Patrick Montagner: Learning from the past, preparing for the future
Keynote speech by Mr Patrick Montagner, Member of the Supervisory Board of the
European Central Bank, at the 11th Institute of International Finance (IIF) Colloquium
on European Banking Regulation and Supervision, Frankfurt am Main, 5 December
2024.
* * *
Thank you for inviting me to speak here in my new capacity as a member of the ECB's
Supervisory Board. I've been asked to give you the ECB's view on the preparedness
and competitiveness of the EU's banking system, and on how the regulatory and
supervisory framework can foster conditions that help to balance growth and resilience.
Above all, a resilient banking sector is a precondition for economic growth. That's why
the Basel Committee on Banking Supervision has just publicly reaffirmed its expectation
concerning the Basel III framework being implemented in full, consistently and as soon
as possible.
Let me first recall some facts about the recent past. The aim of prudential supervision is
not to avoid all risks, but to have sufficient confidence in the preparedness of each
individual bank to face all its risks. A cornerstone of what we do is assessing whether all
material risks are being properly managed by the banks. If we look back on the great
financial crisis, we can see that there were a lot of imbalances within the global
economy. On top of that, the banking sector was not prepared to face these shocks and
had taken a lot of risks which had either not been assessed properly or, in some cases,
not assessed at all. This was mainly due to the race to the bottom in financial regulation
that started in the 1990s, driven by the belief that light regulation and supervision could
act as a catalyst for economic growth. Up until 2014, we were faced with huge
fragmentation within the EU, with different adaptations of the Capital Requirements
1
Directive , different supervisory practices and different requirements. And the banking
sector itself was complaining about this situation, with each bank thinking its
competitors were benefiting from a friendlier regime. The result was the worst depletion
of wealth since the Great Depression of the 1930s, including a huge bailout by
taxpayers and the failure of several major banks - unable to survive due to their poor
governance and risk culture.
Turning to the current situation, we can all be satisfied with how far we have come in
the last ten years. Over the past decade the overall profitability of European banks has
increased. In 2024 banks under European banking supervision reported a return on
equity of around 10%, compared with 6% in 2015. Banks' return on assets rose from
0.4% to 0.7% over the same period. During the years of low interest rates and low
inflation profitability was much lower and it only recovered when interest rates
increased. The non-performing loans ratio has decreased dramatically, from 7% in 2015
to below 2% today. Meanwhile, all banks under European banking supervision, whether
significant or less significant, are now subject to the same supervisory standards -
applied in the same way across all 21 countries. And harmonisation with practices in
the rest of the EU has also greatly improved.
So, clearly, good regulation and good supervision have been essential to create a safe
and harmonised level playing field and to allow the EU banking system to play its role in
the economy without compromising banks' lending capacity. They have also helped
banks withstand some unexpected turmoil in recent years: Russia's war of aggression
in Ukraine and the energy supply shock, as well as the banking turmoil of March 2023
in some other countries. Weakening banking regulation and supervision would not
boost the competitiveness of the EU economy. The issue of competitiveness should be
addressed in a different way and the recent report by Mario Draghi has delivered some
key messages, notably the need to encourage innovation and productivity in the
European Union.
We all know that there are still significant discrepancies between countries that could
create market distortions, in particular discrepancies in tax and corporate insolvency
laws. Achieving a harmonised single market also requires structural reform in all
countries. I won't repeat here the rationale behind the need to create a truly single
market for capital, but I would nevertheless like to emphasise that we need to complete
the banking union. This requires, first, a fully-fledged European deposit insurance
scheme and, second, a stronger European framework for crisis management (and here
I am referring to the crisis management and deposit insurance, or CMDI, framework).
Both will promote integration and reduce national fragmentation. A more integrated
European banking sector will be more efficient and competitive.
Of course, the ECB remains open to discussing possible simplifications and
streamlining of its approach to banking supervision. The reform of our Supervisory
Review and Evaluation Process (SREP) is one key element. Changes will be
implemented gradually, starting in the second half of 2024, and will be finalised for the
2026 SREP cycle. The SREP reform will enable us to be more efficient, more
comprehensive, and more effective - and will enhance our communication with banks.
Allow me to elaborate further on my point by taking climate and nature-related risks as
an example. The EU legislator did not invent climate risk or the burden of ensuring an
orderly transition. The risk has been around for a long time. The Intergovernmental
Panel on Climate Change (IPCC) was created in 1988 to provide scientific assessments
and recommendations related to the current state of knowledge about climate change.
The Paris Agreement was adopted in 2015 at the UN Climate Change Conference
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COP21 after the Fifth Assessment Report of the IPCC. So clearly, all the facts have
been on the table for decades. The latest tragedy in Spain has shown that the financial
cost can severely hit the economy, not just at the regional but also at the national level.
