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European banks must brace themselves for rising insolvencies, greater geopolitical risks and upheaval in energy-intensive industries, the eurozone’s new chief banking supervisor has warned.
Claudia Buch, who became chair of the European Central Bank’s supervisory arm in January, said in an interview with the Financial Times that banks were “not out of the woods yet” despite emerging in what she said was a “good position” after the Covid-19 pandemic and Russia’s full-scale invasion of Ukraine.
The ECB’s increase in its benchmark interest rate to a record high of 4 per cent to tackle soaring inflation last year “still has to filter its way through the financial system”, Buch said, adding that bankruptcies and loan defaults were likely to keep rising for some time.
“It’s just extremely unlikely that we would have a period of structural change where there’s no increase in defaults,” she said. Europe’s “industrial regions will look very different in the future, depending on the availability of renewable energy in different countries”.
“We will have more relocation of activities, we will have more sectoral relocation . . . firms have to adjust,” she predicted. “This is something banks have to factor in.”
European insolvencies fell sharply in 2020-22 when governments provided vast amounts of aid to companies to blunt the impact of the pandemic and the energy crisis caused by Russia’s war. But they have since risen higher than pre-pandemic levels, as stagnant growth, rising borrowing costs and high energy prices took their toll on more companies.
Banks in the region have enjoyed a surge in profits as low defaults and high interest rates boosted lending margins. This has put them on course to return more than €120bn to shareholders in 2024, up more than 50 per cent from last year.
Yet Buch worries about complacency because the methods banks use to gauge risk are too backward-looking. “Most of the risk models that the banks are using don’t really give us a story about how risks will evolve in the future, because they are based on the past,” she said.
Promising to be “very vigilant” on this issue, Buch wants lenders to use more specific scenarios to map out how risks may materialise in the future. “Take, for example, the Red Sea scenario, or sources of fragmentation of global supply chains: how would that affect the specific corporate customers, the sectors to which the bank is exposed?” she said.
Buch, who was previously vice-president of Germany’s Bundesbank, is not well known to many bank executives and analysts. But her tough message is already starting to sink in. Andrea Filtri, co-head of research at Mediobanca, last week described the “Buch doctrine” as “a new philosophy of regulation, based on a greater emphasis on ‘unknown unknowns’.”
Shares of European banks still trade at a significant discount to their US rivals and some executives — such as UBS chief Sergio Ermotti — have blamed excessive regulation for holding back lenders in Europe.
Yet Buch gave these claims short shrift. “This is what we also sometimes hear from industry — that we are too strict,” she said, adding that the ECB had calculated how US rules would affect the biggest European banks and found their capital requirements would be higher.
“If anything, we don’t find evidence that our rules are stricter for these largest banks. For Europe’s smaller and mid-sized banks, US regulation would result in slightly lower capital requirements. But I’m quite glad about our stricter approach, given what happened recently at several mid-sized US banks.”
She pointed out that the valuation gap between European and US banks was similar in other sectors of the economy. “So that brings us to a broader question. What is driving these differences in valuations?” she said, pointing out it could reflect Europe’s thinner and more illiquid capital markets, or its lower growth potential.
Banks also privately complain about the ECB’s recent threat to impose daily fines on those that do not meet its expectations for tackling climate change risks, saying companies are not providing them with the information they need.
Buch said it was “realistic” for banks to meet those requirements, and gave the example of energy-efficiency certificates for mortgages. “That is something one can, in most of the countries, easily get at a certain price.” But, she added, “even in that space, we’re seeing deficiencies, so the banks are not getting the information that they should get in order to assess these risks”.
The threat of daily fines, while yet to be enforced, is “a general escalation tool that we would use for other issues”, Buch said.
Such issues could range from banks’ outdated IT systems to shortfalls in data aggregation and reporting. The ECB is also in the middle of a stress test exercise to assess banks’ defences against cyber attacks, which Buch said “have gone up” in recent years.
Her team continues to put pressure on European banks with operations in Russia to exit. Buch said eurozone banks had cut their Russian activities by half in the past two years and those still present, which include Italy’s UniCredit and Austria’s Raiffeisen, had been given “clear expectations on how we expect a downsizing of activities and exit strategies”.
Letter in response to this article:
One ‘unknown unknown’ banks should know about / From Trevor Wood, Partner, Vedder Price, London EC2, UK
