José Manuel Campa interview with Corriere della Sera: "Banks are robust but we need to monitor borrowing"

On the rise in interest rates, ‘we need to take a broader view because this is going to have an impact on the whole economy’, says José Manuel Campa, Chairperson of the European authority that prepares scorecards for the banks.

Possible scenarios include credit losses and lower value assets.

In terms of financial stability, how are banks reacting to the rise in interest rates?

‘This rise in interest rates has probably been the fastest rise in recent decades,’ replied José Manuel Campa, Chairperson of the European Banking Authority, when speaking to Economia del Corriere during a break in the Mediobanca Italian CEO Conference held in Milan last week. ‘And it comes after a period of very low rates, which lasted longer than expected. The net interest income of many banks has increased because the adjustment of asset prices has been faster than the adjustment of liabilities. This is not the case for all banks; it depends on their business model. But, of course, the interest rate cycle is longer than that.’

What do you mean by that?

‘It's not just about net interest income, but also about the impact that the rise in interest rates has on the value of assets: fixed-income assets, but also other financial and real estate assets.’

Should we take a broader view when assessing the impact of rising rates on banks?

‘Definitely. For example, we have to look at the impact on the economy, the potential increase in credit losses and the general decrease in asset quality. We’re now in the middle of the bank stress tests, and will publish the results in July. Our adverse scenario predicts high inflation, high interest rates, which will have an impact on asset prices and lead to a decrease in economic activity and higher unemployment. I think that is a relevant hypothesis that hasn’t yet materialised. Employment continues to show a good performance and production is better than what was predicted a year ago. The implications for economic activity have been mild so far. However, all aspects will have to be evaluated.’

What about the stability of financial intermediaries other than banks?

‘This is important because, over the last decade, there has been a major shift of financial assets away from banks. For us, it's difficult to see what's happening in non-banking intermediation, but it could have an impact on financial stability and thus cause repercussions for banks. It’s an area of concern. Certain phenomena occurred last year, such as problems with UK pension funds and volatile cryptocurrencies.’

What impact is the rise in rates having on credit availability and prices?

‘Credit terms have become tougher. Banks tell us they are increasing interest rates and putting more restrictions on granting loans. The rise in rates is having the consequences that were intended and expected. The result has been a slowdown in lending growth: lending volumes across the European Union hardly grew at all in the first quarter. I don’t think we’re witnessing such a credit crunch that people who should be eligible for loans are not able to get them. But some credit terms have tightened. Interest rates on existing loans are being adjusted, which puts pressure on the disposable income of households or businesses with variable-rate debt.’

You mentioned the ongoing stress tests. How are these going to go?

‘Well, we have to wait for the results. I don't have them yet, but I can say there are at least two things to consider. The first is that the adverse scenario hypothesis we are working on is, I think, the correct one, with higher inflation leading to higher interest rates for a longer period, having an impact on economic activity, which decreases, with higher unemployment and an increase in defaults on loans. This also comes with a correction in share prices, fixed-interest securities, real estate prices, which will experience sharp drops. The second aspect is that this year we’re paying close attention to the sectoral breakdown of credit quality, because the shock that has hit the economy has been asymmetrical.’

Aren't these all reasons for concern?

‘They are. But the banks are starting from a rather good position. At the end of last year, capital ratios were averagely high, NPL levels were low, and credit quality was good. So, even if the shock of our adverse scenario is potentially huge, I think that banks are able, on average, to absorb that shock.’

What are the lessons that Europe should take from the collapse of Silicon Valley Bank and other US regional banks?

‘The first is the necessity of managing interest rate risk. That’s very important. And this is an area we are monitoring closely: Europe has stricter banking regulations than US regional banks. The second lesson is about risk diversification. In the case of Silicon Valley Bank, there was a concentration of fixed-income portfolios and a concentration of deposits; a very large amount of bank deposits, with very few depositor companies, all concentrated in a specific sector with large amounts of uninsured deposits.’

And the third lesson from SVB’s failure?

‘It’s about the impact of digitisation on bank runs. There were no queues outside the branches; bank runs are becoming digital in nature and this needs to be monitored better. For us, then, the lessons are about the stability of deposits and the speed with which bank runs can occur. We therefore need oversight and monitoring of social media and communications by banks and supervisory authorities.’

The interview was conducted by Federico Fubini

Corriere della Serra (Italy)