And we have many other recent examples showing the macro-financial relevance of
climate and nature-related risks. On the one hand, the cost of the transition will be high.
On the other hand, analysis consistently confirms that the costs of doing too little too
late are much higher. The ECB supervisory stress test in 2022 confirmed this analysis
for the banking sector. The reinsurance sector, which is exposed to natural
catastrophes more routinely than the banking sector, has clearly understood this and
shown that, without rapid adaptation, insurance could become unaffordable in some
regions. Regrettably, the prevailing consensus in climate science tells us that we are far
from on track to meet the goal of limiting global heating to two degrees Celsius, as set
out in the Paris Agreement. Diluting regulation, supervisory intensity and effectiveness
will do nothing to change the scale and magnitude of these risks, either in the very near
future or in the medium and long term. Instead, we need to renew our efforts and banks
need to demonstrate their ability to correctly assess and properly manage these risks -
risks which will undoubtedly have a negative impact on their profitability and resilience.
Digitalisation is another important factor that will drive bank profitability in the future.
And once again, the facts leave no room for doubt. Customers expect the same from
their banks as they do from any other business: they want to be able to easily access all
of the services associated with their bank account. Banks also now face competition
from newcomers that are not held back by legacy IT systems. They will therefore need
to implement efficient digital solutions for their customers, find economies of scale and
ensure the highest levels of IT security. At the same time, digitalisation doesn't mean
the end of face-to-face interactions between banks and their customers: some people
still want to go into their local branch in person, especially older people and those
carrying out more complex financial transactions. The ability to respond to customers'
evolving needs will be crucial for the future of established banks. They are facing
competition from new financial service providers that are trying to attract business in the
most profitable segment of banking operations: payments.
In addition, banks need to make major investments in their cyber and IT resilience to
stay at the forefront of technological developments and prevent disruptions or breaches.
Investment in IT will be key to ensuring the banking sector remains sound and
competitive in the future. Economies of scale and a more integrated EU market are
likely to be needed in order to absorb the cost and boost profitability. That's a key point:
IT investment needs to be strengthened to maintain competitiveness vis-à-vis US
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peers. A study last year observed that the annual IT budget for US global systemically
important banks (G-SIBs) in 2021 was around 0.36% of total assets, compared with
0.19% for euro area G-SIBs.
Therefore, one of our supervisory priorities at the ECB is assessing how banks
formulate, implement and monitor their digitalisation strategies, and how they manage
the related risks. Building on our findings and surveys, we recently published criteria
and best practices for banks' digital activities.4
But some questions related to technology are far from being solved. Generative artificial
intelligence (AI) tools have the potential to transform some parts of the banking
business, although as yet there is no clear evidence that they have been fully
incorporated into banks' digitalisation strategies. Crucially, consumer rights and privacy
must also be respected when issues related to AI are being addressed. And without
good IT systems, AI tools won't be correctly fed by banks' data.
Let me conclude. The ECB's mandate to keep banks safe and sound makes a critical
contribution to the overall competitiveness of the banking sector. And this works both
ways, as the resilience of the banking sector is also about its competitiveness. We are
therefore looking closely at the sustainability of banks' business models and their future
profitability. Moreover, by establishing a harmonised framework for its supervisory
activities through the Single Rulebook, the ECB has reduced the fragmentation that
existed previously. And the SREP reform is another important milestone in our efforts to
better assess risks while stabilising the methodologies we use. However, much of the
work that still needs to be done falls outside of the ECB's remit. A strong supervisory
framework plays a key role in supporting the growth and competitiveness of the
economy but will never replace the need for structural reforms to boost productivity.
Other factors will also play a major role, such as changing demographics, including
ageing societies, and geopolitical risks.
Overall, the profitability of European banks has increased significantly in recent years,
but they need to continue adapting to a changing environment presenting a cluster of
challenges. Long-term investment and a strong capital base will be crucial for banks to
meet these challenges. From the ECB's perspective, there is no room for complacency.
1
Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013
on access to the activity of credit institutions and the prudential supervision of credit
institutions and investment firms, amending Directive 2002/87/EC and repealing
Directives 2006/48/EC and 2006/49/EC (OJ L 176, 27.6.2013, p. 338).
2
Conference of the Parties (or "COP") to the United Nations Framework Convention on
Climate Change (UNFCCC).
3
Di Vito, L., Martín Fuentes, N. and Matos Leite, J. (2023), "Understanding the
profitability gap between euro area and US global systemically important banks ",
Occasional Paper Series , No 327, ECB, August.
4
ECB (2024), Digitalisation: key assessment criteria and collection of sound practices ,
11 July.