Margarita Delgado: Keynote address - 4th Annual European Financial
Integration Conference
Keynote address by Ms Margarita Delgado, Deputy Governor of the Bank of Spain, at
the 4th Annual European Financial Integration Conference, organised by the
Association for Financial Markets in Europe (AFME) and the Official Monetary and
Financial Institutions Forum (OMFIF), Frankfurt am Main, 28 May 2024.
* * *
First of all, I would like to thank the Association for Financial Markets in Europe (AFME)
and the Official Monetary and Financial Institutions Forum (OMFIF) for inviting me to
the 4th Annual European Financial Integration Conference. I am sure that in today's
agenda will hear very interesting ideas regarding European Financial integration from
different perspectives, including technology, innovation, the capital markets union,
sustainability and so on. All these thoughts will need to be set in the context of the
current uncertain macroeconomic and geopolitical environment.
I will start with an overview of the European macroeconomic situation, followed by an
analysis of the current state of the banking sector, as well as the main challenges it
faces in the medium term. Additionally, I will discuss the bold decisions that European
policymakers must make during this legislative cycle to promote greater market
integration.
Global economic activity was more buoyant than expected in late 2023 and in the early
stages of this year, compared with the figures envisaged in the ECB's latest
1
macroeconomic projections exercise of March 2024. At the same time, economic
activity has evolved differently across geographical areas, with a clear contrast between
the improvement observed in the United States and China and the relative weakness
observed in the euro area. In this context, the global disinflationary process has
continued amid declining energy prices, a reduction in supply disturbances and the
ongoing impact of restrictive monetary policy in the main advanced economies. Finally,
international financial markets are being shaped by the recent delay in the expected
path of interest rate cuts by the Fed.
In this context, economic activity in the euro area has remained weak since mid-2023
and only more recently has it shown signs of improvement. The ECB's most recent
projection exercise predicted an average annual GDP growth rate of 0.6% in 2024, 0.2
pp higher than the figure observed in 2023. However, in early 2024 the euro area has
shown signs of a stronger recovery than initially expected. Indeed, according to
Eurostat's flash estimate, quarterly GDP growth stood at 0.3% in the first quarter of
2024, clearly above the figure of 0.1% envisaged in the ECB's March projections.
Moreover, in the medium term GDP growth is expected to strengthen gradually, with
private consumption as the main driver supported by growth in household disposable
income. Declining inflation and robust wage growth are two additional factors to
consider. Meanwhile, the ECB's monetary policy will exert less drag on the economy as
monetary conditions gradually normalise over the projection period. As a result, the
ECB's March projection exercise envisages moderate growth rates of 1.5% in 2025 and
1.6% in 2026, slightly above the average annual growth of the last two decades (1.4%).
As for inflation, in recent months it has performed largely as expected in the ECB's
latest projection exercise, declining by a cumulative 8.2 percentage points (pp) from its
peak in October 2022 (and by 3.0 pp since March 2023 in the case of underlying
inflation), in a context in which the ECB's monetary policy continued to be transmitted
2
robustly to financial conditions. However, according to the flash indicator, HICP
inflation held at 2.4% in April, 0.2 pp above the March forecast.
Going forward, inflation is expected to decline further in the coming quarters, albeit with
a somewhat bumpy profile in the short term. Indeed, energy base effects, the unwinding
of crisis-related fiscal measures and the relatively slow moderation of services inflation
will cause inflation rates to fluctuate during 2024. Overall, the projections envisage a
moderation in inflation to 2.3% on average in 2024 (compared with 5.4% in 2023) and
to around 2% in 2025 and 2026.
This progressive reduction in inflation would be compatible with robust - although more
moderate - wage growth, against the backdrop of a recovery in labour productivity and
the containment of business margins. These are expected to act as a cushion for wage
pressures in the face of weak demand and the unwinding of supply bottlenecks.
3
As for productivity, it is important to highlight the role of labour hoarding by firms to
explain the positive performance of employment in recent quarters. Despite weak
demand, employers prefer to retain workers as they perceive labour shortages to be
high and expect existing shocks to be temporary. Therefore, the ongoing recovery in
activity is expected to be less intensive in employment, thus boosting productivity.
In my opinion, the risks surrounding these inflation projections are balanced. On the
one hand, as I have explained, the gradual downward trajectory towards the 2%
inflation target is conditional on the moderation of wage inflation, a recovery in
productivity and profit margins continuing to act as buffers to inflationary pressures. If
these assumptions do not materialise, inflation would be higher than expected in the
baseline scenario. On the contrary, if the effects of monetary policy on activity and
inflation are stronger than expected, we could observe a negative deviation of inflation
from the target.
