Press Release - Banks adapting to the new normal: Striking a balance between prudence and pragmatism - Speech by Yves Mersch, Member of the Executive Board of the ECB, Dinner Speech at the Mandarine Gestion Investment Conference, Munich, 19 September 2016
Introduction
Eight years ago, almost to the day, US investment bank Lehman Brothers went bankrupt. Its default unleashed a global financial crisis we still haven’t fully recovered from.
Regulators worldwide responded to the crisis by imposing stricter rules to make the financial system more resilient.
Addressing financial sector weaknesses is an important step. When addressing these we need to keep in mind the challenges banks are facing as they adapt to a new operating environment. They face challenges to their business models and to their profitability, they face increasing competition from the non-bank sector and have to contend with new technologies in the payments field as well as new regulations.[1]
Today I want to focus on two of these in greater detail. First, I will consider how the economic environment has made it more difficult for banks in some countries to lend. I will then take a look at the financial regulation and the changes that are still being implemented.
Adapting to the new operating environment has not been easy. Banks have been very vocal critics of tighter regulation and low interest rates, particularly here in Germany.
The ECB is aware of this criticism, and of the crucial role banks play in transmitting our accommodative monetary policy stance to the real economy. At the same time, the financial crisis has taught us that banks’ capital and risk buffers were too low and regulation of certain markets needed to be tightened.
Striking the right balance between prudence and pragmatism
We need to learn from the past, which saw the biggest bailout in history, costing European taxpayers almost €2 trillion.[2] Germany’s government, by the way, was one of those in Europe that spent the most to support the country’s financial institutions.
This experience has led to a paradigm shift: from ‘bailout’ to ‘bail-in’. In other words, banks’ shareholders and creditors, rather than taxpayers, will be called on first to bear any losses arising from a bank’s failure. Stronger and more harmonised regulation is necessary, no doubt, but we should not go too far and keep in mind that banks need some leeway to operate effectively.
Implications of the low growth and low interest rate environment
Let’s take a closer look at the economic environment banks are operating in today.
Low growth and low inflation are not only European phenomena, but are prevalent in many mature economies around the globe. They are driven by factors such ageing populations, shrinking workforces, rapid technological progress and the aftermath of severe economic downturns.
In the euro area, a mood of uncertainty and a weak economic recovery are holding back investment and bank lending. This mood is informed by geopolitical uncertainties, subdued growth prospects in emerging markets, necessary balance sheet adjustments in a number of sectors, the slow implementation of structural reforms in general[3], as well as Brexit and the refugee crisis.
Economic downturns following the financial crisis have, in some euro area countries, exacerbated the problem of non-performing loans (NPLs) for banks. This legacy issue has seriously handicapped their lending to companies and households. The 2014 comprehensive assessment, which for the first time evaluated euro area banks’ assets according to the same standards, identified an upward revision of the estimated non-performing exposures amounting to €136 billion, or 18%. Banks stepped up their provisions accordingly, but the NPL problem cannot be solved with capital alone. The ECB is fully aware of this and is developing guidelines for banks, asking them for example to create operational structures and draw up strategies to manage and ultimately reduce their NPL stock in a timely manner. National authorities need to play their part as well and take the necessary steps to resolve the issue, for instance by making changes to the judicial system.[4]
We cannot afford to waste too much time. High levels of NPLs are paralysing banks, preventing them from passing on the ECB’s monetary stimulus to companies and households, and effectively holding back the recovery in the euro area.
The comprehensive assessment was a starting point and a milestone: it gave us a better idea of the size and the nature of the problem we are facing. We have to be realistic though; improvements will not happen overnight. It will take years. We have to be patient – and determined. The economic environment plays a key role in overcoming the issue. Recessions tend to increase the dimension of NPLs. It is not surprising that the problem is most pronounced in countries with the weakest growth dynamics. Therefore, structural reforms that aim to spur growth are an indispensable precondition to remove the millstone that weighs heavily on the banking sector.
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