The European banks have been complaining about the negative impact of low interest rates on their books. Is this really the main problem that the banks are facing?
It is one of the issues related to bank profitability. But it is only one of the issues. And it is not even the most critical one. For a long time, low interest rates enabled a very low cost of financing, led to an improvement in the value of securities and bonds, and enhanced credit quality for corporates and small and medium-sized enterprises that create jobs. Only a few years later and probably this is what is happening now, some negative effects are starting to be felt in net interest income, but this effect is less significant than the earlier positive effects.
So what is most important for the banks?
What most affects banks’ profitability is their exposure to non-performing loans, which weigh heavily on profits. Then there is the issue of tough competition, that is coming currently from both non-banks, such as FinTech companies, and the oversized banking sector in the euro area as a whole as well as cost-to-income ratios, which are too high in the euro area. Against this background, the banks need to adjust their business models.
What do you recommend they do specifically? Enter into mergers? Reduce their staff numbers?
There are various ways of dealing with the issue of an oversized banking sector. The most painful way is being forced to leave the market, which can happen when a very weak bank is deemed to be failing or likely to fail. A more positive approach is, for example, to enter into a merger when it makes sense to do so.
Why are there so few mergers in the euro area?
First, because it is much easier to pursue mergers when growth is stronger. And that’s why, now that growth has returned, I think such mergers are going to start to happen. Second, there is uncertainty regarding the quality of the balance sheets of the banks that can be purchased. These problems of exposure to non-performing loans, namely the difficulty involved in making an accurate assessment of those exposures and the different legal regimes in each country, weigh heavily on banks’ decisions to go ahead with cross-border mergers. But I think that with growth returning and with the huge amount of work that is being done in relation to non-performing loans, we are going to see a number of mergers taking place within countries and across borders.
There have been some in Portugal ...
Yes, we’ve already seen some banks being bought with foreign capital.
Aren’t you afraid that this could culminate in an increase in political pressures opposing this?
Political elements are outside of my remit. But I think that the euro area has to be and has to see itself as a single jurisdiction. That is why, in my opinion, cross-border mergers within the euro area are the way forward and I doubt that politicians would have a negative view of such developments.
And, in Portugal, in particular, what do you think about the way the problems recorded in the banks were resolved, with the solution ultimately being the entry of foreign capital?
The Portuguese situation was a legacy that the SSM [Single Supervisory Mechanism] inherited, and for certain banks it happened that the entry of foreign capital was the only reasonable solution. This being said, I would like to point out that, considering that the euro area banking sector is oversized and that some banks are not earning their cost of capital it is the responsibility of their owners and senior management to think about how to plan for the future. If they do this early enough, they can decide for themselves which are their preferred partner companies. If they don’t do this and wait until the last minute to agree on a merger because their situation has become very weak, then they will have a lot less power over their destiny and will have to accept investors who are prepared to take risks. One thing is sure: now is the best time to do it, when the economy is growing again, the issue of non-performing loans is being tackled and politicians are talking about completing banking union.
With regard to non-performing loans, the ECB published for consultation guidance on new loans that was due to enter into force at the beginning of 2018 and this proposal was not well received by countries where this problem is more acute. Is there going to be a delay putting this into practice?
It is fair to say that we were a little optimistic in hoping that it would be possible, with the consultation period ending on 8 December 2017, to implement the proposal on 1 January 2018. Even if we’d had the full month of December to do the work, it would have been difficult. Now that we know we are going to have lots of comments, we want to examine them very closely, taking on board improvements to the draft text of the guidance and explaining why we didn’t accept other suggestions and considerations.
How much longer will it take?
I think this process of analysis will take a month or two. It is therefore very likely that implementation will be postponed by a few months. However, I would say that it doesn’t change much whether it happens on say 1 January, 1 April or 1 June. What matters is that things are moving in this direction.
Is it conceivable that it will be further delayed, until 2019?
I see no reason why it would be. All we need is sufficient time to take account of the comments on the first draft. We don’t need a year for that; we need a few months at most.
Are you going to make any changes in response to the European Parliament’s opinion that the guidance to banks on non-performing loans goes beyond the mandate of the European Central Bank (ECB)?
We are not exceeding the ECB’s mandate. Not only is it our mandate, but it is also our obligation to tackle the risks and weaknesses in the banks. That is the aim of supervisors. We would be exceeding our mandate if we were trying to apply general rules to all of the banks, which is not the case.
