we decided to extend the end of the period in which we recommend that banks should not pay dividends or buy back shares from October 2020 until the end of the year. .. provided new information on the likely path back to normality...
ECB Banking Supervision today published its first assessment of the
potential vulnerabilities of the euro area banking sector in the wake of
the coronavirus (COVID-19) outbreak. Also on the basis of the results
of this assessment, we decided to extend the end of the period in which
we recommend that banks should not pay dividends or buy back shares from
October 2020 until the end of the year. We also provided new
information on the likely path back to normality, i.e. a gradual exit
from the extraordinary capital and liquidity relief measures, as well as
the way forward with respect to the operational relief measures taken
at the outset of the crisis.
In this blog post I will explain our
assessment of the results of the vulnerability analysis and discuss the
rationale behind the package of measures announced today.
The
current macroeconomic shock is of unprecedented magnitude and it is
still highly uncertain how it will develop in the future, including its
eventual impact on the banking sector. We know that this year the fall
in GDP will be the most severe in peacetime for the European economy.
But the economic outlook remains contingent on too many uncertain
variables, including a possible strong resurgence of infections
accompanied by more stringent containment measures.
While the
vulnerability analysis represents an important first insight into the
aggregate resilience of the euro area banking sector under different
scenarios, there is still material uncertainty about the extent to which
asset quality will have deteriorated once the moratorium measures are
lifted, particularly for the most affected economic sectors and bank
portfolios. This uncertainty around the trajectory of asset quality is
reflected in the different provisioning policies adopted by banks and is
a matter of supervisory concern.
Let’s take a look at each of these elements in turn.
The results of the vulnerability analysis
The
vulnerability analysis is our best estimate, at this specific point in
time, of the impact that the COVID-19 outbreak may have on the euro area
banking sector. As the planned EU-wide stress test exercise was
cancelled this year due to the pandemic, we, like other competent
authorities, decided to carry out a top-down analysis using data that
were already available, without asking the banks for additional
information. The exercise was based on data from the end of 2019 and it
applied, with some adjustments, the methodology developed by the
European Banking Authority (EBA), which includes the assumption of
static balance sheets.
The analysis projects how the prudential
position of banks will develop under two macroeconomic scenarios
included in the June 2020 Eurosystem staff macroeconomic projections:
the central macroeconomic projection (central scenario), which is still
the most likely to materialise according to ECB staff, and the
alternative severe scenario, which involves a strong resurgence of
infections accompanied by more stringent containment measures.
The
central scenario foresees euro area GDP falling by 8.7% this year,
before growing by 5.2% in 2021 and 3.3% in 2022. Under this scenario, by
the end of 2022 aggregate capital depletion for the euro area banking
sector will be 1.9%, reducing average Common Equity Tier 1 (CET1)
capital from 14.5% to 12.6%. Most banks would reach maximum capital
depletion in 2022. Under this central scenario, our opinion is that the
euro area banking sector will remain, in aggregate, well capitalised and
can continue to fulfil its core function of lending to the real
economy.
However, a more severe scenario is also plausible,
whereby GDP would fall by 12.6% this year and grow by just 3.3% in 2021
and 3.8% in 2022. In short, a much deeper recession and a much slower
recovery than in the central scenario. Under the severe scenario, the
aggregate CET1 ratio of the euro area banking sector would decline, on
average, by 5.7 percentage points, reaching 8.8% by the end of 2022.
Such a pronounced reduction of the sector’s own funds would prove
challenging, and several banks would need to take action to continue
meeting minimum capital requirements. Still, the overall shortfall of
the sector would be contained.
The scenarios and the analysis of
their impact on the banking sector have also taken into account, as far
as possible, the significant fiscal, monetary and supervisory measures
that have already been taken to help cushion the economic impact of the
crisis.
As I mentioned, the analysis has been conducted within a
top-down framework and, also considering the current unusual working
modalities, we have not discussed bank-specific results with individual
banks. Our supervisors will use the findings in a non-mechanistic way to
assess banks’ macroeconomic projections, provisioning policies and
capital plans.
