More bad loans and extra work for banks on the horizon
Interview with José Manuel Campa, Chairperson of the European Banking Authority (EBA) on the conditions and challenges facing banks in the Union, and on their future
Spanish banker and economist José Manuel Campa heads the European Banking Authority (EBA), headquartered in Paris. Established 10 years ago, the EBA is responsible for the single rulebook and supervision of banks in the Union. It is also responsible for carrying out stress tests of the largest systemically important European banks.
Last year the European economy contracted by more than 6% as a result of the pandemic and the measures adopted to stem its spread. This also had consequences for the banking sector. How successfully have European banks responded to the problems connected with COVID-19?
Banks have, of course, a major role to play in supporting the economy and its recovery, so it is important that they should be well capitalised and have sufficient liquidity. At the beginning of the crisis, in the first quarter of 2020, they achieved high levels of capital and liquidity, which further increased over the course of the year. This was partly due to action taken by monetary authorities to guarantee liquidity, and partly to fiscal measures that introduced moratoria on loan repayments and a range of public guarantee schemes implemented by banks. At the end of last year, banks on average had high capital ratios, which were higher than at the start of 2020. The same applies to their liquidity ratios, which were also higher than at the beginning of the year.
So European banks have responded well to the crisis conditions?
Yes, I would say so. Right at the start of the crisis, banks showed operational resilience in that they were able to service their customers at the height of the tension. They then also showed an ability to listen to the needs of households and businesses by providing liquidity and through loan repayment moratoria. Our assessment so far is that, overall, the credit sector has performed well in terms of solvency, while the capital ratios of banks also remain high.
Would it be true to say that banks have learnt something from the previous financial crisis?
Yes, I think they have. Not only that, but in the 10 years since the last crisis we have built a better banking system, with far higher levels of capital and liquidity. At the end of 2011, for example, the capital ratio of Core Tier 1 banks was on average 11%, while at the beginning of last year it was 15%, in other words four percentage points higher. The regulatory framework we have established has also contributed to better bank governance in difficult circumstances.
Certainly, although on the other hand we are seeing that bad, non-performing loans are on the increase again in some parts of the economy and that some countries are also increasingly seriously affected by the consequences of the pandemic and lockdowns that are still ongoing. As far as the increase in bad loans is concerned, what is your view of the present conditions and the future development of these events?
It is absolutely the case that the crisis will cause losses on banks’ balance sheets and worsen the quality of loans. The volume of non-performing loans has been declining on average in the EU since the end of last year, but, as you say, some sectors and countries are more badly affected. In some countries the share of bad loans will increase in the coming quarters, especially if they are not covered by government guarantees. As you know, the EBA is currently in the middle of conducting stress tests. We will publish the results in July and these will help us understand how individual banks are performing. I believe that the share of non-performing loans will increase, but, as we have said, the current position of banks is good, so they will be able to absorb it.
On the subject of bad loans, there has also been some discussion of the possibility of establishing a kind of European bad bank. This would, of course, be a demanding and lengthy project. Is it a good, feasible idea?
The idea that has been circulating of a bad bank has arisen because of the issue of the management of bad, non-performing loans, which are likely to increase in number. If there are more of these loans, banks will have to manage them and will look for a bad bank that can be actively involved with them. From this point of view there would be advantages from a larger market that would attract investors, and this market would be European. Frankly, my understanding of this is that the proposals are not aimed at setting up a European bad bank as such. Rather, the idea is to set up a network of national bad banks that already have experience of how to manage assets and how to securitise them. It would be good for these practices to be common and coordinated among different national bad banks.
Yes, we know this in Slovenia because we have been through our own rather painful and expensive bank recovery and we set up a bad bank just under 8 years ago. How, in the light of this, do you see the Slovenian banking sector now? Is it sufficiently resilient, capitalised and solid to be able to navigate the difficult conditions of a health crisis?
My impression is that the banks in Slovenia have restructured and, according to the information I have, their level of capitalisation is good and even slightly higher than the EU average. The level of non-performing loans is also good and the ratio is favourable. It appears that the banks are in a relatively good state, which is something that also applies to the EU average. Naturally, I do not have detailed information on the characteristics and situation of individual banks, but my general impression is that conditions are good.
