30 December 2020

SSM's Enria: wide-ranging Interview with Börsen-Zeitung

To be honest, it was a difficult decision. Indeed, we had different views in the Supervisory Board. There was a lot of pressure from the banking industry and from investors, and there was still a lot of uncertainty. So it was indeed a balancing act. But in the end we obtained very broad support for this solution.

You felt pressure from banks and investors. From politicians as well, for example from the European Parliament?

When I first joined the ECB in 1999, the then president, Wim Duisenberg, quoted the lyrics of folk-rock duo Simon & Garfunkel: “hearing without listening”. We may have had pressure from several sides but our board is, ultimately, fully independent. The European Parliament has always shown a more conservative attitude. When a substantial amount of public support is being given to banks and to borrowers, they clearly fear that this will be distributed among shareholders rather than being used to support the economy and households. That is a very important factor that we take into account in our decisions.

It is obvious that the burden on banks will increase in the course of the pandemic. In an adverse scenario the ECB has estimated that the amount of non-performing loans (NPLs) in the euro area might reach €1.4 trillion by the end of 2022.

At the moment, the key focus of our supervisory activities is the proper measurement of credit risk. The banks still have some way to go in that respect.

How do you know?

One month ago only 21 of the 113 significant institutions were able to forecast the level their NPLs will have reached by the end of 2021. There is still a lot of uncertainty over future credit risk and banks need to prepare for an increase in NPL levels.

Three years ago you had already begun to champion a secondary market for NPLs through the creation of dedicated asset management companies (AMCs). A few days ago the European Commission launched a new NPL action plan calling for a network of national AMCs. Why are banks so reluctant to use these companies?

Banks are not reluctant, to be honest. Right now there are several AMCs already operating – in Ireland, Spain and Italy, for example. But you’re right: I first made this point in 2017. Because one thing we did not get right during the financial crisis was that we took far too long to clean banks’ balance sheets. Only in 2019 did NPLs on European banks’ balance sheets return to their pre-crisis levels. In the United States it took them just three years from the 2008 shock to achieve this. But to work quickly you need the appropriate tools and I think AMCs are among the most effective.

So would you consider supervisory incentives for banks which are using an AMC, as a way of promoting this tool?

We wouldn’t use the carrot in this case – we would rather use the stick. We are putting pressure on banks to reduce their NPL levels. We are asking them to fully provision for these assets within a set period of time and to submit realistic and ambitious NPL reduction targets to us.

Besides NPL vehicles, cross-border mergers and acquisitions are seen as a solution to the problems in the European banking sector. The ECB has gradually warmed to that idea.

We are open not just to cross-border consolidation but also to any type of mergers and acquisitions. The reason for supporting consolidation is not really to increase cross-border integration. Nor is it about creating larger banks. The point is: after every crisis you need to reduce excess capacity in some way. In the European banking sector this process was not completed in the wake of the great financial crisis – and is still not complete. Several banks have remained in the market because they have enjoyed public support and because funding costs have been extremely low, not least in the light of the very accommodative monetary policy. The business models of these banks are not viable from a long-term perspective. So we think consolidation could be a trigger for banks to refocus, become more cost-efficient, invest more in technology and digitalisation and achieve higher profitability. This is a purely prudential concern.

Is there a ballpark figure you could give us on how many banks lack a viable business model?

No. But I would like to give a positive signal here. The crisis has been a very bleak moment for us all but from the perspective of restructuring and restoring efficiency to the banking sector it has been a catalyst for change. Several CEOs have told me that their productivity has increased substantially, sometimes by 20% or 25%. Several banks have slashed their branch networks by 30% or more. Others are biting the bullet and reducing staff numbers that were no longer sustainable. Some banks are making substantial investments in payment platforms and new digital distribution channels. And we have also seen some steps towards consolidation, especially in Italy and Spain.

In the Italian banking sector hardly a stone has been left unturned in recent years as, for instance, cooperative banks also have merged as a result of pressure from the ECB. In Germany that hasn’t been happening to any great extent, has it?

