José Manuel Campa interview with Delo: Bank profits likely to have peaked

  • Interview
  • 17 MAY 2024

Bank profits likely to have peaked

When interest rates began to rise, banks and their supervisors, and us too at the EBA, all expressed our expectations on the quality of bank assets, says José Manuel Campa.

‘Our recent stress tests have shown that, even under truly adverse conditions, the banking sector in Europe holds up and is able to continue financing the economy, which is good,’ says José Manuel Campa, Chairperson of the European Banking Authority (EBA). We spoke to the Spanish economist about the challenges facing the European banks, about interest rates, the economic environment, the new stress tests, how green bank balance sheets are, and the importance of the upcoming European elections.

Mr Campa, 2023 was initially somewhat turbulent for European banks, especially with the difficulties seen in the US and Swiss banking sectors. However, they mostly seem to have ended the year well, at least in terms of profitability, liquidity and capital adequacy. Do you agree?

Yes, absolutely. Despite those events, European banks have performed well and have come through this period in good shape. And not just because of their sound financial management, and the capital levels that they had and still have. I should note here that last July we published the results of our stress tests, which we run every other year. At the time, we also drew up an adverse scenario that was quite pessimistic regarding the economic forecasts. It envisaged rising interest rates, high inflation, and high unemployment. The stress tests showed that even under these truly adverse conditions, the banking sector in Europe holds up and is able to continue financing the economy, which is good. As for the actual performance in 2023, it also pointed to good profits and liquidity for banks. By year-end, banks saw higher profits and a return on equity that they had not seen in many years, and the same was true of their liquidity.

Banking portfolios reflect the society we live in, because banks lend money to our society

Yes, although the risk analysis done by the EBA last year suggested that the credit portfolio quality is deteriorating. Can you tell us more?

Of course. When interest rates began to rise, banks and their supervisors, and us too at the EBA, all expressed our expectations about the quality of bank assets. Events of this kind are quite common in the economy. As interest rates rise, credit conditions tighten, economic growth slows slightly, and the credit portfolio quality deteriorates. Following all the months of rising interest rates, there was an increased tightening of credit, at the same time economic growth slowed down and we went through several quarters of virtually zero growth. But the overall quality of the credit portfolio did not deteriorate, partly because the economy is still working, and the unemployment rate remains low, which is good. However, we can see certain vulnerable points and credit risks that have materialised. One of these is the commercial real estate sector. There have been some credit downgrades resulting from exposure to the US real estate sector, but not only due to this. Certain risks have been created and we have already seen damage and provisioning as a result, while the share of non-performing loans in this sector is increasing.

Another area we are focusing on is lending to SMEs, corporations and consumers. The overall NPL share here is still very low.

Recent data released showed that certain major European economies, including France and Spain, are recording higher-than-expected growth in the first quarter. Do you have any comments?

When interest rates began to rise, there was a risk that they would spill over into the economy, which could lead to a slowdown in economic growth, a potential rise in unemployment, and a credit deterioration. So far, this cycle has been a lot less bumpy and more benign than initially expected. This is good news for the economy, and for the public. And also good news for banks. The economy has weathered the rise in interest rates much better than expected.

To sum up then, can we talk about a soft landing for the European economy and the European public?

I certainly hope so. This is the path that the ECB has tried to lead us down.

What is the impact of the weak economic environment and very low economic growth in certain EU countries on lending and banking activity generally?

As I said earlier, the slowdown in economic growth during the rise in interest rates did less harm than we initially expected. This is good news. Although it is true that credit growth is slowing. This is partly a deliberate consequence of tighter lending conditions and the interest rate policy.

At the same time there are no signs of a credit crunch or a credit squeeze, at least in our opinion. So, for borrowers with viable projects, there is no difficulty in obtaining loans. The banking sector seems to be channelling its lending in the right way. Admittedly, it is more costly, because interest rates are also higher than before. But that’s the way things have to work.

What are your predictions for the financial stability of the euro area?

The business conditions for banks are good, and healthy. Banks have sound capital and liquidity indicators, low NPL ratios, and higher profitability. That’s a good starting point. But there are still major uncertainties in the macroeconomic area, and here I would highlight two broad factors.

