François-Louis Michaud's interview with Les Echos: We can't afford the emergence of zombie banks or businesses

We can't afford the emergence of zombie banks or businesses

According to the Executive Director of the European Banking Authority (EBA), banks have successfully absorbed the shock of the crisis, but there is still considerable uncertainty about the ability to measure risk in balance sheets. In his view, the greatest risk to the sector would be that of inaction.  

After a year of health crisis, how do banks fare?

Banks have been facing an unprecedented shock for one year, but one which is exogenous to the financial sphere. Thanks to the efforts of banks and authorities, the sector has entered the crisis in a much better situation than ten years ago, with more capital and more liquidity. In addition, banks have made progress on their information systems and risk management, and managed to dispose of risky assets. Another contribution of the 2008 crisis is that everyone has moved quickly into crisis mode, both in the private and public spheres. This is a great novelty.

But the impact of the crisis seems to have been delayed, isn’t this the case?

Very much so. The public sphere has intervened massively: governments have provided funding, guaranteed certain loans, allowed borrowers to defer repayments, and central banks have injected massive liquidity. The authorities encouraged banks to use all the existing flexibilities. All this has helped to withstand the peak of the crisis and to defer its impact on banks’ balance sheets for almost a year. As a quid pro quo, banks were asked to continue to assess their risks, so as not to break the thermometer, and to postpone the payment of dividends in order to maintain a maximum level of capital.

Is the prolonging of the pandemic making the whole system fragile?

As the crisis continues, tensions are increasing on certain sectors and potentially on those that finance them. Much will depend on the speed at which the activity will restart. For the time being, the recognition of losses is being delayed, but banks and their customers do need to use this period to restructure their funding or operations to prepare for the exit from the crisis.

Have banks sufficiently provisioned against the risks of unpaid payments?

We can see that the levels of provisioning differ significantly from one bank to another, from one country to another, which is quite normal. Their portfolios are different as are their sectors of activity. Moreover, provisioning is not an exact science: it is based on medium term credit risk assumptions. Today, however, there is a great deal of uncertainty. Traditional models no longer function as they should. Nobody can really model the current situation. Banks need to review their assumptions to review their models.

This is worrying! Does it mean that we do not know what is beneath the surface?

Indeed, for almost a year, there has been a combination of this uncertainty — the usual metrics no longer work as before — and, on the other hand, there has been a relaxation of the monitoring and reporting obligations. Inspections have been reduced and we have delayed the stress test exercise by one year. This is a much more uncertain situation with less visibility than under normal conditions. All these measures were necessary for banks to focus on their core economic function. Now, this situation should not last too long as it could have a negative impact on how banks are perceived in the market. This is why the stress test that the EBA launched at the end of January, for the whole banking sector in the European Union, is very important.

When will the authorities lift the flexibilities granted to the sector?

Everyone is aware that we cannot afford removing emergency measures too quickly. Depending on how the crisis will evolve, it may also be necessary to prolong them or to take some other measures. At the same time, we cannot afford the emergence of zombie banks or businesses, nor to defer the necessary restructuring measures because this would have an impact on the way out of the crisis.

What is the biggest risk for the European banking sector today?

The sector as a whole was not profitable at the beginning of the crisis due to a combination of factors: the lack of massive restructuring ten years ago, unlike in the United States, overcapacity, a low interest rate environment, the cost of upgrading digitally, and new incumbents. The health crisis does not help. On the other hand, not all banks are in a bad shape, far from it. But there is a collective interest for them to restructure.

What does it mean exactly?

The authorities, for their part, announced that they would welcome restructuring activities. We see mergers in Italy, Spain, but also some restructuring in France. The greatest risk, indeed, would be that of inaction, in a wait and see mode. Just like it happened ten years ago, the risk would be that banks say “situation too uncertain, let’s differ decisions”. In fact now is already the “new normal”. Banks need to start moving and manage uncertainty. Which, in a way, is their job.

Should we necessarily expect marriages between banks?

The main challenge for banks is to reduce their costs and the solution is not necessarily mergers or acquisitions. In order to serve customers, several options are possible. For instance, in Europe, the market is sufficiently integrated to serve other countries from one’s home market thanks to the free provision of services. We see some consolidation in consumer credit. As regards acquisitions, much has been done to harmonise the rules. Now, the ball is in the banks’ camp to make full use of this harmonisation!