I think we have already seen a strengthening of the German cooperative banking sector in terms of integration and with regard to institutional protection schemes. The association of Sparkassen, or savings banks, is now engaged in a productive debate on these matters and in a constructive dialogue with the supervisory authorities.

The ECB is asking the Sparkassen to seek declarations from the municipalities, as their owners, of unlimited liability in the course of the reform of their institutional protection scheme. But this would cause problems for them, as it runs counter to municipal law.

I don’t wish to enter into the specifics of this issue. The key point for us is this: when you have these protection schemes at sector level, they need to function properly so that the banks can take decisions quickly and deploy their resources effectively in the event of a crisis.

The ECB is not only reviewing institutional protection schemes, it is also significantly tightening its fit-and-proper requirements for bank executives.

We have been quite vocal for some time now about our dissatisfaction with the current framework, which is enshrined in directives that are being implemented in very different ways in the Member States. In some countries, for example, the assessment only happens after the directors have been appointed. So we plan to publish a revised guide soon to clarify how we will perform fit and proper assessments. The idea is to establish a Europe-wide process.

How will you do this?

We will ask banks to inform us of their intention to appoint a director, before the appointment is made. That will enable us to provide feedback in advance, if there are potential issues with the appointment. We will look more carefully into the accountability of individual directors. If they have been members of boards which have been lax or guilty of misconduct in the past, for example, we will take those issues into consideration. And we will also clarify how we will review suitability assessments in the event of new developments. For instance, if a bank is fined because of major breaches related to money laundering, you need to reassess the current board to see if board members bear specific responsibility and if they are still fit and proper in the light of this new evidence. We are also working on the application of new technologies in order to make the compliance process less cumbersome.

An ECB survey has concluded that information technology (IT) risk management in banks is better when one or more board members have a certain level of IT expertise. Will IT expertise requirements be introduced for boards?

We have noticed that boards with members who have IT expertise are more effective in containing cyber risks and we have recommended that banks consider this aspect very carefully. But in general I don’t think we should take a rules-based approach that would require each board to include an IT expert. The suitability assessment is not only about individuals. It is about the overall diversity you want to have on a board. A diversity of perspectives, professional skills and gender is an important factor in fostering viable governance for banks and challenging the CEO and the managers in a credible fashion.

You have said that “banks cannot be left at the mercy of the supposed genius of a dominant CEO”.

Boards need to be able to challenge management and offer different perspectives when necessary. To do so, they need members with sufficient banking expertise. When this is lacking, we express our concerns and ask banks to remediate. For instance, we have seen many banks with very poor data management. If we see such a problem, we will advise the bank to fix it by attributing specific responsibilities to a board member.

You have also stressed the importance of corporate culture in banks. Where are the main deficits?

When I saw the chain of scandals that took place in the aftermath of the Lehman crisis – rigging benchmark rates, mis-selling products, money laundering and the like – I thought that to some extent they were a legacy of the misconduct that had led to the crisis, and that things would return to normal. Instead, such activities are still occurring. We have seen a number of difficult situations at banks that have put their reputation, and sometimes their business viability at risk. This means we need to establish a strong culture in banks. This process will take time and the ultimate responsibility lies with the banks themselves, but we will definitely continue to push for change.

Does the ECB have an ambition to take on a new role, as the EU anti-money laundering authority that is going to be established in the next two years?

No, we do not. The Treaty says specifically that we cannot take on these types of responsibilities. But as prudential supervisors we of course have a great interest in ensuring that these tasks and responsibilities are carried out in the most effective way possible. We think that, since money laundering is inherently a cross-border business, it is important to have a stronger European perspective. This could be achieved by developing a much more harmonised regulatory framework and, ideally, setting up a European authority.

Would you prefer to see the new authority established within the European Banking Authority or as a separate organisation?

That is not up to us to decide.