There is clearly no room for complacency, but we
can take some comfort from the fact that the sweeping regulatory reforms
of the past decade have actually brought the banking sector into a
position where, overall, it is sufficiently resilient to tackle a shock
of a magnitude never seen before in the European Union.
This
being said, the outcome of the exercise also indicates that authorities
must be ready to take additional action if the economic situation
further deteriorates due to a strong resurgence of infections and more
stringent containment measures.
Prudence in times of uncertainty
The
macroeconomic outlook remains uncertain, and there are persistent
difficulties in accurately estimating the capital trajectory after the
existing moratoria come to an end. In our view, this justifies measures
that mitigate the risk of simultaneous deleveraging and procyclical
behaviour. These measures include extending the recommendation to
refrain from distributions and buy-backs until the end of 2020 while
giving banks enough time to replenish their buffers organically.
Regarding
our decision on distributions, once again our guiding principle has
been to safeguard the resilience of the system in the face of
fundamental uncertainty by preserving loss-absorbing capacity at a time
when any forecasts about short-term economic developments and their
impact on the banking sector are highly volatile.
This decision
has not been taken lightly. I am aware of the concerns raised by
investors about the suspension of distributions and I would like to
strongly emphasise the exceptional and temporary nature of this
recommendation. We will review our decision in December and, if we can
estimate with more certainty the impact of the macroeconomic outlook on
asset quality and our supervisors are convinced that banks’ capital
projections are sufficiently reliable, we will repeal the recommendation
and move back to our ordinary assessment of planned distributions on a
bank-by-bank basis. We prefer to be prudent today rather than having
regrets tomorrow should overall economic conditions deteriorate further.
As I also noted in March when we issued the original
recommendation, I believe that this prudent behaviour now will benefit
shareholders in the long run and help to preserve banks’ franchise
value. I am firmly convinced that, by following the recommendation,
banks are also enhancing their reputation by signalling to stakeholders
and the general public that they take their collective social
responsibility seriously at a time of great suffering and extreme
uncertainty for all European citizens. With more available capital,
banks can book more provisions now for potential losses down the road,
especially when the national measures on moratoria are lifted. Doing so
will support the economic recovery when this challenging period is over.
A healthy banking sector will be crucial in supporting sustainable
economic growth.
We are also mindful of the recommendation of the
European Systemic Risk Board of 27 May 2020. In this recommendation,
competent authorities were explicitly invited to ask financial
institutions to refrain – until 1 January 2021 – from distributing
dividends, buying back shares or creating an obligation to pay variable
remuneration that has the effect of reducing the quantity and quality of
own funds of EU financial groups. To that effect, I have sent a letter
today to all the banks under our direct supervision asking them to adopt
extreme moderation in variable remuneration payments until the end of
the year.
Return to normality
I will now address the
third key aspect of our supervisory approach, which concerns how we
communicate our exit strategy from the supervisory relief measures taken
at the outset of the coronavirus crisis.
In March 2020 we adopted
several supervisory relief measures aimed at enabling banks to absorb
losses and keep lending to the real economy, preventing the risk of
abrupt deleveraging processes as much as possible.
As part of this
effort, we announced that we would allow banks to temporarily operate
below the applicable capital and liquidity buffers. And here I would
like to underscore once again that buffers are specifically designed to
be used in situations like the current one in order to avoid the
regulatory framework having a procyclical impact.
We already
communicated that supervisors will not attach any negative judgement to
banks which are making use of the buffers (see FAQs on ECB supervisory measures in reaction to the coronavirus).
The
Basel Committee on Banking Supervision also recently recommended that
banks use their buffers, confirming that “a measured drawdown of banks’
Basel III buffers” was “both anticipated and appropriate in the current
period of stress” (see press release of 17 June 2020).
So
banks are encouraged to use their available buffers to absorb losses
and continue lending to the real economy without concerns about
potentially being stigmatised for using them or needing to quickly
replenish them.