Banks fear that the new Basel 3 prudential rules will prevent them from financing the economy in the midst of crisis. What is your view?

The subject is very passionate. The logic response of the Basel Committee was to postpone the implementation of Basel 3 by one year until 1 January 2023. Now, the European Commission is preparing its legislative proposal and asked us to update our impact assessment, based on figures at the end of 2019. One should not exaggerate the immediate impact of Basel 3 on the banking sector as it is going to be phased until 1 January 2028. So, we have time ahead of us. The capital burden would increase by 18 % or EUR 30 billion. This is half of what was expected in the previous study, which also shows the difficulty of carrying out such estimates, and this is a lot, but the impact is not the same for all — it is mainly borne by large international banks. Let’s bear in mind, however, that the bulk of Basel 3 is already in place, that this has contributed to the soundness of the system, and that the better capitalised banks are also the most profitable ones in the long term.

Do you see a risk of regulatory divergence with the UK due to Brexit?

It is clear that the situation will change but it is difficult to make forecasts. In any case, the great cataclysm that was so much feared did not happen. And this owes a lot to the work of the authorities on both sides of the English Channel. We should take comfort from that.

Are you confident that you will conclude a Memorandum of Understanding with London in March and beyond, do you need equivalence with London?

I am very confident that this Memorandum of Understanding will be signed soon. As regards equivalence, it is the European Commission that carries out this work. Of course, it would be easier to have an equivalence regime, but solutions can always be found to work together, regardless of the modus operandi. It is in the mutual interest of banks and their authorities to find the right solutions, so I am confident that they will be found.

Recent scandals have given the impression that fintechs are less regulated than banks and are attacking the market. Will you tighten the screw?

There are indeed actors that today play a key role in the banking value chain. They are out of the scope of regulation and can potentially establish themselves as competitors in their own right for banks. For the critical activities they provide, they must fall within the regulatory framework governing these activities. We support the Commission to find the right balance. The idea is to encourage innovation, but in a harmonised way in Europe and without jeopardising financial stability.

Banks only choose green finance, but the so-called taxonomy, this European project for the classification of green and brown assets, divides them. Should it be delayed?

Most major banks have already made progress on these subjects, internally and with their customers, and sometimes with their own taxonomy. Their first preoccupation is, therefore, to see how what they have already done will be affected by the European taxonomy and to ensure that all investments already made will not be lost. There is a concern for consistency, which we share. After that, there is a concern for the transition. Banks want to avoid too abrupt an impact on their customers and on their own income. But one risk would be to say that, because we are sensitive to this issue, we delay the implementation of the taxonomy and of transparency. This European tool can become an international standard.

You took up your new role at the EBA in September. What are your priorities?

The EBA turns ten this year. It was created just after the euro crisis and it immediately started working on the regulatory rebuild, followed suite with the banking union, Brexit, which forced it to move from London to Paris, and now it is facing a health crisis. I am very impressed by the quality of the teams and their work. We must maintain their technical skills, preserve their motivation and prepare a new generation of leaders. The EBA now needs to be even more effective and adapt to the new frontiers of regulation: fintech, environmental and social standards, etc.

Your objective was to restore credibility after several scandals.

One of my first actions was to strengthen the Legal Department in January with a reinforced compliance team on ethical issues and additional resources. For example, our rules for the staff leaving our organisation have been tightened: what they can do next, the jobs they can accept elsewhere, the period during which they can interact with us after leaving the EBA. This may go from six months to one year depending on the seniority of the staff members.

You have just been the subject of the cyber-attack linked to Microsoft’s messaging software. Has the situation stabilised?

Thanks to the precautionary measures taken, the EBA has managed to quickly eliminate the existing threat and its email communication services have, therefore, been restored. We have also openly and proactively communicated on our situation, following the best practices we recommend to banks. The EBA remains on heightened security alert and we will continue to monitor the situation.

The use of teleworking and digital banking practices increase this risk. Are we in a new dimension?

We are in a continuum: cyber risk has been extremely present in recent years and banks are aware of it. Some technologies are more visible, but in the financial sector this is not new. There is an intensification of the digital means that banks make available to their customers, so the issue is actually gaining momentum, but in the continuation of what we have seen.

The interview was conducted by Edouard Lederer and Thibaut Madelin.

Les Echos, 10th of March 2021