The Basel Committee on Banking Supervision recently declared an end to the regulatory reforms that followed the great financial crisis. Are we at the peak of the regulatory cycle right now or is it already behind us?

The last package endorsed by the Basel Committee, which now has to be implemented, is definitely the conclusion of the post-financial crisis regulatory cycle. And I think we are all experiencing a kind of fatigue – on the supervisory side as well as on the industry side. Sometimes I hear industry voices trying to use the coronavirus (COVID-19) crisis to ask for postponements of and changes to the Basel framework.

There has been already a delay of one year…

Yes, and the phase-in extends until 2028 for the most impactful measures. So I think that it really is time to bring this process to a close. It is important that this package is now transposed into European legislation and implemented.

After regulation has reached its peak, will it then level out or will the requirements be reduced again?

These are structural changes to our regulatory framework. I don’t think we should be cyclical in this. We should try to maintain the current level of prudential requirements, as enshrined in our regulatory framework, for a long time to come.

After the Single Supervisory Mechanism was introduced at the end of 2014 it was obviously in start-up phase for a while. Now that it is fully up and running, and fully equipped, what is on your agenda for the next five years?

My mandate will end in three years so that is my target time frame for planning purposes, which is long enough. I’m afraid our agenda will to a large extent be dictated by the developments and repercussions of the COVID-19 pandemic. This will drive structural changes in the composition of our economies, so the banking sector will have to adjust significantly.

In what regard?

There will be two major groups of problems. The first consists of risks arising in banks’ balance sheets from these developments, mainly credit risk. That will keep us busy for one to one and a half years. The second consists of structural repercussions in terms of digitalisation, cost efficiency and consolidation.

What else is on the cards, other than the repercussions of the crisis?

I see three main areas. One is green finance and sustainability – climate change brings long-term risks which need to be managed now. The second is cyber risk, which is becoming more and more relevant for banks.

Has the number of cyber incidents increased during the pandemic restrictions?

There has been a certain increase in attacks, especially distributed denial of service attacks and phishing attacks on customers. To be honest, having seen all the banks moving to remote provision of services, and knowing that many banks also had outsourcing contracts with companies in other jurisdictions during an extensive lockdown, I have so far been pleasantly surprised that we did not experience a huge spike in cyber incidents. This means that the cyber-hygiene measures we have been advocating are having a positive impact. Our cyber incident reporting framework enables us to interact with banks so that we can always pass on to them the knowledge gained from collecting this information.

And what is the third area?

The third priority concerns simplification and transparency. I think we did an excellent job in setting up shop here in Frankfurt as a new European supervisor. After codifying our practices in great detail we now need to gradually become a more transparent supervisor, well understood by the banking industry, market participants and users of financial services, and maybe also a little less heavy-handed in some processes.

Which processes?

For instance, banks often mention our reporting requirements and data requests. I have received a letter from an industry association arguing that we were asking for an excessive amount of data, that different directorates general within the ECB were asking for similar data in a slightly different format, that the ECB and the national authorities were asking for data in an uncoordinated fashion and that the supervisory side and the central banking side were asking for similar data without checking whether those same data were already available to other authorities.

They have a point.

Indeed, they have a point. I think we need to simplify our structures, our requirements. That is an area where we have to improve.

There is not only a COVID-19 pandemic at the moment but also a pandemic of fake news. How do you plan to cope with that as a supervisor?

Managing information is very difficult. I have been a supervisor for a long time and when I started in my profession supervision never featured in the newspapers. Now we are moving in a different environment and it is much more difficult for us. One reason I have emphasised transparency is to make sure that reliable information is available on how supervisors see the banking sector and assess its risks. Reliable information can guide the market and prevent rumours that could trigger panic moves in it. I see a lot of stories, sometimes totally misleading, and unfounded information about what we are doing. Sometimes it’s a struggle because you cannot disclose the real information as you are bound by confidentiality. And it’s only by being more transparent that you can win this challenge.

SSM

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