I thank you for this opportunity to share some thoughts on the evolving supervisory response to the pandemic, as we brace for the impact of the shock and prepare for a “new normal”.
Looking ahead, even beyond the pandemic, is exactly what we should
all be doing at this juncture, banks and supervisors alike. The sooner
we start the better off we will be, once we finally get there. “Never
let a good crisis go to waste” – Winston Churchill’s famous dictum,
which he coined while working to set up the United Nations after the
Second World War, surely applies here. The programme of today’s dialogue
is therefore very timely, in my view, and I thank you for this
opportunity to share some thoughts on the evolving supervisory response
to the pandemic, as we brace for the impact of the shock and prepare for
a “new normal”.
What I consider to be the first two phases of
ECB Banking Supervision’s response to the pandemic have been widely
covered in the public domain. But let me briefly summarise them again
here and, in so doing, set the scene for the discussion on what comes
Our immediate response to the coronavirus (COVID-19) shock
saw rapid and unified action across the euro area, something that would
have been quite unthinkable before the banking union was set up. We had
two main guiding principles: supervisory relief and capital
conservation. By releasing buffers and preventing capital from flowing
out of the sector, we helped to avert the sharp tightening of credit
standards that characterised the response to previous shocks. Not only
did we give banks capital and operational relief, but we also granted
them temporary flexibility in relation to the management of
non-performing loans (NPLs), loan loss provisioning and loan
classifications. These measures were intended to accompany and smoothen
the implementation of national loan guarantee and loan moratorium
programmes on an unprecedented scale. We have seen the value in making
full use of microprudential tools during the first phase of our response
to contribute to overall financial stability across the banking union.
This is no small development. Market-based evidence shows that the
combined monetary policy and supervisory response helped to keep at bay
the sorts of bank-sovereign doom loop dynamics we have seen in the past,
which, in itself, is a remarkable result. Of course, the flip side of
capital relief is capital conservation: to ensure that no capital is
flowing out of the banking sector in this situation of profound
uncertainty, we recommended that banks refrain from dividend
distributions and share buy-backs.
In a second phase, we moved on
to assessing risks, vulnerabilities and the potential impact of the
pandemic on banks’ balance sheets. We conducted a desktop analysis to
assess the potential vulnerability of significant institutions under two
scenarios: one central and one severe. Both scenarios were based on the
June 2020 Eurosystem staff macroeconomic projections. The severe
scenario envisaged a significant increase in COVID-19 infections in the
autumn and renewed containment measures. The results of this
vulnerability analysis showed that the banking sector was resilient
overall and well positioned to withstand the deep and abrupt recession
caused by the pandemic. But the results also indicated the potential for
material tail risk. Under the more adverse scenario, which remains
plausible in the light of recent developments, capital depletion could
be material (a decline of 5.7 percentage points in the Common Equity
Tier 1 ratio, on average) and NPLs could soar to around €1.4 trillion.
Perhaps more importantly, we observed a very high level of uncertainty
prevailing over the banking sector. This was reflected in very diverse
capital planning assumptions used by banks, estimates of the cost of
risk that were too dispersed and sometimes optimistic, and a widespread
tendency to refrain from reclassifying assets. In a letter to banks in
July, we asked the sector to focus more on proactively identifying
distressed borrowers and managing deteriorating assets at an early
stage. With the same precautionary stance, we also extended our blanket
recommendation that banks should refrain from dividend distributions. A
choice of prolonged capital conservation which, in our view, has proven
to be effective and underpins banks’ stated intentions to expand, on
aggregate, their loan books and risk-weighted assets by the end of 2020.
But let us turn to the present and look ahead. The September
2020 ECB staff macroeconomic projections do not show a worsening with
respect to the June projections and provide broadly comparable results,
including in terms of overarching uncertainty around the outcomes.
Economic activity remains far below pre-pandemic levels and the recovery
is asymmetric across sectors and countries. The economic, financial and
social costs associated with a severe scenario remain very high. At the
same time, consumer spending and business investment have rebounded
somewhat over the summer.
Let me be clear that, at the current
juncture, our supervisory strategy has moved into a new phase. On the
one hand, it is time for banks to brace for the impact that will likely
materialise as the system-wide moratoria are lifted. On the other hand, a
proactive attitude is needed on all sides for the pandemic not to act
as a mere amplifier of long-lasting and well-known structural
deficiencies.. Rather, it should serve as a catalyst for a stronger
banking sector in the future.
While we still cannot see the impact
of the shock materialising in current supervisory data, we believe that
no bank should postpone any longer the fundamental risk management duty
intrinsic to its own mandate. Early identification of arrears,
case-by-case reclassifications and prudent provisioning choices are now
crucially important. Borrower-specific debt restructuring and
forbearance practices must be used to distinguish viable distressed
customers from non-viable ones. The available flexibility and tolerance
were justified when the impressive moratoria measures were first being
introduced, in the light of all the operational challenges they
entailed. But as most of those programmes will soon be expiring, every
effort should be made to avert costly cliff effects in time.
are currently reviewing the banks’ responses to the letter we sent in
July and we plan to gradually intensify our scrutiny of banks’
preparedness to deal with the impending deterioration in the quality of
their assets. Solid credit risk management practices and prudent
provisioning outcomes are particularly important here. A clearer picture
on the trajectory of asset quality will also be needed to inform our
review of the recommendation to suspend dividend payments, which we will
complete in December.
