On 5 October 2021, the European Central Bank published a speech by a member of its Supervisory Board, Edouard Fernandez-Bollo. The speech is entitled ‘ECB Banking Supervision’s post-pandemic priorities – the way forward’.
In his speech Mr Fernandez-Bollo reflects on some of the challenges and priorities that lie ahead for the banking sector. These include:
- The banking sector has shown itself to be much more resilient than in previous crises of a similar magnitude. Nevertheless, it is important to emphasise that a number of risks – both directly and indirectly related to the pandemic – still need to be addressed. The full impact of the COVID-19 shock has yet to materialise on banks’ balance sheets and may only do so once government support measures are withdrawn. The ECB has found that some banks’ early warning systems and procedures for assessing borrowers’ unlikeliness to pay are overly reliant on ineffective indicators, outdated ratings and backward-looking information. The ECB has also observed some “search for yield” behaviour in financial markets, including by banks. This can be seen in the exuberance in asset valuations in certain segments of the equity market, increasing leverage by banks, and the ever more complex and opaque financial products being traded by banks. The ECB’s message is clear, bank governance needs to address this immediately.
- Banks must effectively incorporate climate risks into their risk governance framework. ECB Banking Supervision carried out an extensive survey of banks’ self-assessments against its supervisory expectations on climate-related and environmental risks. The results were somewhat mixed. What is lacking, even in 80% of the banks that deem climate-related and environmental risks very important for their business model, is the definition of a clear strategic and operational framework to deal with these risks in their day-to-day operations. Next year the ECB will conduct a full supervisory review of banks’ practices for incorporating climate risks into their risk frameworks, as it gradually rolls out a dedicated Supervisory Review and Evaluation Process methodology that will eventually influence banks’ Pillar 2 capital requirements. The ECB will also carry out a supervisory stress test focusing on climate-related risks, the methodology for which will soon be shared with the banks under its supervision.
- The path out of the pandemic also needs to address the structural challenges to the stability of the banking system. A major challenge is profitability: even though it is now returning to pre-pandemic levels after the shock of 2020, profitability levels before the crisis were lower than in other large banking systems, such as the United States, and lower than the implied market cost of capital.