Regarding the regulation of loans benefiting from moratoria on loan repayments, proposals have been made in Slovenia, including by the Ministry of Finance, to extend moratoria on loans taken out in more crisis-affected sectors of the economy. What do you think of this?
Good question. As you know, we have a number of guidelines regarding the moratoria that ended in March. The EBA’s clear position is that it is a good thing that these moratoria have ended. Moratoria were extremely helpful during the crisis, but now, a year on, it is time for individual assessments of the needs of individual customers, rather than for generally applicable rules in this sector. Existing regulations already provide opportunities to defer loan repayment if the customer is entitled to it and the bank agrees to it. In short, a year on, it is time for banks to address their customers’ needs individually, on a case-by-case basis.
When it comes down to it, that is also what bank managers are paid for.
Going back to this year’s stress tests of the largest banks in the EU, can you explain to us the key elements of the baseline scenario and the risks of the adverse scenario which the EBA is testing in banks in the event of a deterioration of financial conditions?
The position this year is different from that in previous years. In the light of conditions, we have, as you know, prepared two scenarios. The first is the baseline scenario that is largely forecast by the European Central Bank, while the second is the adverse scenario that would occur if conditions deteriorated. This adverse scenario is extremely severe.
Banks need to improve profitability and must address cost reductions and risk structure, together with their customers.
It assumes a contraction in GDP across all EU countries, and the difference in forecast economic growth between the baseline scenario and the adverse scenario is the biggest out of all the stress tests we have conducted. This severity is important since it provides an unlikely, but still possible scenario. Our assessment for the time being is that even in this case the banking system has sufficient capital, while the stress tests are verifying this at each individual bank and will enable national bank supervisors to see how they need to develop supervision in order to ensure that the system remains robust.
Given the conditions, the risks and the fact that, according to the most recent figures from Eurostat, the economy of the EU and the euro area also contracted in the first quarter of this year, what is the probability now of new problems and a possible crisis in the financial sector as well?
The risk of a financial crisis, as you describe it, essentially depends on two points. The first is the speed and scale of the recovery, which will depend on how we bring the pandemic and the health crisis under control and how successful the vaccination programme is. The second aspect, as we have already said, will be the action taken and whether fiscal support remains. As regards the speed and scale of the recovery, we are observing a significant delay in vaccinations compared to our expectations a few months ago, but new vaccines will probably still be achievable, which is good. As regards fiscal and monetary support, governments are guaranteeing that these will continue, and this will also include support for banks. I believe that these two aspects will also help banks with management during the recovery phase. It will still be extremely important for them to continue to monitor the quality of loans. If they notice a deterioration, they will have to acknowledge the situation quickly and help their customers to the best of their ability. Naturally, banks will also have to ascertain how potential bad loans would affect their capital.
The EBA has also recommended that banks adopt a ‘green asset ratio’ (GAR) to show how their policy is environmentally sustainable. Have these environmental recommendations also been adopted by bankers and the banking community? How can capital profits and environmental protection go hand in hand?
As you know, the EU has prepared a long-term strategy that envisages climate neutrality by 2050. This requires a change in our productive and economic activities and, of course, banks must also follow this path.
Moratoria were extremely helpful during the crisis, but now, a year on, it is time for individual assessments of the needs of customers, rather than for generally applicable rules in this sector.
They must first ensure that such activities are adequately funded. Even more importantly, they must ensure that adequate funding is available on favourable terms and with proper risk analysis. From our point of view, we have presented this green asset ratio. This is a matrix through which banks can communicate with their stakeholders and present their strategy to them, so that they can better understand how the bank will work on its environmentally sustainable agenda, how the bank as an institution imagines climate neutrality by 2050 and how it intends to finance the economy. I think that banks are ready for this challenge and willing to take part in it. In answer to your question about whether there is a trade-off between profits and environmental protection, I can tell you that I do not see a compromise here, since it is not possible to confuse short-term profitability with long-term risks and long-term sustainability. I believe that for banks it is the long-term picture that matters, that they are about long-term, sustainable development, long-term viability and long-term profitability. That is why they must work sustainably and participate in the green agenda.
That’s true, but in the end it is the owners and managers of banks who need to make up their minds first. They must first internalise this green agenda within themselves.
