Sabine Lautenschläger: The European banking sector - a quick
pulse check
Speech by Ms Sabine Lautenschläger, Member of the Executive Board of the European Central
Bank and Vice-Chair of the Supervisory Board of the Single Supervisory Mechanism, at the Euro
Finance Week Conference, Frankfurt am Main, 15 November 2016.
* * *
Since the financial crisis of 2008, the health of the banking sector has become one of the hot
topics in public debate. And with good reason, because banks are important for all of us - in
good times and in bad.
In good times, banks help to finance enterprises which, in turn, drive economic growth and
provide employment. In bad times, banks can threaten the financial system and damage the
economy - as we have learned during the recent financial crisis.
Against that backdrop, the purpose of my speech today is to do a quick pulse check and see how
European banks are doing.
European banks - more resilient and less profitable
Let us begin by talking about the obvious!
First, banks have become much more resilient. Higher capital buffers are helping them to
withstand even severe shocks. The recent stress test conducted by the European Banking
Authority confirmed the increased resilience of European banks.
However, that rather benign finding seems to be contradicted by the collective pulse check that is
conducted by the markets. Since the beginning of the year, the share prices of European banks
have fallen by more than 20%, on average. It seems that, in the view of the markets, European
banks are not that healthy.
The diagnosis is not a lack of stability but a lack of profitability. And indeed, the return on equity of
large banks in the euro area is mostly still below the estimated cost of capital.
Attempts to explain this lack of profitability have focused on low interest rates. It is true, of course,
that low interest rates are a challenge for banks. Still, we should not completely ignore their
positive effects. They reduce funding costs for banks and support the economy, which also
indirectly benefits banks.
But it is not just low interest rates that pose a challenge to banks. Other issues play a role, too:
high costs eat into profits; non-performing loans weigh down balance sheets; and fee-generating
business has become more difficult. Digitalisation has introduced fintech companies as new
competitors, and the banking landscape in general is still characterised by overcapacities. This
increases competition and depresses margins.
European banking supervision - a comprehensive treatment plan
Banks have become more resilient, but they do operate in an environment that is characterised
by constant change and constant competition. In order to retain their resilience and preserve their
profitability, banks have to change as well. Most importantly, they have to rethink their business
models.
From our perspective as supervisors, the viability of business models is currently one of the
main points of attention. While it is not our role to tell banks how they should operate, we must
warn them against the temptation to prop up their profits by taking on too much risk. An
excessive search for yield could easily lead to new troubles for the banks themselves and the
financial system as a whole.
And against the backdrop of low profitability, abundant liquidity and high competition, this is not a
purely hypothetical concern. As a result, we are not only scrutinising business models and
profitability drivers, but are also taking a close look at risk management. This is reflected in our
supervisory priorities today and for the coming years.
In a nutshell, effective risk management rests on two pillars: sound governance structures and
high-quality data. With regard to internal governance, we recently published the results of a
thematic review. Its conclusion: many euro area banks need to improve the way they conduct
business and manage their risks in order to achieve international best practices. With regard to
data quality, the "Principles for effective risk data aggregation and risk reporting" published by the
Basel Committee on Banking Supervision in 2013 are a suitable benchmark. We will closely
monitor whether banks are applying these principles.
Another important issue in the context of risk management is the internal models that banks use
to calculate their risk-weighted assets which, in turn, serve as a basis for determining capital
requirements. For the next three years we will conduct a targeted review of these internal models
in order to ensure consistent model outputs and restrict unjustified variability in the calculation of
risk-weighted assets.
Through our review, we will gain in-depth knowledge of the internal models for credit and market
risk used by European banks, as well as of their standards and best practices. We will put this
knowledge to use for several objectives.
Our follow-up decisions, in particular when approving models and requesting improvements or
add-ons, will contribute to a level playing field regarding the calculation of capital requirements.
We will also use the knowledge we acquire to hone our supervisory expectations and our
guidance for banks regarding credit and market risks. And we will base our position in
international supervisory and regulatory groups on the knowledge and experience we gain during
the project. Our review is certainly a huge project - in 2017 alone, we will be conducting more
than 100 assessments, each of them covering three to four models. Nevertheless, the benefits
will be equally large.
In addition to business models and risk management, we are currently focusing on a third issue:
credit risk. Most prominently, this includes the issue of non-performing loans that I mentioned
before. It is the banks themselves that have to tackle this issue as quickly as possible. However,
they sometimes face obstacles in the form of inadequate national legislation and national judicial
frameworks, as described in the stocktake of national practices we published in September.
Here, policymakers can play an important role by reforming relevant legislation.
As supervisors, we can assist the banks by pointing out best practices and ensuring that they
are applied. Today, we will close the public consultation on our guidance for banks on dealing
with non-performing loans. That guidance takes the form of recommendations to banks and
defines a number of best practices that we have identified. It sets out our supervisory
expectations and serves as a basis for supervisors to evaluate how banks handle
nonperforming loans.
Conclusion
Ladies and gentlemen, to sum up: banks are more resilient than they were just a few years ago.
However, they still have to improve their fitness. They have to adjust to a new economic
environment; they have to adapt to the digital world; and they have to become more efficient and
deal with legacy assets. This is no small task, but it has to be done.
Moreover, the banks have to get used to a new regulatory framework. That framework should be
finalised by the end of the year, and it should be finalised at the global level. Banking became a
global sector years ago, and regulation must follow in order to ensure stability.
Thank you for your attention.