillant's interview with Dagens Industri: Credit is a means to survive as a consumer

  • Interview
  • 9 JUNE 2022
Consumer credit is necessary in tough times, and banks – especially Swedish ones – are ready to cope with both high inflation and an economic downturn. This is according to Isabelle Vaillant, Director of Prudential Regulation at the European Banking Authority (EBA). She also argues that a major reason for the sector’s stability is improved regulatory frameworks.

How resilient are European banks if the economy goes into recession?

‘In the global situation we are in now, it’s really important to measure resilience. I’m happy to say that European banks, including those in Sweden, are in very good shape, despite the pandemic. We have built a strong financial sector in the EU after the financial crisis, and we have a more robust system.

‘Capital ratios [Ed: Tier 1, i.e. how much capital banks are required to hold in relation to their assets], which are an important indicator for everyone in the market and for the supervisory authorities, are good, at over 15%. They are continuing to grow, which is reassuring. In Sweden, they are even better: 19-20%, which is very high, especially as central banks have provided a lot of liquidity. So we at a very good starting point for navigating away from in this new crisis. It’s also important that the cost of risk has remained fairly low thus far and operating costs have fallen slightly.

‘We should not underestimate the need to review the sanctions system and manage reputational and cyber-risk. Here, too, we must continue to build resilience.’

 

Will an economic slowdown have any impact on the implementation of Basel III [see box]?

‘The implementation of Basel III has been a long time coming – since 2017, when an agreement on the final details was reached. The impression at the time was that the agreement would have a major impact and be difficult to swallow, but I can see that over the past 5 years; the banks have achieved very good results and adapted quickly. They are well prepared, and can take the final step without difficulty. On the contrary, I believe that the supervisory framework has been seen as an asset in navigating through the pandemic.

‘I would add that the Basel III package is a structural change, the key to a more robust banking system. With this in mind, it’s important to continue to build regulatory frameworks for financial stability. We also need to provide for other structural reforms, such as insolvency procedures, which is something the European Commission is still looking at.’

What do you say to those who have concerns about higher capital requirements – which could stifle growth – and increased complexity in the regulations?

‘You can view it as a cost of regulation, if I can put it that way. This is an effect of regulation, but it is always proportionate to new trends, new risks and different structures in the banking system. It’s more of an adaptation with immediate impact, but it’s also an investment for better and more stable financing.

‘Complexity is something we are having to approach from a different perspective; we have tried to adapt over the last decade. The diversity of business models and products has often led to long texts and different types of rules. At the same time, we should also recognise that there may be a need to adapt the rules to the different products.

‘Beyond that, I think we have to adapt to more important things: new conditions. Digitisation, for example, really is a new paradigm. From the EBA’s perspective, we are returning about EUR 40 billion, previously diverted from banks’ capital, to the banking system thanks to recognition carried out by analytical programs. Software has a value, as long as it’s modern and up to date, not from the 1970s.’

 

The ECB’s bank lending survey indicates a significant increase in demand for consumer credit. The share of non-performing loans is 2%, while the share of loans with an increased risk of credit losses (step 2) is 9% and rising. Is this a concern for the EBA?

‘Consumer credit will be a necessity, given the times we are living in. When inflation is high and purchasing power is declining, it’s a way to survive as a consumer, if I can put it that way. Naturally, the demand for consumer credit is rising, and we will be monitoring this increase. This wasn’t the case during the pandemic, but there was considerable government support and flexibility in the use of regulatory frameworks. Now we have to face a completely different situation, with high inflation. We’ve not seen any deterioration in credit quality so far. There are early indications that we need to address the situation, but we’re confident that the regulatory framework is flexible enough. Then we’re back to the question of whether capital ratios are sufficient for unexpected risks, and we are in a good position in the EU to face potential risks.’

‘It’s good that the financial sector is seen as part of the solution for the transition to sustainability.’

ISABELLE VAILLANT ON THE ROLE OF BANKS IN ADDRESSING SUSTAINABILITY AND CLIMATE ISSUES

You have said that investing in digital is crucial to be able to compete. How far have European banks come in terms of digitisation and what remains to be done?

‘We’ve undoubtedly seen a sharp acceleration in investments in digital technologies, products and internal systems, which intensified during the Covid crisis. So there are positive trends that we are seeing. Cloud solutions, digital wallets, digital platforms and certain biometric products have been introduced.

But the use of technologies such as big data and machine learning, which we have written discussion papers about, is more limited than we expected. Maybe it’s good in the sense that it affects risk in the business, which is the essence of any bank. This is something we’ll be monitoring.

‘But we can see that banks’ investment in digital innovation in their own data systems is still growing at a good pace, well above 10%. That’s pretty good.’

 

You mentioned cyber-risks earlier. How does the EBA view cybersecurity?

‘We need to upgrade cybersecurity. When it comes to cyber-risks, we are at an early stage. We have strict principles regarding risk management, which is good. This is a priority for both banks and supervisory authorities, and we need to acquire more skills.

‘At the EBA, we have started to build incident reporting, which I think is very important. We’ve done this for payments, and plan to do so for third-party providers as well.

In this respect, we hope that EU legislation will be a game changer that can also help banks upgrade their cyber-risk management practices.’

 

Klarna is known for ‘buy now, pay later’ products. Many banks are talking about developing their own similar solutions. What’s your view of this type of financial product for consumers?

‘I think it’s an interesting and appealing innovation, and I’m pleased that Sweden is a pilot project in this regard. Although it’s an innovation, it can be broken down to being an extension of traditional payment services. It’s an attractive product in the situation we’re facing: with inflation and reduced purchasing power, this is the kind of product you need as a consumer.

‘As a supervisory authority, we need to look at the consumer angle – to ensure that the fees and costs of credit are disclosed transparently. We also need to look at the group structure and what sources of funding they rely on. This also applies to Klarna, which you mentioned. A few years ago there was a concern about shadow banking, and now this is something we need to start looking at more closely.’

 

Sustainability is a big issue for the financial sector. What are the main challenges and opportunities?

‘It’s good that the financial sector is seen as part of the solution for the transition to sustainability. Good reforms allow the banking sector, like the rest of the EU, to show leadership in the transition. Things have changed in the last 2 years – we have the taxonomy and we’re incorporating ESG into supervision. All banks are developing their own green-labelled products, and balance sheets are also becoming greener. It’s a paradigm shift in banking.

‘Now we need to show that it’s not just about labelling, but that it delivers real green benefits. Moving to long-term value creation is a challenge facing us all. Supervisory authorities can help by making banks more resilient, and this, together with risk management practices, will ease the transition, which is in place just like openness and transparency. That’s good.

‘Now it’s time for the final step, which is probably one of the most difficult: to accurately measure all the new dimensions of risk. To this end, the EBA has produced a discussion paper to identify and measure new types of risk.’

 

We are used to financial stress tests. Will there be sustainability or climate stress tests in the future?

‘This is nothing new in the sense that we’ve been trying to build this for several years, in part thanks to the International Monetary Fund (IMF) which has expressed an interest. There have already been some pilot tests. The EBA published results last year, and we developed sensitivity analyses, which are important tools to build on. Now we’re in sync and cooperating with all supervisory authorities, such as the Swedish authorities and the ECB.

‘We’re building a set of tests to provide objective measurements that we can rely on. This is important because climate risks need to be proven to everyone on an ongoing basis so that we can take reliable action. Now we’re developing proper stress tests, not just sensitivity analyses and pilot tests. The European Commission has issued a strategy for sustainable finance, in which the EBA has a specific role. It’s significant that we have developed this from a supervisory perspective since last year.’