State of play in the banking sector
As we recently marked the start of a new year, I think this is an
opportune moment to take stock of the current situation and consider the
outlook for the European banking sector.
Overall, the European banking system has proven resilient in the
face of the coronavirus (COVID-19) pandemic. This was thanks first of
all to the regulatory reforms introduced since the great financial
crisis, providing banks with higher and stronger loss absorbing
capacity, as well as to the implementation of a strengthened European
institutional framework, including European banking supervision. The
latter not only decisively pushed banks to clean up their balance sheets
throughout the post-crisis period, but also enabled a swift and unified
supervisory response to the pandemic as it broke out, providing forward
guidance and supervisory relief to all institutions across the euro
area. The role played by regulation and supervision during the pandemic
is a forceful reminder of the importance of completing regulatory and
institutional reforms in the euro area to make the banking sector as
resilient as possible to future shocks.
Public support also played a key role. An unparalleled level and
array of support measures – ranging from extraordinarily accommodative
monetary policy to loan moratoria, loan guarantees and fiscal transfers
in favour of bank customers – directly and indirectly protected banks’
balance sheets.
As a result, banks remain generally well capitalised, hold ample liquidity and are able to perform their key role as lenders.
While the extraordinary public support measures have prevented a
surge in the level of non-performing loans, which have in fact continued
to fall during the pandemic, a strong focus on risk controls remains of
the essence: the full impact of the pandemic on asset quality may only
become apparent once these measures are fully phased out.
Classifications of loans as underperforming (stage 2) remain higher than
before the pandemic and loans that have benefited from COVID-19 support
measures appear to have a slightly higher risk profile. Risks may be
more pronounced in sectors particularly affected by the pandemic, such
as accommodation and food services or commercial real estate. In
addition, there is continued uncertainty about the future path of the
pandemic and the impact of current supply chain bottlenecks. This is why
improving banks’ credit risk management remains our top priority. In
this context, we will follow up on last year’s work to ensure that banks
address any weaknesses in their credit risk measurement and management
practices that we have identified in our Supervisory Review and
Evaluation Process (SREP). We will also look closely at banks’ exposures
towards sectors hit particularly hard by the COVID-19 shock by carrying
out targeted reviews and on-site inspections.
We are also concerned that, following a prolonged period of low
interest rates, investors’ search for yield and excessive risk-taking
may make financial markets vulnerable to abrupt asset price corrections
and disorderly deleveraging. The leveraged finance sector, which deals
with loans to highly indebted borrowers, is one particular area of
concern. Issuances have continued to increase during the pandemic, while
the corresponding lending standards have been loosened, showing little
adherence to supervisory expectations formulated well before the
pandemic. We will carry out targeted on-site inspections to ensure that
banks strengthen their risk management practices for this type of
lending. Another area of concern is residential real estate, where
vulnerabilities are building up in several countries – as recent work by
the ECB has shown.
European banks are facing a number of challenges
In addition to these more cyclical challenges, our banks are facing a
number of structural challenges, which the pandemic is bringing further
to the fore. European banks have been struggling with low levels of
profitability for more than a decade now. Bank valuations and
profitability are generally higher in the United States than in Europe.
One structural reason for this is that European banks face greater
difficulty in reaping economies of scale and scope than their US peers,
as they are not really operating in a truly integrated single market for
financial services.
Moreover, banks are facing two major structural shifts: an
intensifying digital transformation process and the green transition.
The digital transformation process should be seen as an opportunity
for banks to become more efficient and find new sources of revenue. And
some banks are already taking this opportunity. We will need to have a
strong supervisory focus on the IT and cyber risks that may increase as
banks introduce new digital initiatives of their own. Moreover, we will
help to ensure a regulatory level playing field between banks and big
tech and fintech firms in relation to those risks that warrant a uniform
approach across different types of entities. We welcome the current
legislative discussions on these topics, such as the Digital Operational
Resilience Act (DORA) and the Regulation on Markets in Crypto-assets
(MiCA), and we hope to see good progress in this area during the French
Presidency of the Council of the European Union.
The second structural shift facing the banking sector today is the green transition.
The climate crisis is exposing our banks to physical and transition
risks, which they need to be ready to manage. Banks will need to
strengthen their risk management frameworks and reassess their business
strategies.
A recent ECB assessment shows that banks have made some progress in
adapting their practices to manage these risks, but none are close to
meeting our supervisory expectations.
So more work is clearly needed. To that end, we have already planned a
number of specific supervisory measures for next year and beyond,
including a thematic review of banks’ environmental risk management
practices and a stress test on climate-related risks.
The need to update our regulatory and institutional frameworks
As I have already mentioned, the regulatory reforms that followed
the global financial crisis made our banking system stronger, which has
proven crucial during the COVID-19 crisis, as the comfortable capital
and liquidity positions enabled banks to continue supporting households,
small businesses and corporates at the onset of a very harsh recession...
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