One of them is geopolitical uncertainty, which can materialise in different ways. First, in the Russian invasion of Ukraine and the war, and then in the rise in energy and commodity prices, which shot up to very high levels. We have seen huge pressure on the markets, and then the fragmentation of global value chains. Then there is the second area: cyber risks, cyberattacks and disruptions. So far, this has not materialised, but we need maximum vigilance in this area.

New stress tests are planned for next year, 2025. They are run every other year, and each bank is assessed separately.

Another aspect is the evolution of interest rates. If they remain at current levels, or start falling as signalled by the central banks, this would again lead to a normal credit cycle. This is better for the development of the economy, unless there is financial instability. If inflation persists, interest rates would have to rise again, thus increasing the pressure points. From a banking sector perspective, we believe that the high profitability levels seen last year and which have continued in the first quarter of this year are probably close to the peak. We are seeing signs of credit quality deteriorating slightly, which would negatively impact profitability. Similarly, the short-term effects of interest rates have already materialised in banking profits. Banks now have to find funding in an environment with less liquidity, and they have to seek money on the market, which is likely to be more expensive in the future. All of this will have an impact on interest margins. Our view is that banks have already reached their peak of profitability, probably right now.

Do you expect the European Central Bank to start reducing its interest rates in June?

I don’t know. I don’t have any details of this (he laughs). However, there has been some signs of this from several members of the [ECB] Governing Council. But I feel that the ECB has shown, if I might paraphrase, that it is data driven. So, I think it will rely heavily on the news over the coming weeks on inflation and GDP, and make a final decision on that basis.

European banks have recently called on Brussels to declare them a key strategic sector, while, at the same time they have warned about their competitiveness, and therefore that the future of the Union is at stake. What is your view of this?

Banks play a leading role in the EU when it comes to financing the economy. They provide key services for households and businesses. When we think about big challenges facing the EU, there is the transition to a more sustainable economy, which requires major financial investment. Then, there are the challenges linked to major European projects in different areas. Here, we are talking about defence, infrastructure, the so-called strategic sectors. All of this will require investment and financing at European level.

Obviously, in the EU, we will finance these investments with both public funds and private, market-based resources, especially for projects that the banks do not usually participate in with equity. Here, banks will play a key role, but not on their own; rather in the broader context of the entire financial sector that the banks are at the heart of.

The European Banking Authority, the EBA, is an independent institution and reports to the European Parliament, the European Commission and the European Council. Next month there will be the European Parliament elections. How important will they be for you?

First of all, as a citizen, I can say extremely important. This is a democratic process in which we as citizens can contribute to Europe, and have our say in it by electing our representatives to the European Parliament. This is an important process that we need to take seriously.

Every election is important, but this one in particular because in the end we have to garner enough momentum to make Europe ready for the future. And when I talk about Europe, I think about us. As we said earlier, this requires a wide range of decisions to build more Europe, to invest in the transformation of our industries, to develop strategic sectors, and to deliver on security and defence. All of this requires more Europe. A resounding message in this direction would provide the right impetus.

For us, the European Parliament is a very important stakeholder, as is the Commission, which will also be replaced towards the end of the year. We look forward to working with all of them in the future. So far, the European Parliament and the Commission have supported our mission fully, and the EBA as an institution. I expect them to continue doing so. And I hope that together, from within our mission, we will contribute to a prosperous Europe by ensuring stability for the financial sector, and developing single market rules for banks and supervisors. And not just for banks, but also for payment institutions, cryptocurrency issuers and others, to ensure what we call digital operational resilience. We are preparing for all this, and they are very important to us.

So, how do you see the future of the European banking union, another of the pillars of Europe?

I am glad you asked that. It is essential that we continue working towards a banking union. This is a major, ground-breaking project, that started ten years ago, that clearly needed a single set of rules, and the coordinated and cohesive supranational supervision of institutions. And this is in the hands of the ECB. In addition, we have a regulatory framework for the resolution of banks in difficulties. And we must make further progress on this. There has been progress made in relation to bank deposits, and we have moved forward on banking supervision, bank resolution and recovery measures. As you know, there is an important part of the legislation still under discussion, and this is crisis management. We have to make more improvements on this. The European Parliament adopted a report on deposit insurance just over a month ago, and this is progressing. We must continue to push for institutional and regulatory progress, and ultimately deliver better and more competitive banking services within the Union. That is why it is essential for us to finish the work that remains.

