Interview with Cyprus News Agency

Interview with Claudia Buch, Chair of the Supervisory Board of the ECB, conducted by Gregory Savva

16 May 2024

Can you comment on the situation of the Cypriot banking sector from the supervisor’s standpoint? What are the challenges going forward?

What I would say about the Cypriot banking sector is very similar to what I would say about many European banks. So the situation is good, the banks are well capitalised. And now a specific feature for Cyprus: the share of non-performing loans (NPLs) has decreased quite significantly over the past years from around 50% to about 7% now. This is a very big reduction. It’s still higher, though, than the euro area average. There’s some way to go but this is a remarkable improvement. Generally, the banks are profitable right now because we have higher interest rates and that’s good for banks’ profits. Now you also asked about what to worry about and potential risks for the future. And clearly we haven’t yet seen the full impact of higher interest rates on banks’ balance sheets. So as there’s more pass-through and more impact of higher interest rates on deposit rates, of course this would have negative implications for profitability. It might also be difficult for the banks to pass on higher interest rates to their corporate clients because we also know that in many areas credit demand is weak. So what happens to bank profitability going forward is certainly something to watch. And there’s of course the big issue about risks, novel risks, geopolitical risks, climate risk. This is really something that European supervisors are focusing on. We work very closely with the banks to make sure that they are vigilant and that they also conduct good forward-looking risk assessments as regards these novel risks.

We have a merger under way here in Cyprus. Hellenic Bank, the island’s second largest lender, is under acquisition from Greece’s Eurobank. What is the supervisor’s view on this cross-border merger?

There’s one rule that supervisors have: they never speak about individual banks. I can’t say anything about this case. I can say something general about how supervisors look at consolidation in the banking industry. But again this is not a statement about the current case or the current cases that we are seeing. In some sense, we are neutral with regard to what types of business decisions banks take in terms of consolidation, whether they merge domestically or across borders. Supervisors really look at the prudential implications. And prudential implications mean: how capitalised are the banks? What is their liquidity situation? What is their governance? What is their business model? These are the things we look at and, as you may know, in Europe there’s also a discussion about cross-border banking activities. We’ve also looked at the supervisory approach to this and there’s certainly nothing that stands in the way from a supervisory perspective when it comes to banks’ cross-border activities. But again, this is a very general statement. It’s not related to the specific cases.

On a general point, and correct me if I am wrong: since its inception the Single Supervisory Mechanism (SSM) has always been advocating for cross-border mergers or acquisitions, which would create larger and more resilient banking groups or banking institutions. Is this correct? Is this a fair point?

I wouldn’t necessarily say we’ve been advocating [mergers] because, as I said, we don’t really have a view on what type of consolidation is the better approach. We look at the prudential implications. There’s certainly been an expectation that the banking union – which is not just about supervision, it’s also about the Single Resolution Mechanism – would lead to more cross-border activity. And we have seen more cross-border activity, but not that much. The integration process is a very slow process. This is why I said we’ve looked into what more can be done from a supervisory perspective to make clear what our approach is to consolidation, cross-border consolidation. We’ve explained this to the banks. But from this review that we’ve done, we don’t really see anything that would stand in the way from a supervisory perspective. Of course, we have to acknowledge that the countries in Europe are very different and there are different legal systems that apply, different cultures. These might also be factors that hold back or promote cross-border activity.

Let’s turn to the euro area banking sector. How do you see euro area banks and how do they compare with their US peers?

When we look at the past ten years – we’re celebrating the tenth anniversary of the banking union – European banks have become stronger and more resilient. And this is to a large extent the effect of the post-crisis financial sector reforms. They have more capital, they have better governance and I think we are in a very good position. Now you’re asking about how this compares to the United States. I would say that we are seeing – and this is sometimes cited by market participants – that the valuations of European banks differ from US banks and are lower in Europe. It’s actually interesting to see that the same also holds for other industries, so maybe that’s a broader question about the competitiveness of the European economy. But this is for others to also assess. I wouldn’t say that this regulation or supervision is the reason for the differences in valuations. Of course, the US banks are regulated as well. They have a very refined regulatory framework and supervision. I think supervision is the wrong place to look for these differences in valuations. It is my task, our task – jointly with the colleagues from Cyprus and the other SSM countries – to make sure that the European banks are strong and resilient and service the European economies and citizens in the end.

OK, you made clear that supervision is not the culprit here when comparing EU and US banks. Supervision has been a good thing. If we take the example of the COVID pandemic, the EU banks had all the fundamentals and the capital metrics to absorb all the shocks. And even now with the geopolitical crisis, they are not doing badly and perhaps this is due to supervision. Right?