ECB simulations
show that if banks decided to use their capital buffers there would be
clear benefits for the economy and for the banks themselves, without any
noticeable negative effect on their capital position. Lending growth
would be higher compared with a scenario where they aim to preserve
their current regulatory capital levels. Using the buffers would support
higher GDP growth and, as a result, credit losses would also be lower,
leading to higher bank profits. The positive effect on credit quality
and profits would almost completely compensate for the effect of balance
sheet expansion, so that the overall capital position of the sector
would be broadly similar both when buffers are used and when they are
kept intact.
In this context, we are clarifying today that banks
will not be required to start replenishing their capital buffers before
the peak in capital depletion is reached. In any case, compliance with
the Pillar 2 Guidance and the combined buffer requirement will not be
required any earlier than the end of 2022.
We hope that, as the
overall situation improves, it will be possible to carry out the EU-wide
stress test next year under the aegis of the EBA. This will inform the
2021 supervisory cycle and the setting of the Pillar 2 Guidance. The
specific timeline for reaching the capital levels set out in this
Guidance will be decided on a case-by-case basis in accordance with the
individual situation of each bank. In particular, ECB Banking
Supervision will look at the profitability of banks and how much capital
will be necessary to replenish the buffer. To be perfectly clear: if a
longer time frame is necessary because the buffers have been used to
keep lending to the real economy or to absorb losses caused by the
crisis, our supervisors will work with the bank to decide on the most
appropriate time frame, taking into account the criteria mentioned
above.
Regarding the combined buffer requirement, I know that
banks are even more reluctant to use this buffer, mainly because of
automatic triggers limiting remunerations and distributions, including
coupons on capital instruments other than common equity. As we have
already said, we cannot influence the legislative limitations on
payments but we can exercise flexibility in assessing the capital
conservation plans that banks are required to submit for our approval.
And we will do so while applying the same criteria and timelines
indicated above for the Pillar 2 Guidance buffer.
This should
provide banks with ample assurance that we will not require accelerated
compliance with the buffers once the crisis situation is over.
A
similar approach will be followed for replenishing the buffers of
high-quality liquid assets, which are required to ensure compliance with
the liquidity coverage ratio. Banks will not be required to restore
compliance with the buffer requirement any earlier than the end of 2021.
In any case, specific adjustment paths will be designed, taking into
account the prevailing conditions in funding markets.
Finally,
let’s take a look at our operational relief measures. We announced today
that banks will not be required to submit their plans for reducing
non-performing loans (NPLs) until March 2021. By then, we expect them to
have a better overview of the impact of the COVID-19 crisis on their
asset quality, which should enable more accurate NPL targets to be set.
Banks with high levels of NPLs are nevertheless expected to pursue all
available opportunities to bring their asset quality to sustainable
levels. All banks are encouraged to put in place effective management
practices and strengthen their operational capacity to deal with the
expected increase in distressed exposures.
On the other hand, the
six-month suspension of pending supervisory decisions has not been
renewed. It is our assessment that the operational challenges that banks
faced at the start of the pandemic have become more manageable, as
remote working arrangements have proved resilient and efficient and
staff begin returning to their offices. This means that, from October
2020 onwards, banks will be expected to resume remedial actions
following the findings of Supervisory Review and Evaluation Process
(SREP) assessments, on-site inspections and internal model
investigations. Supervisory processes for adopting new decisions on the
targeted review of internal models (TRIM), on-site follow up letters and
internal models decisions will also start again from October 2020.
The ECB also expects national competent authorities to apply all the measures discussed above to less significant banks.
With
today’s disclosure of the aggregate results of our vulnerability
analysis, the extension of the dividend distribution recommendation and
the indications on the contingent phasing-out of our supervisory relief
measures, we have provided a comprehensive package to help banks better
understand our supervisory strategy and plan ahead for the foreseeable
future.
In the extraordinary circumstances created by the
pandemic, all our supervisory measures and actions are and will continue
to be aimed at ensuring that the banking sector can remain resilient
and support the economic recovery with an adequate supply of credit.
SSM blog
© ECB - European Central Bank