Isabelle Vaillant's interview with Il Sole 24 Ore: The EBA supports the banks ‘but says no to any further moratoria extensions’

The EBA supports the banks ‘but says no to any further moratoria extensions’

For the Director of Supervisory Policy, Isabelle Vaillant, ‘the soundness in Europe and Italy is a cause for optimism. Government guarantees for loans are a good thing: state intervention is important because it will curb any surge in NPLs.’

‘Not a cliff-edge but a plateau: if the banks manage the rise in non-performing loans quickly and well and if governments intervene with adequate government support measures, a surge in NPLs due to the pandemic can be avoided and the banks will continue to be part of the solution by keeping the flow of credit open.’

So says Isabelle Vaillant, the EBA Director of Prudential Regulation, in this exclusive interview.

How healthy are Europe’s banks as we slowly emerge from the pandemic this year?

Uncertainty remains over how long it will take to come out of the crisis, but this must be counterbalanced by a dose of optimism. I see the current level of soundness of the banks as a cause for optimism, it makes me optimistic. At the start of the pandemic, Europe’s banks were in good shape and they still are. We have managed to navigate this economic crisis with the banks’ support and this could only happen because we had worked hard on the soundness of the banks before the crisis. The banking system has so far made an important contribution by continuing to grant loans and the banks have been part of the solution. And they are continuing to lend. In my view, it is vitally important that in this phase of uncertainty, the banks can keep financing the economy: we must make sure that this carries on.

Are Italy’s banks also in good shape?

Italy is one of the countries worst affected by the pandemic but Italy’s banks have shown resilience and have remained within the European average for asset ratios. This is a good result because they are not showing signs of having had to take a bigger hit than other banks in Europe. Even on the management of NPLs, Italy’s banks reduced non-payments in 2019 and this trend continued in 2020, so they remained on track.

To help the banks manage the crisis caused by the pandemic and keep issuing loans, the EBA introduced flexibility into the regulations: has this worked? The guidelines on moratoria have expired: will they be renewed?

Introducing flexibility into the regulations has been one of the key interventions. When we thought it was right to introduce the guidelines on moratoria to prevent automated mechanisms from kicking in, we did so. And we extended them when necessary. Now is the time for monitoring the situation: monitoring, monitoring, that is what the EBA is doing now. However, at this stage we have no intention of extending the guidelines further. The moratoria have expired or are expiring and the window for the suspension of automated mechanisms has closed. We are closely monitoring the situation: this is our main task this spring, our highest priority.

Isn’t there a risk of a ‘cliff-edge effect’, a huge wave of NPLs once the moratoria end? The banks are calling for a gradual return of the regulations to normal…

The risk of a major increase in non-payments, which we had predicted in the early stages of the pandemic, did not materialise in the sense that we did not see a surge in NPLs in 2020. There has been an increase up to now, but it has been modest. We have entered a new phase, the transition to exiting the crisis; it is time to clear the balance sheets of non-performing loans. Initially we predicted a peak in non-payments, but I would say that it might be more of a ‘plateau’, a smooth transition to a new economy that could take 2 or 3 years. This is why we would prefer the banks to remain cautious in their analysis of their loan portfolios, partly to support what will be a structural change to a new economic model. And anyway, the increase in non-performing loans will be clearly limited to a few sectors; it will not be widespread. The peak we predicted has not materialised for now and so the situation might develop in a different way, with a more gradual transition and also with a shift from the banks to the public finances.

In what way?

The state’s role will gradually increase and the government guarantees will be enforced. And this transition, with a growing role for the state, will be significant. But in the meantime, the banks must continue their provisioning for expected losses. The banks must do their job, take early action, continue to recognise the forthcoming credit risks and do their capital planning, and spot the counterparties facing difficulties as quickly as possible. They are doing this, but too slowly. This is why we are urging the banks to do their job without further delay. Now is the time to analyse every loan, every file. The banks know their customers inside out; they are able to detect and identify individual clients’ difficulties and intervene by talking to the counterparties and, where necessary, restructuring their debts.

But under the moratorium, isn’t it difficult to determine the real risk of non-payment?

We know that there is a big difference between the different categories of loans. Many moratoria have expired or are expiring and the moratoria being renewed are on the most high-risk loans. So an important phase of monitoring and assessing exposure begins now. It is essential that the banks now take action and identify as quickly as possible any likely non-payments, and this is where we are urging them to act. The situation is more complicated and uncertain when the lockdown continues. But we have indicated to the banks how we expect them to intervene, sooner rather than later. We are discussing with the supervisory authorities how to accelerate this process.

Some European banks are reducing their expected loss provisioning, because non-performing loans are lower than expected. Do you share this optimism?

US banks have reduced their provisioning, perhaps on government-backed loans. We are preferring to emphasise the fact that there are still many uncertainties out there and we are advising the banks to be cautious, i.e. to identify risks now instead of putting this off.

The capital and liquidity buffers have not been used very much. Is this the fault of stigma?

Capital and liquidity are two very different buffers. Planning is important for capital management. The banks are having to face many uncertainties, not just the pandemic: they are having to manage the transition to a new economy, increasing digitalisation and greater action to combat climate change, increased competition from non-traditional and non-banking operators, regulatory reforms, new value chains. I do not think that the stigma about capital buffers is the main reason for their lack of use; it is more a question of management, of active capital management. It is not prudent to lower the thresholds for capital in respect of a whole range of uncertainties, and in this I can understand the banks. The capital buffer is around 5% and is very high, so it is understandable that the banks have not wanted to use it. It is not clear that the liquidity ratio should be used in situations of stress and that the banks can go below 100%. This message has not got through, especially to the rating agencies. This must be made clearer. In the context of Basel, we are thinking about revising the structure of the buffers and their use. In Europe, the buffers are very stratified, there are many levels of intervention, we have counted 11 triggers. As a regulatory authority, it is important for us that investors properly understand the role of the buffers. And we are dealing with this; there is a review in progress.

This is also the year of the stress tests, in the midst of the pandemic: what is expected?

The stress tests this year are very important. They are particularly significant because they measure the health of the banking system, looking ahead and in relation to adverse scenarios. They are not a pass-or-fail examination. The results of the stress test will be the starting point for a detailed understanding of how each bank can navigate and get through the end of the crisis. This year even more than in the past, it is important to be able to evaluate resilience to the crisis bank by bank and see how each bank thinks it can exit the crisis, using what strategies and on what time scales. Differences will become apparent between the banks; it will be interesting.

The EBA is 10 years old this year. What is your assessment of its first decade?

Much has been done but there is still a great deal to do. We need to complete the banking union; the EDIS single guarantee on deposits is essential. Europe also needs to introduce a set of regulations as soon as possible to manage the insolvency of smaller banks.

The interview was conducted by Isabella Bufacchi.

Il Sole 24 Ore, 7 May 2021.