While the banking sector was able to survive the immediate most severe hit of the crisis, there are no reasons for complacency....establish a harmonised administrative liquidation regime backed by a common insurance scheme to finance the transfer of assets and liabilities (transfer strategy tools)..
- Resolvability in times of COVID-19
So, to my first point: Resolvability in times of Covid-19.
The pandemic represents an unprecedented shock for the European economy
and worldwide. According to the latest European Commission’s 2020
outlook, broadly in line with the ECB’s GDP forecasts, the euro area
economy will contract by 7.8% in 2020 and will recover by 4.2% in 2021.
This
scenario would amount to a far deeper downturn compared to the great
financial crisis, when euro area GDP had fallen by 4.5%. Furthermore, an
asymmetric recovery across different sectors of the economy and Member
States is expected.
In contrast with the last crisis, this current
crisis did not originate from the financial sector. Indeed, the euro
area banking system entered the crisis on a much stronger footing than
at the start of the great financial crisis. Thanks also to the
regulatory reforms introduced, its resilience has in aggregate increased
in terms of capital and liquidity.
According to the ECB banking supervision, over the five years between Q4-2014 and Q4-2019, for significant banks
- the Tier 1 average capital ratio increased by almost 3 percentage points, to 16.1% (from 13.3%);
- the leverage has been reduced by 1.6 pp, to 5,6%;
- while the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) improved respectively to almost 150 and 114%.
- Finally,
for this five year period, the average gross NPL ratio decreased by 4.6
percentage points, to 3.2%, (from approximately 1 trillion to about 500
bln. in terms of volumes). In the second quarter of this year the NPL
ratio further decreased to 2,9%.
As regards the Minimum
Requirement for Own Funds and Eligible Liabilities - or MREL in
resolution jargon - between 2017 and 2019 banks continued to build-up
their capacity to reach the SRB requirements.
At the end of last
year, the average MREL shortfall reduced to 1% of total risk weighted
assets from 1.8% at end-2017, while the aggregate funding needs required
for compliance decreased to approximately 4% of the total consolidated
MREL requirement at end-2019, from 7,2% in 2018.
The build-up of
the MREL capacity continued in the current year, although at a lower
pace due to the impact of Covid-19; in the first two quarters of 2020
banks issued almost 180 billion of gross eligible funds, an amount 4,7%
lower than in the first two quarters of 2019 (chart 1). In terms of
volatility of funding costs, after the peak registered in March, the
indexes of subordinated and senior bonds have been progressively
recovering, however in October they have been characterised by
fluctuations and negative reaction to the renewed concerns over the
pandemic developments; at end-October the index on subordinated debt was
1.7 times the value registered before the virus outbreak (chart 2). By
the same token, gross bond issuances of euro area banks have shown
fluctuations in the recent period, while remaining in the lower issuance
range of the 2015-19 average (chart 3).
While the banking sector
was able to survive the immediate most severe hit of the crisis, there
are no reasons for complacency. The new wave of restrictions implemented
across Europe to curb the resurgence of the health crisis will again
increase uncertainty for households and corporates; as a consequence,
the impact on the banking sector itself is not yet clear and will
largely depend on the effects of the measures taken to support the real
economy and how industries fare during the crisis. On the positive side,
the baseline scenario underlying the vulnerability analysis conducted
in the summer by the ECB confirms that the banking sector is resilient
overall. However, the results also show material consequences should
tail risks materialise. Under the more adverse – much less probable -
scenario, capital depletion could lead to an average decline of 5.7
percentage points in core capital - the Common Equity Tier 1 ratio -
with a potential increase of non-performing loans (NPLs) to around €1.4
trillion, much higher than in the great financial crisis.
Against
this background, the uncertain outlook poses significant challenges to
financial stability. This is why a strong resolution framework that
prepares for and can manage bank failures is a key element in mitigating
the negative impact of the current crisis. When it comes to resolution
planning, at the SRB we have been carefully monitoring the impact on
banks and financial markets and have joined the other authorities in an
effort to alleviate the immediate operational burden on banks. At the
same time, we continued to ensure that banks make progress to strengthen
their resolvability.
Let me mention some of the actions we took
in connection to COVID-19. We had to balance the need to provide relief
to banks to face the current economic (and operational) challenges, and
the need to make progress on the requirements to become “resolvable”. On
the operational side, we postponed less urgent information or data
requests, in line with the EBA’s recommendations. Overall banks managed
to respect the limited extension of the deadlines, therefore our 2020
resolution planning cycle remains well-on track.
In terms of MREL
requirements, since the legislation envisages that the capital buffers
are added on top of MREL, the SRB has implemented the capital relief
measures taken by some national macroprudential authorities. In
addition, as regards existing binding MREL targets, i.e. those set under
the BRRD1 rules, the SRB announced that it would take a forward-looking
approach to banks that may face difficulties in meeting these targets
before new MREL decisions under the new BRRD 2 rules take effect; the
new provisions envisage binding targets, an intermediate one in 2022 and
a final one in 2024.
