21 February 2024

SSM's Buch: “Strengthening bank resilience is priority”

We are indeed facing heightened uncertainty. The new macro-financial environment, geopolitical risks, climate change and the risk of cyber threats are all highly relevant challenges for banks. This is why strengthening banks’ resilience is one of our priorities.

In addition to weak economic growth, Europe is facing significant geopolitical risks. Do banks take these risks into account sufficiently when managing their business? 

We are indeed facing heightened uncertainty. The new macro-financial environment, geopolitical risks, climate change and the risk of cyber threats are all highly relevant challenges for banks. This is why strengthening banks’ resilience is one of our priorities.

European banks are now better capitalised, which is good news. But there are still deficiencies in internal governance and risk controls and, in this new environment, these need to be addressed. In a fast-changing risk landscape, it is important that both financial and non-financial risks are managed effectively.

One issue is that standard risk models are often not the most suitable for analysing new risks. Banks need to work with different scenarios to ensure that they would also remain resilient under adverse circumstances. We have, for example, reviewed prudential overlays and found that some banks do not sufficiently take new risks into account in their provisioning practices. Our supervisory teams will therefore continue to focus on provisioning practices, particularly in relation to vulnerable portfolios. We have also stepped up our efforts to ensure that banks take climate-related risks into account and make progress in adapting internal information systems and improving risk data aggregation practices. To tackle cyber risk, we are currently conducting a cyber resilience stress test.

We are seeing an uptick in corporate insolvencies. This is already having an effect on the banking sector, for example through an increase in loans classified as underperforming. What can and should be done to prevent a new surge in non-performing loans in the coming years?

Corporate insolvencies are increasing in many countries. Insolvencies were quite low until recently and even fell during the pandemic, also owing to the fiscal support that many firms received. This was certainly needed to prevent scarring effects, but it makes risk measurement more difficult. Past data may not show the typical correlation between economic downturns, rising insolvencies and loan losses.

We are already seeing that asset quality is starting to deteriorate. Up to the end of 2022, we had 32 almost uninterrupted quarters of declining non-performing loans (NPLs). But this trend has since reversed. The volume of NPLs has increased modestly since last year. Underperforming loans, particularly in the consumer lending business, are also increasing. Still, the cost of risk that many banks report – in other words their loan loss provisions as a share of total loans – remains relatively low and stable. This suggests that there could be some misalignment between emerging risks and banks’ own risk assessments.

Banks therefore need to be particularly vigilant with regard to credit risk management. They need to strengthen their capacity to deal with distressed debtors. And they need to closely monitor credit risk, particularly in relation to real estate portfolios, firms affected by the energy transition and firms exposed to weaknesses in global supply chains...

 more at SSM

© ECB - European Central Bank