Every election is important, but this one in particular because in the end we have to garner enough momentum to make Europe ready for the future.

And you will have to complete this task with the future European Parliament and Commission?

Yes. And don’t forget the European Council, and the governments.

Of course. What’s your view of the Slovenian banking sector?

Looking beyond the banks, there is a feeling that your economy is very strong. My impression is that Slovenia has integrated very successfully during its twenty years of EU membership, living standards have risen, and the welfare of the Slovenian people and the economy has increased. Banks operating in the region also have good capital and liquidity ratios, and low NPL ratios. My impression is that banks are generally sound.

By the way, how do you, as a Slovenian citizen, see these twenty years that Slovenia has been part of the Union?

There have been ups and downs, but in the end it still is quite a success story. More could be achieved, of course. As you know, we had problems in the financial sector, and a very costly bank bailout. Later, after 2014, we had above-average economic growth within the EU. But I believe that the Union is more than just finance and banks. We are now part of Europe, we can travel freely, young people can study abroad under the Erasmus programme. Twenty years on, Slovenia is back in the Europe it has always belonged to, politically, economically, and culturally. We are now part of a great continent of 500 million people, this is our common home, and we must protect and look after it. In short, membership of the Union has been a success for us.

I am glad to hear that.

Good. And how do you see the main challenges for European banks over the longer term, until 2030?

In the short term, I already mentioned geopolitical tensions, the economic environment and interest rates. Beyond this, there are two fundamental trends for the banking industry. The one I have mentioned is sustainability, and transitioning to sustainability. This will bring about significant changes in banking portfolios, and in risk management in banking. Banks will need to re-assess their portfolios, and acquire the knowledge and experience to manage these risks properly.

The second aspect is technological progress. I hope banks take advantage of the good business cycle to use their high profits to invest in the future. And this requires major investment in technology. So that they enhance resilience and cybersecurity, making sure that they are sufficiently protected against potential attacks and that their systems are robust enough and operational. The second aspect is to improve their internal processes to make them more efficient, and the third is to focus even more on their customers and, in competition with other providers that are already present or are likely to arrive, to provide them with a better service than the others.

Yes, new competition for banks has been coming from the crypto sector and from fintech firms for some time now. Some bankers are also concerned about the introduction of a digital euro. What do you think of this?

We are following the digital euro project very closely, and have a part in it. This is an ECB project. We are not directly involved in it, but we are responsible for regulating privately issued digital currencies. Cryptocurrencies issued by banks or other financial institutions must comply with our regulations, and if they ultimately become large enough to have an impact on the euro, they will come under our direct supervision. We are following this very closely. All of this is part of the technological progress. Banks need to adapt to this technology, and find ways to profitably integrate it into their business. We are a regulator, and we pay more attention to risks. We want to make sure that the risks posed by these technologies are properly assessed and managed. A digital euro is similar to the introduction of privately issued stable currencies in the EU, and is part of the process of technological advances that banks must adapt to.

When are you planning new stress tests for European banks?

New stress tests are planned for next year, 2025. They are run every other year, and each bank is assessed separately. We will probably start early in the year, and publish the results sometime before the summer.

But we do all kinds of tests, and right now we are doing climate stress tests, not for each bank separately, but for the banking industry as a whole. We are working together with regulators for insurance corporations and in asset management. We are preparing an assessment of the robustness of Europe’s financial industry - of banks, insurance corporations, and asset management companies - to see how ready it is for the challenges of the ‘fit for 55’ strategy. This strategy underpins the transformation of the EU economy by 2030. The results will probably be published by the end of this year.

Bankers are keen to talk about ESG principles, which also include environmentally responsible behaviour. But how green are the portfolios of European banks in reality?

A fair answer would be that banking portfolios reflect the society we live in, as banks lend money to our society. The banking sector in general is as green as the things that we do. We know that we have to make the transformation to get where we want to be in twenty or thirty years’ time. And banks need this transition too. That is why we are now putting pressure on them on two fronts.

First, they have to disclose their portfolio size and other information. It is important that investors and other stakeholders can assess each bank separately, and judge how green they are. Second, we require banks to have clear plans for their transformation towards a sustainable economy. And to tell us how they are acting, and where they want to be in 2030 or 2050.


The interview was conducted by Miha Jenko

Delo (Slovenia)