13 May 2021

Interview with Andrea Enria, Chair of the Supervisory Board of the ECB: Restructuring debt

Supervisory relief measures have created capital space for banks to adopt tailor-made debt restructuring measures, says Supervisory Board Chair Andrea Enria. Acting early is good for banks and borrowers. If banks “wait and see” this could lead to bankruptcies at a later stage.

These are unprecedented times, for the European banking sector as well. What uncertainties do you see? What are the key risks and vulnerabilities?

Overall, since the outbreak of the pandemic European banks have shown strong resilience. I see this as the result of our long-standing efforts to strengthen banks’ capital, asset quality and liquidity buffers. But it is also thanks to the extraordinary support measures provided by central banks, governments and supervisory authorities which, while supporting businesses and households, have also cushioned an adverse shock to the banking sector.

Nevertheless, European banks are still facing some challenges, particularly when it comes to their asset quality and profitability outlook. The deepest European recession in peacetime has not yet translated into a surge in sour loans thanks to the exceptional support provided by public policies. So far, banks have factored in only a limited increase in credit risk, but when government support measures are withdrawn, some households and businesses might struggle to honour their debts. This could, in turn, have an adverse impact on bank balance sheets. Hence, banks must manage credit risk proactively. Otherwise, they may face a surge in unexpected losses at a later stage, which could hinder their ability to support the recovery of businesses, households and the economy at large.

Persistently low profitability reflects structural weaknesses in our banking sector that pre-date the pandemic shock. But the harsh recession has further limited the income-generating capacity of banks and driven an increase in impairments, triggering a substantial decrease in profitability. Return on equity in the banking union was 1.5% in the fourth quarter of 2020, down from 5.2% in the same period of 2019. Banks have to take measures to refocus their business models and improve their cost efficiency, also by taking advantage of digitalisation and considering consolidation options. As a supervisor, I would like to see banks safeguard their profitability in the wake of this shock by planning structural measures of this kind, instead of relying on overly benign asset quality projections or engaging in highly leveraged business.

The non-performing loans ratio has declined during the pandemic. But how serious do you think the situation could become once the support measures are lifted? What would be the best course of action for banks? What role do you think the stress tests run by the European Banking Authority (EBA) will play in addressing the problems of the European banking sector?

It is true that banks have continued to actively reduce the stock of legacy non-performing loans (NPLs) during the pandemic. While macroeconomic projections point to a sharp rebound of our economy in the second part of this year, there is still a good deal of uncertainty on the likely trajectory of banks’ asset quality. Clearly the flow of new NPLs will accelerate once the government support measures expire. It is therefore crucial that banks identify distressed debtors in a timely manner. They need to assess debtors’ ability to pay beyond the moratoria and other support measures and provision accordingly. And when banks see signs of distress they must consider targeted forbearance and timely debt restructuring solutions to maximise value recovery. As I have said on several occasions, supervisory flexibility on capital buffers is still fully available: no bank should delay early recognition of losses because of concerns about supervisory reaction.

Currently, the EBA is stress-testing 38 euro area banks as part of its EU-wide stress test and we are conducting a parallel stress test for another 53 banks that we directly supervise but that are not included in the EBA sample. The results of both stress tests will provide valuable insights into the banks’ resilience and their capital adequacy.

Countries hit hardest by the pandemic, like Spain, Italy, Greece and Portugal, which depend heavily on tourism, see their banking sectors possibly facing an even higher volume of NPLs. Are their banks strong enough to cope with a new wave of NPLs?

Compared with the last crisis, banks are better prepared to deal with an increase in distressed debt. They have stronger capital positions and there has been significant progress in cleaning balance sheets in those countries with high levels of legacy non-performing assets from the last crisis. Yet, there are sectors that were hit particularly hard by the crisis and deserve careful attention in order to accurately assess credit risk. Our supervisors are conducting very detailed analyses of credit risk management practices for exposures to vulnerable sectors, starting with the food and accommodation sector. Commercial real estate is another sector requiring close attention, especially if remote working arrangements are going to become standard practice in the future. Experience suggests that a significant increase in NPLs as a result of the pandemic could impair banks’ lending capacity at a delicate juncture. We now have the EU recovery and resilience fund, which aims to support a robust and sustained rebound of our economy. But for that to succeed, the banking sector’s intermediation capacity must be preserved, as a smooth financing of the recovery is a task shared by both the private and the public sector.

Regarding Greece, how do you assess the measures taken by the banks to deal with the current crisis? What would you recommend? Do you think that a bad bank is necessary? Do you think that measures taken under the Hercules scheme are enough?

In Greece, like in the other European countries, the banks and the Government deployed a wide range of support measures, such as moratoria and subsidies, to provide immediate relief to businesses and citizens most affected by the crisis. At the same time, the ECB’s pandemic relief measures eased banks’ liquidity strains through favourable funding conditions. In addition, we allowed banks to temporarily make use of their capital and liquidity buffers when needed to provide support to the economy. In this context, banks have been encouraged to continue funding the real economy, supporting both households and the corporate sector to avoid further amplification of the economic shocks. And indeed, according to data from the Bank of Greece, credit to non-financial corporations increased substantially over the final months of 2020, reaching growth rates not seen since before the great financial crisis in 2007-08 – around 10% (year on year) in the last quarter of 2020 and the first quarter of 2021.