When I hear that some people are using the
pandemic to question the implementation timeline of the forthcoming
standards on the definition of default or to propose reviewing the
legislative backstop on NPL coverage, I am inclined to think that too
many of the lessons of previous crises may unfortunately not have been
The sooner NPLs are identified and provisioned for, the
faster and smoother the NPL resolution and disposal process will be,
averting damaging hangover effects down the road. Delayed recognition
and poor management of deteriorating asset quality could easily clog up
bank balance sheets with NPLs for a fairly long period of time, making
it more difficult for the banks to support viable customers and underpin
a faster economic recovery. Moreover, portfolio quality is one of the
main drivers of value creation at banks in the current environment.
Analysts and investors expect there to be material adjustments in the
cost of risk in 2020 and have revised down their profitability
expectations for the sector accordingly. Postponing the adjustments
won’t help banks to re-establish themselves as attractive investment
opportunities as quickly as they need to, with all the consequences that
In my view, we have good rules and policies in
place to deal with NPLs more quickly and effectively this time around.
Banks need to focus on effective implementation, and the right time to
do that is now.
Of course, with banks playing their part in
tackling the deterioration in asset quality, authorities will have to
play their part too. In this vein, I more than welcome the debate
relaunched by Valdis Dombrovskis on further improving the functioning of
the secondary markets for NPL sales and NPL securitisations, as well as
on promoting a more integrated use of asset management companies in the
Moreover, we must remember that, when the pandemic struck,
the European banking sector was already suffering from several
structural weaknesses. Persistent low profitability, caused by excess
capacity and low cost efficiency, has driven bank valuations to historic
lows. The need to address these structural issues has become even more
urgent in the light of the likely impact of COVID-19 and the policy
responses from authorities.
First, following this shock, a low
interest rate environment might prevail for a longer period of time.
Taking into account a further deterioration in asset quality, banks may
need to take more decisive action to reshape their business models.
Recent ECB analysis shows that, besides asset quality, the ability to
boost activities generating non-interest income has been essential to
maintain profitability and remain resilient as this crisis has unfolded.
This effort to refocus business models could require investment in new
technologies, which the pandemic may have already made more attractive
owing to customers’ increased interest in digital banking solutions
during the lockdown. Second, to tackle cost efficiency and
transformation issues, banks may build on the experience gained in
managing staff, premises and branches during the lockdown. In
particular, as working remotely and serving customers digitally proved a
feasible alternative overall, banks may consider further exploiting
technology to consolidate cost-efficient strategies in that direction.
We will duly take these elements into account when analysing business
models in the context of our Supervisory Review and Evaluation Process.
this quest to restore profitability, banks should also consider the
possible benefits of business combinations. Reducing overcapacity via
consolidation would, among other things, reduce unhealthy competition
focused on volumes and the race-to-the-bottom type of behaviour, thereby
helping to re-establish sustainable levels of profitability. The
experience of other jurisdictions shows that, in the aftermath of large
shocks, healthy levels of orderly market exits are a key ingredient for a
swift and successful recovery. Here too, as banks play their part,
supervisors and legislators alike should play theirs. The recently
published draft ECB guide on the supervisory approach to consolidation
in the banking sector was intended to be a step in this direction.
Targeted harmonisation could further the integration of the European
single market, for instance by identifying and removing territorial
elements in the current rulebook that represent an obstacle to
cross-border mergers and acquisitions. In my view, it is also essential
that legislators work towards an integrated crisis management framework
that is more conducive to facilitating smooth exits from the market,
including for mid-size banks that would currently be subject to very
diverse national arrangements.
Finally, the COVID-19 pandemic
should not be seen as an opportunity to question the validity of the
recently finalised international prudential framework. The Basel III
reform is addressing weaknesses in the current regulatory framework that
have been identified first and foremost by European authorities. It has
been negotiated with our international counterparts over a long period
of time, and we have reached a satisfactory and balanced conclusion. It
entails a long phasing-in of some elements, such as the output floor,
which are more painful for European banks. Notwithstanding the
challenging times we are living in, we need to maintain a longer-term
view and continue to strengthen our regulatory framework.
sum up, we are continuously adjusting our supervisory strategy in line
with the challenges posed by the pandemic. Our primary focus today is on
making sure that banks are adequately prepared for the immediate impact
of the crisis. But as Churchill also observed, “kites rise highest
against the wind, not with it”. We should therefore also look for ways
to ensure that our banking sector emerges from the pandemic stronger.
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