Finally, the SRB has assessed the need to
adjust transition periods for the build-up of MREL. We have recalibrated
intermediate targets with data referred at June 2020 when we found
material balance sheets changes with respect to the information referred
at December 2019. At least so far, the need for such adjustments was
limited. The SRB will continue to monitor carefully market conditions
and will assess the potential impact on transition periods needed for
the build-up of MREL.
We believe that this pragmatic approach
provides banks with the flexibility they may need in the coming months,
as well as ensuring a level playing field. At the same time, our
collective work on resolvability should carry on to preserve financial
stability and protect taxpayers.
As concerns the prospects of the
banking system going forward, it is of utmost importance to monitor
closely the evolution of the non-performing loans (NPLs). While so far
the crisis has not led to a noticeable increase in deteriorated
exposures, banking supervisors expect a rise of non-performing
exposures, particularly once public support measures, such as payment
moratoria, expire. Against this background, it is key that banks are
ready to cope with the likely surge in NPLs. Banks are required first to
implement adequate policies for the early identification and
measurement of credit risk. Second, they should build the operational
capacity to manage effectively the increase in distressed or defaulted
exposures. Third, intermediaries should ensure adequate levels of
provisioning for their loan books. These actions would make the disposal
process of the NPLs smoother and faster and would allow banks to
minimise any potential cliff effects when the moratoria and other
government support measures begin to expire. On the contrary, any delay
in the NPLs recognition jointly with a poor management of deteriorating
asset quality could negatively affect banks’ balance sheets in the
short-to-medium term. This would also hinder the capability of banks to
support viable firms and households and ultimately the economic
recovery.
In this context, the proposal for a directive on credit
servicers, credit purchasers and the recovery of collateral, currently
undergoing the final stages of negotiation between the European
Parliament and the Council, aims at fostering the development of
secondary markets for NPLs by tackling undue obstacles to credit
servicing and to the transfer of bank loans to third parties across the
EU. The proposal provides inter alia for a definition of the activities
of credit servicers, establishes common standards for authorisation and
supervision and imposes conduct rules across the EU. As a complement to
this initiative, a central platform, eventually run at EU level with
common standards for valuation and due diligence, including vendor data
rooms, could well support the functioning of the NPL secondary markets.
The
deterioration of banks’ asset quality is expected to further worsen
banks’ profitability, which continues to be one of the structural
weaknesses of the euro area banking sector. Indeed, euro area banks have
registered an average return on equity close to zero in the second
quarter of 2020, from 6% an year earlier, and market data show that EU
banks’ share prices are currently priced 28% lower than in December
2019.
The pandemic has also triggered a decisive push in the
demand for digital products. In order to cope with the increasing
competition from non-bank players and newly established credit
institutions with specialised business models, banks should exploit this
situation to accelerate the digital agenda in their planning, as well
as the reorganisation of business models to become more efficient. In
this regard, consolidation of the banking system could be a way to deal
with the challenges of low profitability and digitalisation, reducing at
the same time the current excess capacity. Some ongoing initiatives
signal that banking groups are seriously addressing these topics.
Although there is no role for resolution authorities in the approval of
consolidation transactions, the SRB supports any market initiative that
enhances viability, and is in close dialogue with the supervisory
authorities and the banks themselves. If well designed, such
transactions bring benefits not only in going concern, but may present
opportunities to strengthen banks’ resolvability.
2. Looking forward: SRB programme for the next few years
Now, ladies and gentlemen, I want to move to my second point: the SRB’s programme for the coming years. In
these unprecedented times, work on resolvability and crisis readiness
to ultimately supporting financial stability will be even more
essential. The SRB has set realistic but ambitious objectives in its
multiannual work programme, covering the period 2021-23. Let me mention
some of them.
On resolvability, the focus will be on the
implementation of the “Expectations for Banks”, the best practices
document published by the SRB last April. It is a key reference document
for banks to build, under the SRB steer, the capabilities to become
resolvable gradually, by 2023. This is the deadline to implement such
expectations, and the next resolution planning cycles will give us the
vehicle to advance. In addition, the SRB will further operationalise
resolution plans, making the resolution strategy actionable at short
notice. In the 2021 cycle, the SRB expects to adopt 109 resolution plans
and 233 MREL decisions. The SRB will also start some pilot on-site
visits at the banks, to check certain aspects of the resolution
framework; over time, leveraging on these first experiences, the SRB
will develop the capacity to perform fully-fledged on-site inspections
on resolution topics, which will be carried out in full cooperation with
national resolution authorities.
As regards the policy framework,
the SRB will refine and update the MREL policy to complete the
implementation of the banking package, including guidance to respond to
MREL breaches, implement the new provisions of the eligibility framework
as well as the EBA RTS on various MREL-related aspects. The SRB will
also develop a new methodology to conduct resolvability assessments,
fully based on the Expectation for Banks, which will feed into a heatmap
aimed at tracking individual banks’ progress and benchmarking across
banks. This will also be used as a basis to take formal action to remove
substantive impediments, if banks’ progress is found to be
insufficient.
