José Manuel Campa interview with Ta Nea: Raising interest rates is a two-edged sword

José Manuel Campa: raising interest rates is a two-edged sword

The Chairperson of the European Banking Authority (EBA) talks about the challenges ahead for banks

In the short term, an interest rate hike may be a good thing, but if the economy deteriorates, banks will face challenges, including a possible increase in non-performing loans, European Banking Authority (EBA) Chairperson José Manuel Campa warned in his interview with TA NEA, ahead of his visit to Athens to take part in a conference on ‘The Future of Sustainable Finance’.

What are the implications of the war in Ukraine for European banks?

Total banking sector exposures to Russia were slightly over EUR 70 billion and to Ukraine around EUR 17 billion, totalling around EUR 90 billion, or about 0.3% of the system's total assets. Since the beginning of the war in Ukraine, many banks have reduced their direct exposures to Russia and Ukraine by stopping their operations there.

In the short term, the impact is limited. The indirect effects of high energy and commodity prices due to reduced economic activity are of greater concern, so we are monitoring these closely.

What could higher interest rates, high inflation and the economic slowdown mean for banks?

If the economy continues to grow, an increase in interest rates may be profitable for banks, leading to an increase in net interest income, partly through the widening of spreads. However, if the economy deteriorates and interest rates increase further, we expect to see a deterioration in asset quality and an increase in non-performing loans (NPLs), which will have a negative impact on bank profitability.

If inflation persists, this will affect banks’ operating costs, which will impact profitability. In conclusion, in the short term, an interest rate hike may be a good thing, but if the economy deteriorates, there will be challenges ahead for banks.

Do you think we will see a significant increase in NPLs, especially in Greece, which has managed to reduce their volume?

One of the positive results we have seen over the last two and a half years is that, in Greece too, some banks have made notable improvements in reducing NPLs. The total stock of NPLs in the EU decreased between 2020 and 2022. As we move forward, it is likely that NPLs will increase, due to expected problems resulting from the pandemic and the possible deterioration of the macroeconomic environment.

The magnitude of this increase will depend on how the macroeconomic environment evolves; we do not expect a huge increase, however. We believe that today banks are much better placed to cope with any possible increase in NPL inflows.

At the conference, you will talk about sustainable finance. What does this mean for bank lending?

Sustainable finance is a broad term, but it basically refers to the process where environmental, social and governance issues are taken into account when companies make investment decisions and when banks make decisions to lend to companies and households.

In the EU, sustainable finance plays a key role in achieving what is perhaps the EU’s highest priority, the sustainability of productive economies and the transition to a more sustainable productive economy. The financial sector must be there to support this. Banks need to be prepared to properly monitor the risks involved in these investment objectives in order to be able to play a catalytic role.

How would you assess the ability of the European banking sector to meet the requirements of sustainable finance?

In the context of risk management by banks and on the part of the Authority, it is certainly necessary to assess how resilient the system is against difficult and extreme scenarios stemming from environmental and climate challenges. Last year, we ran an exercise on a sample of 29 volunteer banks from 10 countries, to assess their portfolios, focusing on the climate and their climate transition risk.

In this exercise, we focused only on the balance sheet section, which concerned the corporate sector. It did not include government bodies and small and medium-sized enterprises, as we did not have the know-how for this. This know-how is part of the things we need to develop, that is, how to examine the exposure of banks’ balance sheets to climate challenges, not just to large companies.

Next year, we will publish guidelines for banks on how to conduct stress tests; we will also publish guidance for supervisors on how to assess these stress tests in the area of climate risk. Then, our Authority and the corresponding Authorities for the insurance and capital markets will perform system-wide stress tests at the end of next year, with the aim of publishing the results in the summer of 2024. We will look not only at the scenarios, but also at how these scenarios affect each sector – the banking sector, the insurance sector, the capital markets – and whether interactions could exist.

Environmental risks, however, vary from country to country. How will this be reflected in the stress tests?

Indeed, not all are affected in the same way and not all contribute in the same way to these risks. First we have to consider the physical risks – how exposed you are to potential environmental risks, transition risks, how difficult it is to adjust your production capacity to meet these challenges. Secondly, there is the concept of double materiality. Each company, especially each bank, needs to consider to what extent it contributes to potential climate risks with the operations it supports, how the lending the bank provides affects climate risk due to the borrowers’ activities. We will look at physical and transition risks, but also at double materiality, and – as you also said – this will not be the same everywhere, it will depend on the scenario we analyse, which can affect different countries in different ways.

The interview was conducted by Maria Vasileiou

Ta Nea, 27 June 2022