Jacob Gyntelberg's interview with Il Sole 24 Ore: Banks are too optimistic, this is why we are strict

‘Banks are too optimistic, this is why we are strict’

The interview. Jacob Gyntelberg. According to EBA’s Director for Economic and Risk Analysis: ‘The world is changing, provisions are too low’

While the change in the macroeconomic environment in just 1 year has been staggering, ‘banks remain optimistic and their provisions are low’, raising concerns at EBA, the European Banking Authority. Moreover, EBA is still finding substantial differences across banks’ internal models and perceived risk: ‘We are seeing huge differences in banks’ risk assessments for the same company and the same type of loan’. There is still a lot of work to do, but this does not mean that EBA intends to be unduly strict. This is what Jacob Gyntelberg, Director for Economic and Risk Analysis at EBA, told us in this exclusive interview.

Why is the 2023 adverse stress test scenario so strict, much more stringent than the 2021 stress test?

The macroeconomic situation has changed a lot compared to the previous financial year. In 2022, geopolitical tensions have risen, inflation has grown sharply, commodity and energy prices have spiked; rates are also on the rise. From our viewpoint, we are not confident looking to the future. The volume of non-performing loans is very low, but this is also the result of the huge fiscal stimulus measures launched during the pandemic; extensive public aid was provided to households and businesses during COVID‑19, and monetary policy was generous and accommodative. All this is coming to an end exactly at the same time and on a global scale: pandemic-related tax measures have been withdrawn, not only in Europe but also in the United States and Asia, while there has been a general rise in interest rates. Policies have changed. It is true that banks are solid in terms of capital and liquidity. But despite the huge change in the macroeconomic situation, banks continue to be very optimistic; provisions are low and this cannot be reassuring for supervisors. We are concerned that the banks might be too optimistic. The stress tests reflect this feeling among regulators: this is why the adverse scenario has been designed prudentially and is conservative; it is strict but it reflects the world in which we are living and places the banks under stress: in rising interest rates, falling real estate prices, the unemployment rate, falling stock markets.

The adverse scenario is conservative; but is it also realistic and credible?

It needs to be clear that the adverse scenario is not a forecast; it is not what we expect. The scenario is hypothetical and is the result of the collective vision and contribution from the national and European central banks and authorities, the EBA and the ECB, together with the European Systemic Risk Board. We do not intend to be strict beyond what is necessary. The exercise is credible and realistic because, on closer inspection, it is not very far off from the capital trajectories that banks estimate based on their own adverse scenarios. It is true that we are more conservative than the banks, but this is part of our job.

The 2023 stress test requires banks to measure for the first time their risks in 16 sectors of economic activity. Why?

This novelty is the result of the experience we gained during the pandemic and the energy crisis triggered by the war in Ukraine. During the COVID‑19 period, and more recently with the surge in energy prices, the diversity of exposures across the various sectors of the economy has been more substantial than in the previous decade. There are major differences in counterparty risk when broken down by sector in the context of the energy crisis. Consider, for example, companies that had to solve the problem of supply bottlenecks, or companies in Eastern Europe more exposed to Russia’s energy cuts. Our aim is to make sure we understand to what extent banks differ from one another in terms of balance sheet composition. We want to learn more about this, and about how this influences the banks’ response to shocks and thus the stress test. In addition, analysis by sector will be important for the stress tests on climate risk. Thus, we suggest that banks start right now to get used to our requests with this breakdown by sector. For now, we are asking banks to what extent they are able to quantitatively assess and manage climate risks: this is a request, not a requirement.

‘Stress tests reflect the regulators’ concern about excessive optimism among credit institutions’

EBA has already introduced the new definition of default and the ECB is pressing for an improvement in the internal models: banks are experiencing all of this as a squeeze, they feel under increasing pressure.

EBA’s guidelines on the definition of default are not recent, they were published years ago and we have not added anything to them. Rather, what continues to surprise us is that we are still finding diversity in the internal models, in the risk perceived by banks: we are seeing huge differences between banks in their risk assessments for the same company and the same type of loan. Even large companies are assessed in very different ways; this shows that work needs to be done on harmonisation. Internal models are used by banks to measure risks and determine risk-weighted assets and prudential capital. They also aim to improve risk management. This is why EBA and ECB/SSM are pushing for high-quality internal models and risk management and the consequent adequate capital levels. It’s a process that has been under way for 7 years now, and our position has not changed, it is still the same.

On climate risks, on the other hand, the stress test has not tested the banks, because climate methodologies are still a work in progress. What do you mean?

Climate-related risks have a longer time horizon than the stress test, which is an exercise that uses a static balance sheet tested over 3 years in a baseline scenario and in an adverse scenario. We believe that transition risk, e.g. a tax on CO2 emissions, would not have a large impact on banks’ balance sheets over a 3‑year period. Therefore, we have decided to take some more time to reflect on how to proceed with the methodology we will use to measure banks’ resilience to climate risk.

What are the options on the table?

Will climate risk be incorporated in stress testing? As I said, the nature of climate risks has a longer time horizon than the 3 years of the stress test. In light of this, I do not think that climate-related risks will be included in the current stress test. This is our orientation at the moment. However, we will continue to aim to measure capital adequacy in the future so as to enable banks to finance the green transition even in an adverse scenario that takes into account transition risk and physical risk. One of the options we are weighing is to carry out an exercise focused on climate risks, entirely separate from the stress tests. But the green transition is not only a source of higher costs and risks for banks: it is also a business opportunity to increase profitability by expanding their lending customer base.

The interview was conducted by Isabella Bufacchi

Il Sole 24 Ore, 14 February 2023