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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[1] has shown.
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.[2] 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.[3] 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.[4] 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.
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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