José Manuel Campa interview with Handelsblatt: 'Banks must prepare for a crisis lasting several years'

"Banks must prepare for a crisis lasting several years" 

José Manuel Campa, the head of the European Banking Authority (EBA) warns financial institutions about long-lasting strain due to the fall in commercial real estate prices.

Mr Campa, how dangerous could the crisis in commercial real estate prove for banks?

Commercial real estate is currently one of the biggest risks for the banking sector, alongside the management of interest rate risks and the impact of cyclical and geopolitical uncertainties on economic development. Fortunately, commercial real estate loans do not account for a very high a share in the financing portfolios of European banks across the industry. Of course, this will be more challenging for banks specialising in commercial real estate than for banks with a broader focus.

The pressure has so far been particularly high on the US office market. Are loans for European commercial property less risky, or will the problems sooner or later spill over into Europe?

The problems in the US can be traced primarily to the sharp rise in interest rates and the trend towards more working from home. The effects will presumably be less marked in Europe than in the United States, but the underlying trends are similar. So the adjustments in Europe will continue for a while yet. The banks need to be prepared for a crisis lasting several years.

Could the problems in commercial real estate also lead to banks failing?

Some banks that specialise in commercial real estate financing could face more of a challenge than others that have a broader focus. However, I do not see any systemic threat to the banking system as a whole.

German banks are particularly heavily invested in the US real estate market. Is this the return of ‘stupid German money’ – as was widely mocked before and during the 2008 financial crisis?

Some German banks are more active in the commercial real estate market than average, including in the US market. But I wouldn’t call that ‘stupid German money’. There is a surplus of savings deposits in Germany. It is therefore logical that German banks have to invest outside Germany. Their investment decisions are sometimes good, sometimes not so good.

What is the current state of the European banking sector?

Overall, European banks are well capitalised; they have sufficient liquidity and their credit quality is good. Increased interest rates have made banks, on average, very profitable over the past year, although they have benefited from evolving interest rates to varying degrees. In the meantime, however, high interest rates are placing an increasing burden on the economy and consequently on the banks’ customers. We therefore expect more defaulting on loans, which will reduce banks’ profits. Also, falling interest rates are likely to bring the profitability of banks back down in the future.

Several German bankers are seeing little sign of a wave of insolvencies so far and attribute this to the strong labour market. Could there be fewer bankruptcies this time than in previous economic downturns?

Economic development will ultimately be the decisive factor there. So far, the effects that higher interest rates are having on the economy are still mild. Let's hope it stays that way.

Another phenomenon currently worrying many people is the growing shadow banking system. This includes insurers, credit funds, hedge funds and pension funds, which have been increasingly acting as lenders for years. In the United States, the volume of financing they provide has exceeded the trillion mark. How do you see that development?

This development is a source of concern for financial supervisors around the world. Although the importance of non-banks has grown considerably, we have little information about what these often less closely monitored financial market participants are doing or not doing. We urgently need more information – and we are addressing this issue with the European Systemic Risk Board (ESRB) and the global Financial Stability Board (FSB).

What exactly makes you nervous?

I’m concerned that potential disruptions in those non-bank financial institutions could spill over into the banking sector. Our latest data, from June 2023, show that European banks have lent about EUR 2 trillion to non-banks. That’s about 7% of the balance sheet total of European banks. However, such exposure is concentrated in a few large banks. Overall, the figures have hardly changed over the last 3 years.

So where are your worries coming from?

In addition to the direct links – through loans, for instance, or the sale of bank bonds – there are also numerous indirect links, for example in commercial real estate. The proportion of total lending provided by non-bank financial institutions has risen from 35% to over 50% in the past 3 years.

What does that mean for banks?

Should non-banks suddenly withdraw from this market, banks may be forced to step in and help businesses. Their level of risk in that segment of the market would then rise. Equally, if non-banks launch distress sales, it would have negative consequences for bank exposures.

Does the shadow banking sector need to be more strictly regulated?

First of all, we need to ensure greater transparency. Should it emerge that major risks are being poorly managed, stricter regulation would be required.

"We expect more loan defaults, which will reduce banks' profits."

Should banks cap their business with non-bank financial institutions?

No. The shadow banking sector is not negative per se. It includes insurers, for example, which play an important role in the financial system. However, in their business with non-banks, banks must make sure that they don’t take risks that could jeopardise their own stability and that of the financial system.

More and more European and German banks are offering to trade and provide custody of cryptocurrencies for their customers. Does that worry you?

No. The EU MiCA Regulation, which regulates large swathes of the crypto-assets business, has been in force since summer 2023. Among other things, it stipulates that providers of cryptocurrencies in the EU have to produce a document (white paper) explaining how cryptocurrencies work. Banks offering to trade and provide custody of crypto-assets have to warn their customers of the risks involved.

Are you saying that the MiCA Regulation has made investments in cryptocurrencies safe?

By no means! The business models behind Bitcoin and many other crypto-assets are, at least in part, highly questionable; the new legislation has not changed that. Investing in cryptocurrencies entails great risks. We therefore demand very high safety buffers of the few banks in the EU that have added cryptocurrencies to their own balance sheets. We are doing everything we can to make it an unattractive option for financial institutions.

The interview was conducted by Andreas Kröner and Yasmin Osman.

Handelsblatt (Germany)