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Right across Europe, hopes of a quick rebound in economic activity are starting to fade as COVID-19 cases begin to rise once again. A “second wave” will no doubt put further pressure on the world economy. At this time of uncertainty, how are the banks coping with the COVID-19 shock, and are they prepared for Brexit? We can now speak to the man responsible for leading the supervision of banks across Europe: Andrea Enria is Chair of the Supervisory Board of the European Central Bank.
You’ve had meetings with senior people in the Irish banking system over the last few days. How satisfied are you that the European banking system, in general and in Ireland, will be able to withstand the impact of the COVID-19 pandemic?
Well, European banks have entered this crisis with much stronger capital and liquidity positions, and a much improved asset quality. So this has enabled them to continue lending to households, corporates and small businesses, without materially tightening lending standards in the first phase of the crisis. And that’s also thanks to the policy measures taken by the ECB and national governments. So far, the ability of the banking sector to react has been fairly good. But of course, this is one of the harshest recessions on record, and it will have an impact on banks’ balance sheets. We ran what we call the vulnerability analysis in July, and we tried to estimate how banks’ balance sheets would change in different scenarios. In the scenarios that our economists consider the most likely, banks would be able to withstand a sort of short-lived and deep recession, like the one we are experiencing.
Of course, if the recovery is weaker and more delayed than expected, then the impact on the banks’ balance sheets will be harsher. And it could lead to a significant deterioration in asset quality. In the severe scenario, however, up to €1.4 trillion of non-performing loans would potentially be generated, which is even higher than what we experienced in the last crisis. So we need to prepare, and that’s what we are urging the banks to do.
The banks’ main priority over the past few months has been to tackle the consequences of the pandemic, but they also need to be preparing for Brexit. Are the banks on track to finish their preparations by the end of the year, given that many will be operating in a more fragile environment?
Well, we think that we have done everything possible in preparation for Brexit, as supervisors. We asked the banks to make all the necessary preparations and we think that they have moved significantly in the right direction. They are now ready to take the hit, to some extent. Licences are in place, or the temporary recognition of licences is in place, to continue serving customers on both sides of the Channel. We have target operating models which have been defined for banks that will relocate business, and banks are well on track to achieve their target operating models on time. The European Commission recently decided to grant temporary equivalence to UK central counterparties, which was also essential to avoid financial stability concerns, especially in the clearing of derivatives.
So, all in all, the preparation has been done: I met with my team and we cannot think of anything else that we could do, or that we could ask the banks to do. But still, Brexit will of course have macroeconomic effects on top of the impact of COVID-19. And financial markets have not yet fully priced in the possibility of the United Kingdom leaving the European Union without a trade deal. The fact that we are prepared for a shock doesn’t mean that the negative effects will not materialise, of course.
As payment breaks come to an end, and the banks come under pressure to keep non-performing loans down, are you satisfied that consumers will be adequately protected. What message did you convey to the banks in this regard?
Well, payment breaks have been an essential element of the response to this crisis originating from the pandemic. So they [the payment breaks] have been fundamental to prevent the necessary containment measures (which were taken to deal with the pandemic) from causing an unnecessary destruction of productive capacity, and especially to prevent them from harming households’ finances too. It was a very important element of the policy response to create breathing space in the period of the lockdowns and to bridge to the recovery. Now, as the situation evolves, it’s clear that banks may well have to consider extending payment breaks for their customers. Still, as supervisors, we think it is also important that the banks take into consideration the impact that this has on their asset quality: they should avoid the build-up of unrecognised non-performing loans, and eventually distinguish good customers from bad customers that are unlikely to pay.
So it is now time for banks to start becoming more active in recognising their asset quality issues, also to avoid a huge cliff-edge effect at the end of the payment breaks. Banks need to become more active in this respect, and that’s a point that we brought to their attention with a letter in July.
Andrea Enria, thanks for joining us.