Of course. It is a question of deciding how they wish to position themselves in the sustainable and green agenda. That is why we consult with banks on environmental, social and corporate governance (ESG) and strategy. Banks need to communicate about it, explain how they see their role, what activities they intend to finance, what risks they now have in their balance sheets from a green perspective and what kind of risks they intend to have in their balance sheets in the medium and long term, say in 10 or 15 years – and what their strategy is during the transition period until then. I am pleased that many banks in Europe are already communicating this to their stakeholders, explaining to them what they are no longer willing to finance and that they want to be climate neutral by 2050. These steps are now moving forward.
Banks have been facing new competition from financial technology companies for some time. And bankers complain that fintechs are less regulated and supervised than banks, so that market conditions are more favourable to their competition, while they themselves are too restricted by regulations set by the ECB, EBA, and so on. What is your view on this?
We are also actively involved with fintechs and digitisation. You are absolutely right that banks are a sector that is intensively regulated. Our view is that we should be neutral towards technology and should only assess the risks that it brings. In short, technology that brings the same risks to the system should have the same regulations. Of course, it is also important who manages this technology and how it will affect the other activities that this entity performs. In the case of banks that take deposits from customers, it is of course important that these deposits are adequately protected. On the other hand, not all fintechs take deposits from their customers and we need to evaluate this carefully. In the case of the digital agenda, we need to assess which parts of the regulatory framework new competition is appearing in, how it works and the ways in which regulations are oriented against or in favour of new players. We do this systematically. For example, many new players are appearing in the payments sector, on the basis of rules that are set not only by banks, but by all payment institutions. The second is the area of crypto payments, where we believe there are still gaps in the regulatory framework that need to be addressed. The European Commission has submitted a legislative proposal, which is now under public debate, and we hope that it will be adopted later this year.
In your opinion, what are the main challenges that European banks will face in the next 5 years?
I see at least two challenges in the medium term. The first is the question of the profitability and sustainability of their business models. Return on capital in the industry has to date, in recent years, been low. Banks need to improve profitability, they need to deal with cost reduction and risk structure, with their customers. The second aspect, closely related to the previous question, is how to meet the challenges of digitisation and technology. This means that banks need to adapt their business models and invest in new ways of doing business. This is a challenge that has only been exacerbated by the health crisis. Another important challenge that banks need to prepare for is sustainable orientation, which has already been mentioned.
As you know, there are also plans for a pan-European anti-money-laundering agency. The EBA gained new competences in this area last year. Would you like to take on this job yourself?
I think we are ready for that. Since last year we have had a mandate to implement an anti-money-laundering policy in the EU, and we have been actively doing so for more than a year. It is true, however, that our mandate is rather limited for the time being, and most of the supervisory work is performed by local authorities or local anti-money-laundering bodies. We have told the European Commission that this is problematic from the point of view of communication, coordination and the prosecution of these offences, so we strongly support the Commission’s proposal to strengthen regulation in this area. We hope that the European Council and the European Parliament will agree, because in this area the EU is only as strong as its weakest link.
Another of the challenges of the future is the digital euro. The ECB is due to make a decision on this in July. What is your view of it? Is it a new risk or a new opportunity for banks?
New technologies tend to bring new products, opportunities and risks. I think there are a lot of new opportunities here and indeed banks are already using distributed ledger technology (DLT). As far as digital currencies are concerned, we must, of course, distinguish between those issued by central banks – and the ECB already has a plan for how to proceed if it decides to do so – and privately issued digital or cryptocurrencies. For the latter, we would need to assess what they bring to users and whether the added value they bring is proportionate to the risks they could pose.
Finally, the EBA has celebrated its 10th anniversary this year. How do you see the institution?
Yes, the EBA was established in the middle of the last crisis and began operations in 2011. And when we were talking earlier about how the banking sector came out of the previous crisis and how it has come out of this crisis, and how banks are now stronger and better prepared to support the economy, we are happy with what has been done in these 10 years. There is more to do: we are still in the initial phase as far as the institution is concerned, but we are pleased with the achievements of these last 10 years.
The interview was conducted by Miha Jenko.
Delo, 8 May 2021.