It is important to recognise that Greek banks have continued their efforts to clean up their balance sheets even during the pandemic, with some ranking among the top sellers of NPLs in the European Union in 2020. They have significantly reduced NPLs over the last few years. Between 2016 and 2020, NPLs were down by almost 50%, or €58 billion in absolute terms. The Hercules Asset Protection Scheme, recently extended in its duration and amount, has played a significant role in accelerating NPL disposals. Additional deals of close to €40 billion have been announced by Greek banks for the next 12 months under the Hercules scheme and will be duly assessed by the ECB. We encourage banks to keep pursuing this objective of further NPL reduction so that they can strengthen their balance sheets and thus better serve their clients and finance the economy. Also, banks should continue applying sound underwriting standards, conducting thorough assessments of borrowers’ creditworthiness to distinguish temporary financial difficulties from permanent ones.

Against this background, all avenues for NPL reduction must be used and further potential additions to the NPL resolution toolkit, such as the establishment of a bad bank – or asset management company as I prefer to call it – are worth exploring. In the past, asset management companies have in some instances proved to be an effective tool to help countries emerge from a financial crisis faster.

Do you think Greek banks have sufficient capital? Are there any specific banks you are worried about? This is particularly relevant as a wave of bankruptcies is expected once the support measures are gradually withdrawn.

Greek banks are making progress in their clean-up process through NPL securitisation, sales and other structural measures. This is certainly a positive development. We would encourage them to make use of the flexibility on the temporary use of capital buffers to continue their efforts in this area. In addition, recent market transactions, including junior debt issuances and a share capital increase, which were largely oversubscribed, are a positive sign of market confidence. The participation of a wide range of international investors confirms increasing interest in Greek banks and Greece. The ability to attract fresh resources can help banks further speed up their efforts to reduce the stock of non-performing assets.

As for bankruptcies, I would say that, like in every euro area country, the economic implications of the pandemic entail heightened risks for the banking system. Moratoria and other support measures temporarily reduced the visibility of banks’ losses. So far, payment behaviour following the expiration of moratoria that were in place in Greece until the end of 2020 has been positive, which has translated into a lower-than-expected need for restructuring solutions. However, there is still a risk that this trend may reverse and new NPLs may materialise. Therefore, to strengthen banks’ financing capacity, reducing NPLs further and enhancing their ability to absorb losses remains the key priority. In this regard, the Greek authorities’ decision to lift the suspension of debt enforcement measures, including for e-auctions, is crucial. Ensuring a timely and effective implementation of the new insolvency code, stepping up the pay-out of called state guarantees to banks, and a successful relaunching of the debt enforcement process are important steps forward. They should all further strengthen the payment culture and the ability of banks to fuel the recovery of the Greek economy.

Is there a risk of a new financial crisis following the pandemic? Do you think that the return to normality could or should include the cancellation of private debts?

The massive monetary, fiscal and supervisory policy response has reduced the risks to financial stability. It remains important to avoid a premature and blanket withdrawal of the support measures, which would risk delaying the recovery and amplifying the longer-term scarring effects. Thus, the measures must be phased out with caution.

The far-reaching relaxation of financing conditions triggered by monetary policy accommodation and government-guaranteed loans has already significantly reduced the burden of debt for private borrowers. The capital space created by supervisory relief measures enables banks to adopt tailor-made forbearance and debt restructuring measures. We know from experience that early restructuring of distressed debt benefits banks and borrowers alike, whereas “wait and see” attitudes are likely to lead to a larger wave of bankruptcies at a later stage. I think targeted forbearance and restructuring is the right way forward, rather than outright and undifferentiated forgiveness of private debts.

There are also risks linked to climate change. What are the priorities here?

We are well aware that climate risk represents a major challenge and requires banks’ close and immediate attention. Last year we published the ECB Guide on climate-related and environmental risks, which outlines our supervisory expectations for how climate and environmental risks should be embedded in all relevant bank processes, including reporting and disclosures. We found that banks do not yet comprehensively disclose their climate-related and environmental risk profile and that significant efforts are needed to promote transparency on the exposure to these risks in the financial markets.

We are now assessing how banks are taking account of these risks in their processes and practices. In January, we asked banks to conduct a self-assessment against the supervisory expectations outlined in our Guide and draw up action plans for aligning their practices with those expectations. We are in the process of reviewing the banks’ submissions. As we have already said, this year the outcomes of these assessments are generally not expected to be taken into account when determining capital requirements, but we may impose qualitative or quantitative requirements on a case-by-case basis. Hopefully, the work that we are doing now will help us – and the banks – to prepare for the full review and the stress test of climate-related and environmental risks that will be part of the supervisory cycle in 2022.

SSM

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