The SRB plans also to extend its approach on the
Public Interest Assessment (PIA). In particular, the PIA of each bank is
revised annually as part of the resolution planning, but also at the
point of failure, which allows to take into account the prevailing
circumstances at that point in time. The implementation of the PIA has
been subject to academic and policy debate, focussing on possible
refinements and enhancements. I will mention the following aspects:
first, the possible consideration of system-wide events also at the time
of resolution planning in the context of assessing the financial
stability objective; second, the enhancement of the approach to the
protection of covered deposits, by assessing the financial stability
implications stemming from the funding of the DGS in case of large
pay-outs; third, while resolution is the strategy chosen for most of
banks under the SRB remit, the assessment of the impact of a failure on
the disruption of critical functions of banks at regional level, in
addition to the impact at national level, could still be worth
exploring. I believe the current legislative framework provides the
right level of flexibility for the resolution authorities to perform
these enhancements in an effective way.
On crisis preparedness, a
key focus will be on resolution tools other than bail-in. In 2021 work
will concentrate in particular on the operational preparatory steps for
the sale of business tool (from virtual data rooms to due diligence
process, etc.). In addition, we continue to perform crisis simulations
(dry-run) to test our preparedness: handbooks, ICT platforms,
cooperation procedures, etc. The SRB performed two dry-runs in 2020; the
objective for 2021-23 is to perform several other dry-runs, simulating
the entire management process and decision making in resolution cases
and drawing lessons on the basis of the results obtained.
3. The revision of the crisis management framework
I now move onto my third and final topic: the revision of the crisis management framework.
As I mentioned earlier, the efforts made after the greater financial
crisis – in particular the prudential and crisis management reforms and
the creation of the Banking Union - allowed the European banking system
to weather the challenges brought about by the Covid-19 crisis thus far.
However, this does not imply that it will continue to be so in other
stages of the crisis or in similar situations. The completion of the
Banking Union would instead allow facing the evolution of this or other
crisis in a much better way. In this context, the enhancement of the
crisis management framework will be key in the next few years. Let me
touch briefly on the most important shortcomings and the possible ways
to address them from my personal point of view.
In the first
place, in the current framework a limited number of banks, if deemed
failing and with a negative PIA, would still be subject to different
national insolvency frameworks. This may create some challenges. The
no-creditor-worse-off principle (NCWO) – which seeks to ensure that the
treatment of creditors in resolution is not worse than the treatment
they would have received under normal insolvency proceedings - becomes
very difficult to assess and to meet with different national procedures,
and for cross-border banks may result in different outcomes depending
on the home country of the institution. In addition, the criteria for
liquidation are not aligned to those underlying the failing or likely to
fail assessment, so there is the risk – and it materialised already -
that banks do not exit the market in a relatively short time frame after
they have been declared FOLTF and with a negative PIA, but they end up
in a ‘limbo’.
A second topic which is also under discussion among
policy makers concerns the challenges faced by some medium size
deposit-funded banks which lack an easy access to wholesale funding
markets and could be too small to be resolved but too big to be
liquidated.
In my personal view, a possible solution to these gaps
would be to establish a harmonised administrative liquidation regime
backed by a common insurance scheme to finance the transfer of assets
and liabilities (transfer strategy tools). Similarly to the FDIC, a
common deposit guarantee system able to provide financial support on a
least cost basis as an alternative to pay out of depositors would be a
much more efficient solution. Not only would this ensure centralised
decision-making, but it would also allow for the application of a
harmonised and effective toolbox. In this context, such a common deposit
guarantee system should not enjoy the super-priority ranking granted to
national DGSs under the current framework, and the application of the
least cost test should become a common feature for the access to common
funding.
By contrast, the option of having only national deposit
insurance systems to finance the sale of business would perpetuate an
uneven playing field for banks and depositors across the Banking Union,
lead to higher fragmentation of the banking sector across national lines
and increase the sovereign-bank nexus. The creation of a fully
mutualised deposit insurance scheme remains therefore an essential
component of any solution in the medium to long term, and transitional
solutions based on national guarantee systems should be geared towards
it. It would also help to overcome ring fencing, and enable a better
flow of capital and liquidity across the Banking Union, which would in
itself increase private loss absorption. This is why we need political
agreement to build gradually a common system.
* * *
Conclusion
In conclusion,
these are strange and challenging times. The European response by the
monetary, supervisory and resolution authorities as well the fiscal
response by governments to the outbreak of the Covis-19 crisis have been
larger and more coordinated than ever before. We will come out of the
crisis stronger if we continue to act together. Given the uncertainty of
the economic outlook, work on resolvability becomes even more important
to safeguard financial stability and protect taxpayers. The completion
of the Banking Union and in particular the enhancement of the crisis
management framework would greatly facilitate this task. Resolution is a
field in evolution, where research, analytical and policy studies like
those you are conducting at this Academy may provide a lot of value.
Thank you for your attention.
SRB
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