Isn’t that what you are doing?
No, that is the legislators’ task. We made it very clear that, in the interests of transparency, what we are doing is setting out our expectations, our starting point, because if we didn’t do so, we would not be able to ensure a level playing field for all. And we said very clearly that it would be implemented on a case-by-case and a bank-by-bank basis. I admit that we could have better drafted the document in order to be certain that it was very obvious that everything would be dealt with on a case-by-case basis. Now we will obviously take into account the sound advice we received from the European Parliament and the Council. But, in any case, the Commission was very clear: it is our duty to deal with the banks’ weaknesses. Certainly, we have to do this in the most efficient and most prudent way, but there are no doubts as to the substance of this work.
However, isn’t the substance of the guidance going to change a lot, namely the time frames of two and seven years?
It’s a consultation, and we want to take all of the comments we received into account, so I cannot answer your question. The period for receiving comments closed just a few days ago. I will only know what recommendations I will make to the Supervisory Board once these comments have been assessed. And it will not be decided by me; it will be decided by all of the members of the Supervisory Board.
Could it be said that you were surprised at the criticism you received?
Not entirely. I know that the treatment of bad loans is painful and that some countries are suffering from high levels of exposure to non-performing loans. It would be normal for them not to be enthusiastic. But this is what needs to be done. We don’t want the banks to go into the next crisis overburdened by the legacy of the previous crisis.
Because there is going to be a next crisis; there is always a new crisis. We don’t know what is going to trigger that crisis, or when it will take place, but there will be a new crisis. And by then if nothing had changed on NPLs, I would not have done my job.
Do you still plan to present a proposal for the stock of non-performing loans?
We have already conducted work over a long period of time on non-performing loans. For example, initially we produced a qualitative guidance for banks to address their non-performing loans; and we performed a cross-country analysis of the legal situations in the euro area, in order to show legislators that non-performing loans are not just a matter for supervisors to address, they are for other actors to address, starting with the national legislators. At the European level, the ECOFIN has done a great deal of work on the basis of this analysis. Subsequently we conducted two lines of work in parallel: one was this quantitative addendum for new non-performing loans and the other was on the legacy stock. And, in this context, banks were asked to present their own plans to address non-performing loans, so supervisors could assess and challenge them: are they ambitious enough? Realistic enough? Credible? And now, after numerous meetings and discussions, we are sending letters to the banks with high levels of non-performing loans to inform them of the results of the discussions and what we expect of them over the next twelve months. And next year they will get another letter with a performance assessment. So a great deal has already been done with respect to the legacy stock.
Are you already satisfied with the results?
We have gone from an average of 7.7% for non-performing loans to the current 5.5%. From close to €1 trillion to just over €800 billion currently. But the averages are not everything, it is true. In practice we have three major categories of banks. Some banks acted very fast and launched large-scale exercises to clean up their balance sheets. Then there are banks that are unable to undertake these major clean-ups because their financial positions do not allow it, but year by year they are moving in the right direction and this is fairly good. Finally, we have banks that are in denial and are not adopting sufficiently ambitious measures. We must move these banks along. This is why we are planning to publish something on the quantitative expectations regarding legacy stocks at the end of the first quarter next year. I am not exactly sure what that will be, because I have not seen the work of the ECB’s high level group that is analysing non-performing exposures. This work will take the form of a number of options and the Supervisory Board will decide which is best, perhaps combining some of them. But I repeat, now is the best time to take action. When we started our work on NPLs, banks in some countries told us that it was not a good time because there was no growth, but now growth has returned.
Given that the reaction to the guidance on new non-performing loans was so strong, are you worried about the reaction regarding the stock of non-performing loans?
Well, you say that the reaction "was so strong", but we have 19 countries taking part in the discussions on NPLs and I did not sense there was a majority of countries against the addendum that we presented. In fact, far from it. I do not think that the work will be stopped, we have the support of the European Commission and the Eurogroup, as we heard from Mr Dijsselbloem at a recent press conference. We have a large majority in favour of continuing in this direction and, in fact, this is of even greater importance if we consider that the European Deposit Insurance Scheme is in play again. When legislators talk about increasing solidarity at the same time as reducing risk, the elephant in the room is precisely the exposure to non-performing loans.
What do you think of the platform being implemented by three banks in Portugal in cooperation with the Government to better manage non-performing loans? Is this something that is sufficiently ambitious?