Despite this uncertain geopolitical environment and unequal macroeconomic
landscape, European entities have continued to operate robustly. Over the last ten
years, the banking union was rather unique in terms of risk reduction. Despite a series
of shocks hitting European economies in recent years, macroeconomic volatility has
remained low with the exception of a couple of episodes. First the pandemic (March
2020), then Russia's war against Ukraine, the energy crisis and, last year, the March
2023 banking turmoil. Banks went into these episodes well capitalised, with plenty of
liquidity and hence resilient.
According to the latest data published by the Single Supervisory Mechanism for the last
quarter of 2023, banks have further strengthened their solvency. The average CET1
ratio reached 15.7%, 30 basis points (bps) higher than the previous year. Additionally,
the significant increase in ECB reference interest rates has had a very positive impact
on banks' financial results, achieving an average return on equity of 9.3%, significantly
higher than the previous year (7.7%) and well above the historical range of 5% to 6%.
Furthermore, this interest rate hike has not yet significantly affected the non-performing
loan (NPL) ratio, which has only experienced a slight increase of 3 bps in the last year,
reaching 2.30%. On the other hand, liquidity remains robust, maintaining a liquidity
coverage ratio of above 160% and a net stable funding ratio of over 125%, well above
the regulatory requirements.
Of course, these positive overall figures conceal a much more heterogeneous reality
among entities, countries and business models that needs deeper analysis.
For instance, we should note that the sharp increase in interest rates has been partially
cushioned by households due to the robustness of the euro area labour market, which
reached historically low unemployment levels (6.5% in March). However, as I
mentioned before, according to the ECB the economy remains weak, especially in the
manufacturing sector and particularly in energy -intensive industries. Over the coming
quarters a gradual economic recovery is expected, led by the services sector and
exports growth, in line with the global economic rebound. But we must remain prudent.
The geopolitical situation is still a factor to consider and could generate uncertainty that
affects the economy. For this reason, caution is necessary, and monitoring should be
reinforced in specific sectors within certain regions, such as the commercial real estate
sector, which is already coming under scrutiny by supervisors.
Additionally, other pockets of NPLs could emerge in more vulnerable sectors that have
been heavily impacted by prolonged higher interest rates. Highly targeted portfolio
monitoring is essential to spot any early warning signs that might trigger targeted
supervisory actions.
Under these circumstances, entities should capitalise on their current positive results to
strengthen their solvency and ready themselves to face the upcoming challenges in the
coming years.
The first challenge is digitalisation. Financial institutions will need to continue making
significant investments in new technologies to adapt their business models to the
evolving digital landscape. Like other sectors, the banking industry is putting customers
and their expectations at the core of its strategy. These expectations are
unquestionably evolving in step with technology and banks will have to keep pace if
they wish to remain the predominant players. Responding fully to the needs of
customers will be crucial for the future of banking, given the threats and challenges
looming over the financial system. Digitalisation opens doors to expanding the range of
clients that an institution can reach and increasing the number of channels for product
distribution, while also laying the foundations for enhanced financial services.
However, it also requires substantial investments to reinforce operational resilience.
There is no such thing as zero risk, and it is evident that expanding the technological
ecosystem in which banks operate will significantly increase the attack surface and the
risk of system failures. Banks will need to have strong operational frameworks to
mitigate these risks and to be able to respond to incidents quickly. Supervisors remain
vigilant of this risk due to the severe negative consequences that system failures or
cyberattacks could have not only on trust in the specific institution, but also on trust in
the entire system.
Additionally, the use of technologies such as cloud services often involves having to
depend on external providers. Although these services have clear advantages in terms
of improving firewalls or back-up systems, they also entail concentration risk and the
relinquishment of control. The industry's reliance on a limited number of providers, and
the total inability to switch providers as and when required, may generate
vulnerabilities. This is another aspect that is on the supervisory agenda.
Moreover, digitalisation is closely tied to data aggregation and management, which are
essential for a robust decision-making process and good governance. Investment in this
field is necessary and profitable because the benefits of having high-quality,
wellstructured data in easily processable formats contribute to reducing operational,
technological information and reporting costs in the medium term.
The second major challenge faced by financial entities is adapting to the real
economy's new environmental requirements. This extends beyond climate change
adaptation and mitigation processes to include aspects like biodiversity loss and social
considerations.