First of all, one needs to say that the banks that are well capitalised can also lend better and service the real economy in a better way. The stronger banks are actually those that are in a better position to lend. It’s interesting that you refer to the COVID pandemic because there, indeed, the banks were very resilient. They kept lending to the real economy. We didn’t have a credit crunch or anything like that and that’s clearly due to better capitalisation, better trust in European banks and the effect of the reforms. But there’s one important element that I always stress, which is that we did see a lot of fiscal and monetary support during the COVID pandemic. There was a lot of support given to borrowers, to the real economy. We’ve actually seen a decline in corporate insolvencies in a period where we had a large decline in GDP. Usually, during normal recessions, this is the opposite. We would expect corporate insolvencies to increase. So this has also been a strong stabilising factor for the banking sector. There was fiscal support for the real economy, which indirectly benefited the banks. There was lots of liquidity provision through central banks. Definitely, COVID was a very stressful situation for societies and for the real economy. But the banks came out of it relatively unscathed and this also has implications for the forward-looking risk assessment.

Let’s turn to the outlook for the euro area banks. How do you see the outlook in an environment of elevated interest rates? Do you see a potential rise in NPLs? What are the data so far?

Yes, so far we are seeing a small increase in NPLs but this is really not a very big effect. We also know that, when we have a slowdown in the real economy, it takes time for NPLs to materialise and this is why we are pushing so much for a good forward-looking assessment of risk. Again, this is related to the discussion we just had about COVID. The patterns that we have seen in the past, a recession, a decline in corporate insolvencies – this is not in all likelihood the pattern that we will see in the future. The banks need to conduct a forward-looking risk assessment. They also need to make provisions for potential future risks that could come from very different risks – it can be geopolitical risks, climate-related risks. This forward-looking scenario analysis, scenario planning, is something that is very high on our agenda.

As you spoke about the agenda, what are the priorities of the SSM this year or going forward?

We have very strong foundations. I think we have a functioning system. We cooperate very well with the colleagues across European banking supervision. But the environment around us has changed. We have new risks that we’ve just been discussing. We need to make sure that we understand these risks, that we work with the banks so that they can sufficiently address these risks in their risk management. That’s for the banks and how we interact with the banks. And then we‘ve learned from the banking turmoil last year and from the reports of the authorities that supervision also has to adjust. We have to become more effective, more efficient. That’s the second priority. As the Supervisory Board, we also have to collectively improve our own supervision so that we can focus on the relevant risks and make sure that these risks are being addressed. And we have a third priority, which is reaching out, and also reaching out to the broader public. That’s why it is good to be here.

You gave me a bridge to the next questions in terms of new emerging risks. A very important factor in the euro area and, in fact, in the whole world is the green transition, climate change and climate risks for banks. How important is climate risk for the banking sector and will we see any capital requirements concerning climate risks?

That’s a good question. We asked that question to ourselves and to the banks several years ago when we did the first climate stress test, and we saw that transition risks – in other words, policy changes, but also other things that can happen in the transition to a greener environment – are important. And also physical risks. We’ve seen it in many countries. So these risks are important. Until recently, many banks didn’t really take into account these risks and how they materialise – their credit risk, their operational risk. It’s not new risk categories, but it’s a different impact factor here. We’ve seen that the banks were not sufficiently prepared. Then we defined very clear supervisory expectations and are following up on them, so the banks have until the end of the year to meet our expectations. We gave them clear timelines. Many banks have adjusted, some are still lagging behind. We need to see how they meet our requirements and then we will use the regular toolkit that we have. We can also impose periodic penalty payments on the banks, but we need to see how they meet our expectations and how they’ve adjusted their behaviour.

“Expectations”. Could you elaborate if you can?

Generally, we have expectations regarding how banks should manage risks, how they should control the risks that they see and what internal information systems they have to really measure the risks. In the end, it’s a question of measuring the climate-related risk that’s embedded in a certain lending contract. That is what our expectations are about.

It’s known to everyone that the other risk which has emerged with digitalisation and the progress of technology is cyber risk. And if I remember correctly, you have stated in a speech that we are a bit vulnerable to cyber risk.

Yes, not just the banks but I think we clearly see from all the reporting – and we have had regular reporting for a couple of years on cyber incidents in the banking sector and that information is also visible in the aggregate number and is publicly available – that the frequency and the severity of cyber incidents is increasing. This is why we have been working very closely with the banks for a long time to make sure that they’re sufficiently resilient. And what we have done this year is a cyber resilience stress test. We have a survey and we work very closely with specific banks on how well prepared they are and what recovery mechanisms they have once they’re being affected by a cyber incident. I can’t give you the full results yet because our colleagues are still working on them, but they [the results] will come out this summer. There will be general information for the industry, also in terms of best practices, and then we will follow up with the banks where we’ve seen deficiencies. That would be part of our supervisory process.

Will we be seeing capital requirements in this regard as well, or will it [the findings] be embedded in the dialogue, in the SREP process you have with the banks individually?

Generally, we have the Supervisory Review and Evaluation Process (SREP) as it is called, and that leads to qualitative requirements. Some of the things can’t be remediated with higher capital. But they can also lead to quantitative requirements and it remains to be seen for the individual teams what tools they are using. But of course, if there is higher risk, there also need to be sufficient buffers, sufficient resilience, and that comes through capital.