The scale of this problem, for countries that have it – and Portugal is one of them – is so great that all possible tools must be used. And this is a good tool. The banks must try out different alternatives for themselves and if they decide to sell off loans, they can use this type of platform. I do not know the technical details of how this platform works in Portugal, but we will follow developments closely, because we need as many options as possible to help banks to reduce non-performing loans.
In general terms, what is your opinion on the current situation of the Portuguese banking sector?
The Portuguese Authorities and banks took a series of difficult and painful decisions. And now we are starting to see the positive effects of these measures, but further efforts must still be made. The Portuguese banking sector is not yet where we would like to see it, but I think it is moving towards it. If banks manage to resolve the problem of exposure to non-performing loans, I think that the situation will further improve.
The banks complain that banking supervision was too restrictive, often procyclical. Is it not possible for a supervisor to be more flexible?
I do not think so. If these people thought that asking for more provisions in previous years was procyclical, then now that the economy is growing they should be applauding the work that is being done, for example, with the addendum to the guidance on non-performing loans. But no: the people who previously criticised supervision for being procyclical are the same ones who are now saying that it is killing growth. This is the problem with the work of the supervisors: it is never the right time. Before the crisis it was unnecessary, during the crisis it was procyclical and after the crisis it is killing growth. We cannot be more flexible, we have to deal with risk, preferably when it starts to appear. What I have learnt from my 40 years of experience in supervision is that a small problem fast becomes a major problem if nothing is done right from the start.
In Portugal there is some concern about the introduction of the new standard for reporting financial instruments, IFRS 9. What impact can be expected on banks’ accounts?
For us, the way it is implemented is a cause for concern because there will be many differing situations among banks – some choosing to absorb the full impact immediately, and others absorbing the impact only over a much longer period of time. This could create an environment that is not consistent across banks. But I think that the banks have no reason to be concerned because they have been given the possibility to postpone the impact over a time period that is quite generous.
In Portugal, we have banks owned by non-euro area investors from countries such as China or Angola. Could this be a problem for the supervisory authority?
It is the result of globalisation, it would be surprising if there were no investors from these regions in Europe. And it is our job to authorise these operations since November 2014. So, if we authorised them, it is because we analysed the operation and considered that the supervisory requirements had been met.
How important is it for certain banking sectors, like the Portuguese banking sector, for banking union to be completed?
What is missing is the common European deposit insurance scheme. It is important to complete banking union so that it can be viewed as a single jurisdiction. It is important for European citizens that the insurance for their deposits should be the same, irrespective of the country. And it will allow more cross-border mergers.
Are you optimistic that it will soon be completed?
Yes, I am optimistic that it will be completed. As to whether it will be soon, I can only hope so. There is a difference between hoping it will happen and it actually happening. Currently the European Commission is launching proposals for discussion, which is very positive. But we must keep in mind that the final goal is a truly European Deposit Insurance Scheme. If we make progress, but towards a lesser goal, this would be a concern. I notice some countries saying that this has to happen in parallel with risk reduction, and non-performing loans are precisely the problem that has to be addressed.
And what about Brexit?
I can confirm that we are ready to receive banks or investment companies that want to relocate to the euro area. We have to be ready, it is not an option. We also want the national supervisory authorities of the countries to which these institutions move, to be ready too, recruiting supervisors for this additional task. And I think that Brexit offers us a good opportunity to think about how international banking groups should be structured. We are the “home supervisors” of several international banks that have their base in the euro area but which operate internationally. With Brexit we will increasingly also be the “host supervisors” of banks that have their headquarters outside Europe. American and Japanese banks for example that operate in Europe because they were authorised in the United Kingdom are now going to have to be authorised somewhere in the euro area.
The SSM does not want to issue licences to banks that only have their name on a building and not much more. If banks want to have a significant balance sheet that will be registered in the euro area, we want to have commensurate risk management and risk committees here. For banks with trading operations, we want them to have some trading and hedging capacities located in the euro area, not necessarily full capacity, but a significant capacity. We are also asking legislators to look at the situation of investment banks. In Europe, the regulation of investment banks is a lighter version of the regulation of banks. And many banks coming from the United Kingdom are investment banks. In the UK, the national legislation permits to have them supervised as if they were banks. We have to be sure now, that these systemic investment banks are going to be supervised as banks in the euro area as well, which requires some changes in the European regulation.