02 December 2022

ECON Hearing: SSM's Andrea Enria

The banking sector maintains strong capital and liquidity positions. According to third-quarter results available for listed banks, the sector continues to record good levels of profitability. However, the euro area economic outlook has further deteriorated.

We face a period of lower growth and possible recession, with significant uncertainty over energy supplies. While higher interest rates and margins are boosting banks’ profitability right now, they also affect the ability of highly leveraged customers to pay back their debts or fulfil margin calls and may trigger sharp adjustments in volatile financial markets. Banks need to prepare for the potential adverse impacts of the uncertain environment on their business.

The new risk environment warrants some adjustments to our supervisory approach. Today, I will outline how we are asking banks to prepare. We also expect to publish our updated supervisory priorities for 2023-25 in the coming weeks.

Supervisory risk outlook

Our key focus is that banks remain resilient to the challenges stemming from the current uncertain macro-financial environment. We collected banks’ updated capital trajectories at the end of October to identify any vulnerabilities in their capital adequacy to the energy shock and the heightened risk of recession. Based on our preliminary assessment, a number of banks seem to use relatively mild macroeconomic assumptions in their adverse scenarios, which translates into a moderate impact on their capital ratios. Consequently, supervisors will closely scrutinise capital planning and challenge management actions to ensure an appropriate level of conservatism.

Credit exposures to energy-intensive corporate borrowers are a particular area of supervisory attention. Despite limited signs of distress so far, many energy-intensive sectors are at the beginning of the value chain, where disruptions can trigger chain reactions. Since earlier this year, we have been focusing our attention on credit and derivative exposures to the largest energy commodity traders. We also looked at exposures to the energy utilities sector and are keeping a close eye on developments in energy derivatives markets. Exposures to energy utilities increased by around 14% in the first three quarters of the year, and further credit extension might bring banks closer to their internal risk limits. The focus on the risk management of these exposures is particularly warranted in light of the recent temporary relaxation of margining requirements, enabling the use of uncollateralised bank guarantees as eligible collateral for non-financial corporates accessing central clearing services.

The fast-paced normalisation of interest rates is highlighting vulnerabilities in other sectors, such as residential and commercial real estate markets, consumer finance and leveraged finance. At an aggregate level, leveraged finance exposures account for over 60% of euro area banks’ Common Equity Tier 1 capital. A large share of these are exposures to highly leveraged corporates. This is the riskiest category of an already high-risk asset class, and banks still continue to originate loans of this kind. We will therefore pursue targeted follow-up. In this year’s supervisory assessment, we intend to apply Pillar 2 capital add-ons to a handful of banks, due to substantial deficiencies in their risk management frameworks for leveraged transactions....

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