Europe has committed to transforming its economy to align with these elements,
necessitating substantial investment. Banks cannot remain on the sidelines of this
transformation; they must also design realistic, transparent, and credible transition
plans with intermediate milestones. Achieving this will require significant effort in terms
of developing key performance indicators and obtaining relevant information, which will
also require a significant amount of investment. The financial sector must decide where
it wants to be 10-15 years from now and monitor exposures and compliance with the
milestones established in the transition plans.
As I mentioned, the green transformation of our economy will require enormous
resources, making a capital markets union urgently necessary. This will be one of the
key points to be addressed in today's conference; in my view, it is essential to make the
final push and implement the project outlined in the 2020 action plan. During the last
European Council meeting on April 17 and 18, emphasis was once again placed on the
critical aspects needed for further progress.
These include, among other aspects, harmonising corporate insolvency systems,
promoting the European securitisation market, enhancing convergence and efficiency in
capital markets supervision and designing simple and effective cross-border investment
and savings products for retail clients. Ideally, the European economy would mobilise
the savings currently held in bank deposits towards more productive investment forms.
In other words, building confidence among European savers to invest in products that
offer better long-term returns would benefit both savers and companies, which could
access alternative forms of financing. Therefore, progress towards a capital markets
union should be accelerated. Undoubtedly, a first step towards integration is to work on
the convergence of regulatory and supervisory frameworks and towards a single
financial culture.
Turning back to the banking sector, another aspect to consider is cross-border mergers.
Not forgetting the neutrality that authorities must maintain, we must also recognise that
the absence of notable examples of cross-border mergers in the European Monetary
Union is an anomaly. Such operations would bring benefits such as greater
diversification and potential efficiency gains related to larger size.
So why haven't they occurred before now? I believe that the conditions for banks -
which are the ones that need to propose and analyse the potential business case -
have not yet been met. There are still certain regulatory divergences in Europe:
different insolvency regimes, transaction costs and banking product cultures that have
prevented any notable examples of cross-border operations to date. Having large
PanEuropean banks on an international scale would probably make it easier for our large
companies to raise finance more competitively for their international activities. But this
point also leads me to raise another question: Do we want "Pan-European banking
champions" at any cost? The answer is 'no'. Bigger isn't always better. Every operation
must be based on careful analysis of the specific benefits it would entail, which in any
case should outweigh the associated costs and risks. The resulting business model
must be profitable and sustainable as a result of the synergies that the current
regulatory framework does not provide to our institutions to grow beyond the national
borders. Therefore, I would like to emphasise, once more, the importance of continue
building the foundation of a truly common regulatory framework in Europe for the shake
of our own interest. Our financial system, our companies and economy need to be
stronger to compete at international level.
Finally, in relation to supervision, I'd like to stress that improving the governance and
functioning of the Economic and Monetary Union would significantly reduce the
vulnerability of the European financial system. Specifically, creating a fully mutualised
European deposit insurance scheme would boost citizens' and markets' confidence and
contribute to greater risk-sharing within the euro area, thereby reducing the potential for
fragmentation episodes. In the meantime, the crisis management and deposit insurance
package improves the current rules to better protect taxpayers from the costs of bank
failures.
In conclusion, the European banking system is well positioned. We can consider it
robust, solvent and profitable. The 2023 turmoil involving some medium-sized banks in
the United States and Credit Suisse proved that a sound risk management and
governance structure and a strong and clear regulatory and supervisory framework are
key for the stability of our financial system.
Nevertheless, we must still pay close attention to the consequences that this uncertain
macroeconomic and geopolitical scenario might have for the credit quality of specific
portfolios. Additionally, the new monetary policy scenario also requires our banks to
develop robust, diversified and credible funding plans easily to be operationalised.
Banks should also set effective contingency plans to be able to withstand short-term
liquidity shocks and also ensure the adequate management of their interest rate risk
positions.
I firmly believe that institutions should take advantage of the current profits to make all
necessary investments to ready themselves to address the new digital and
environmental risks.
The world today is much more complex than 30 years ago. Competition across sectors
and geopolitical blocks are even more intense and of a global scale.
Meanwhile, the capital markets union should urgently and definitively gain political
momentum in the next legislative cycle to strengthen and galvanise European
investment and, consequently, the economy. Additionally, completing the third pillar of
the banking union is another priority that must be addressed in order to achieve the full
integration of our banking system.
1
According to the ECB's March 2024 macroeconomic projections, world GDP would
have slowed slightly in 2023 to 3.5%.
2
Harmonised Index of Consumer Prices.
3
Labour hoarding can be defined as that part of labour input which is not fully utilised
by a company during its production process at any given point in time. https://www.ecb.
europa.eu/pub/pdf/other/mb200307_focus04.en.pdf