Europe’s supervisory sheriff: Banks need to earn more
The chairperson of the European Banking Authority says banks’ earnings are a risk because they are not high enough
Europe’s banks have a fundamental problem: They don’t earn enough money. This is the message from the chairperson of the European Banking Authority (EBA), José Manuel Campa. ‘In the longer term, the two biggest risks we see are that banks will have to adapt their business models to become more profitable, and in addition they will have to figure out how to integrate new financial technologies and new products,’ says José Manuel Campa in an interview with Børsen. The EBA is concerned about banks’ earnings for the simple reason that their profits are the first line of defence against future losses on lending. Although banks’ buffer requirements, particularly in the form of capital requirements, have increased significantly since the financial crisis, this does not change the fact that a profit before write-downs is what the supervisory authorities prefer.
Vigilance is essential
Moreover, even though Europe’s banks have avoided problems during the coronavirus pandemic, thanks in part to massive support for the economy from central banks and governments, the EBA remains vigilant.
‘COVID-19 and its consequences have been our main focus over the past year, and while there have been no problems for banks in Europe, there is still a concern that it could lead to an increasing number of non-performing loans and a risk of the economy overheating, which could cause assets such as owner-occupied dwellings to rise too sharply in value,’ says José Manuel Campa.
To keep track of how well Europe’s banks can handle a significant economic and/or financial crisis, one of the main tasks of European banking supervision is to conduct a stress test every 2 years with national supervisors of Europe’s largest banks, including Nordea, Danske Bank, Nykredit, Jyske Bank and Sydbank. The stress test, which will in future be led by Danish economist Jacob Gyntelberg, will measure what happens to banks’ profits and capital base if, for example, unemployment rises sharply and the value of shares and property falls sharply at the same time.
COVID-19 and its consequences have been our main focus over the past year.
Modified stress test
According to the EBA chairperson, the stress test is important for both the authorities and the public, because the results have to be published for each individual bank. But at the same time, he says the stress test is controversial.
‘There have always been some who have been unhappy with the result of the stress tests, and the process is cumbersome and time-consuming – not only for the participating banks, but also for the supervisory authorities. And sometimes it’s difficult to interpret the results because it’s hard to find a common methodology and scenarios that fit everyone,’ he says, continuing:
‘Last year we reviewed the process, and we are looking at whether we should use either a bottom-up process focusing on individual banks, or a top-down approach where we look at the impact on society. I believe the balance lies somewhere in the middle, where we have some top-down scenarios. But we will always publish stress test results for individual banks.’
At the same time, he says banks should expect more regulation, but not focused so much on capital requirements.
‘I think future regulation will depend on which area we’re talking about. As regards prudential regulation [ed: capital regulation], we now need to implement what has already been decided, while we have to step up the fight against money laundering and financial crime. There’s also a need to complete the EU banking union and work on how we are going to regulate financial innovation,’ says José Manuel Campa.
There have always been some who have been unhappy with the result of the stress tests.
José Manuel Campa
The 57-year-old Spaniard was appointed chairperson of the EU banking supervisor by the European Parliament on 14 March 2019.
He holds a master’s degree in Law and Economics from the University of Oviedo and a PhD in Economics from Harvard University.
Before becoming chairperson, he was Head of Regulation at major Spanish bank Santander, and before that, he was a professor of finance and economics at IESE Business School. Between 2009 and 2011 he was Spain’s Minister for Economic Affairs.
EU supervisor appeases Danish mortgage lenders
Since the EU seriously set about harmonising European banking rules 10 years ago, with the creation first of the European Banking Authority, the EBA, and then of a banking union, there has been concern in Denmark side as to whether the country’s very particular mortgage system can survive increasingly uniform EU rules. But those concerns are unfounded, says European Banking Authority chairperson José Manuel Campa.
‘My board is very familiar with the specific Danish bond market, and the Danish Financial Supervisory Authority has been very good at telling us why it does not pose a risk to financial stability or free market competition,’ says José Manuel Campa in an interview with Børsen, where he continues:
‘There’s still room for idiosyncratic products in the various EU Member States, and if there is to be convergence across the EU on financial products in the long term, it must be determined by competition, not by rules or regulators.’
My board is very familiar with the specific Danish bond market.
But National Bank governor Lars Rohde, among others, has for several years actively argued that Denmark should join the EU banking union, even though Danish voters have twice said no to Denmark joining the euro. The two main arguments have been that it can secure Denmark a seat at the table when the euro-area Member States discuss financial matters, and that it can create a larger safety net under the Danish banking sector, and especially Danske Bank, which is a very large bank in relation to the Danish economy.
In the Nordic region, however, only Finland is a member of the banking union. And although the foundations of the banking union were laid in 2012, one of the key elements – a single deposit guarantee fund to protect depositors across the euro area – is nowhere near to being in place.
But although José Manuel Campa denies that the EU will touch the Danish mortgage system, the current system is markedly different from the one created in Denmark at the end of the 18th century.
The international Basel capital requirements of the late 1980s meant that borrowers’ joint and several liability for bonds issued disappeared, as did the requirement for mortgage issuers to be associations.
Within a few years, this meant that all Danish mortgage banks became limited companies, of which only Nykredit remains independent today.
5 questions: What is the EBA and what does the EU’s banking supervisor do?
1. What does the European banking supervisor do?
The European banking supervisor, the EBA, has three main tasks: to develop the detailed regulation of banks in the EU; to ensure that national financial supervisors interpret the rules correctly; and to conduct a stress test every 2 years of the largest banks in the EU, including Nordea, Danske Bank and Nykredit.
2. So does the EBA supervise the financial supervisors?
Yes and no. The EBA can challenge a national supervisor’s interpretation of common EU rules, but does not interfere in day-to-day supervisory work. But the EBA has, for example, investigated whether the Danish and Finnish financial supervisors followed EU rules in connection with Danske Bank’s money-laundering scandal in Estonia. They did, the EBA ruled.
3. Is the EBA the only financial supervisory authority in the EU?
No. The EBA is responsible for banking regulation, while the European Securities and Markets Authority (ESMA) is responsible for EU rules in securities trading, and the European Insurance and Occupational Pensions Authority (EIOPA) is responsible for the insurance and pensions market. A special joint money-laundering supervisor is also on the way. The EBA and ESMA are based in Paris, while EIOPA is in Frankfurt.
4. Why is the EBA stress test important?
A bank that cannot meet the capital requirements in a theoretical stress scenario is in practice required to raise more capital. In the 2013 stress test, published in 2014, 24 out of 123 banks failed the test. However, ten of them had improved their situation before the test was published. The others were given 9 months to change their financial situation.
5. Who is in charge of the EBA?
The EBA, like the Danish Financial Supervisory Authority, is not under direct political control. However, its senior management must be approved by the European Parliament.
The interview was conducted by David Bentow.
Børsen Danish newspaper, 28 July 2021.