 Welcome to the European Central Bank podcast, bringing you insights into the world of economics and central banking. My name is Michael Steen, and today we're marking five years of European banking supervision. Have banks become safer since the financial crisis? Who pays when a bank goes bust? What does a supervisor actually do? And what are the benefits of doing supervision at a European level? Let's start things off with a quote from Mario Draghi, the former president of the ECB, and here he is addressing a staff event to mark the launch of ECB banking supervision. The launching of the banking union without too much emphasis has been the most important act of integration since the launching of the euro itself. And we and none else are the ones who've been tasked by our leaders to translate this political vision into reality. And we made it. My first guest today is Andrea Enria, chair of the supervisory board of the ECB. Andrea, thanks a lot for joining us on the podcast. Thank you. Good afternoon. First of all, could we just start with a very, very basic question? Why do we need banking supervisors? In general, you mean? In general. Well, the banking sector is very a very delicate function for the economy. And when banks fail, let's say there are likely to be, in some cases, extensive repercussions on the whole system, on the ability to finance the economy, on growth, on jobs, and more generally, banks deal with other people's money, especially retail deposits. So these delicate functions mean that you need supervisors to ensure that banks are managed in a safe and prudent manner. We're marking five years of European banking supervision. How do you compare the situation today to, say, five years ago? What has it brought in terms of benefits for citizens? Well, there have been significant improvements. In terms of capital, the banks are much stronger. They can absorb losses more so that the likelihood that their default will be lower. Their balance sheet is now cleaner because they've disposed the bad assets that were the legacy of the crisis. And we have raised the bar in a number of areas in which we can, let's say, we have identified weaknesses in the previous arrangements for supervision and bringing supervision at the European level by itself has made supervision stronger because you adopted the best practices across the whole union. This is a question of it's not the lowest common denominator, but the highest, as it were, in that sense. Yes, absolutely. And is there any other advantage to the sort of Europe-wide element to it? Having the supervision exercise at a different level than the currency has always been an anomaly. After the introduction of the euro in 1999, Tomasopoulos Kepa was then a member of the executive board of the European Central Bank, said clearly that this was unprecedented and that the only way to have a currency at the euro-era level and national supervision work together well would have been for the national supervisors to act as a single body in case of a crisis. And unfortunately, this is not what happened. What happened is that there were national responses. These led to segmentation of markets. Some member states went close to default, actually, because of the banking crisis, as these triggered the sovereign debt crisis. So the very integrity of the euro was in jeopardy. So this means that having the single currency and the single supervision together at the euro-era level is essential. And you alluded to it there in the crisis. There was a lot of public money, of course, went into rescuing the banks, particularly in certain countries like Ireland. The huge sums of money was 64 billion euros. The French government also put a lot of money into shoring up the banking sector. What has happened to try and avoid a repeat of that in the future, apart from this European focus? First of all, there is now a much better capitalized banking sector, which means that there are more private funds to absorb losses in case of a crisis. But also we pushed banks via legislation, of course, the regulatory reforms which were adopted at the global level to prepare for a crisis. That's what is called the recovery and resolution planning or the living will. So banks preparing for what would happen in case of a crisis. And also we asked banks to have more loss absorbing capacity in the form of liabilities that can be converted into equity or written down to zero in case of losses, so that the private parties would take the losses first. That's what is called bail-in, instead of bail-out. So instead of the taxpayer bailing out the bank, it's a bail-in of the investors, the private investors. These are all important principles that, of course, have made the likelihood that the taxpayers will have to put a heavy bill in a future crisis much lower. Does it mean that banks should never fail? I mean, as a supervisor, is our aim to prevent all banks from failing? Or is it more that we want to make sure the conditions are such that it's less dramatic if something goes wrong? Banks should fail, should be able to fail, should be prepared to let them fail. That's part of how a market economy works, how competition works. If banks are inefficient, if they are poorly managed, if they destroy value, they should also stand ready to exit the market and the supervisor should let them actually push them to exit the market. What is important is, first of all, as supervisors to reduce the exact probability that this happens, so to make sure that they are safe and sound in their conduct so that they do not, that you reduce the likelihood of failures. And the second aspect is to reduce the impact of failures if they fail, so to try to create the structural conditions to make them exit from the market with a minimum impact on other functions. And that's where the resolution functions enters into the picture. Yeah, resolution, let's maybe just touch on that briefly. That's what we refer to when a bank is failing and needs to be wound up. Yes, there is a difference between banks which are not raising any concern in terms of the public interest if they fail. They are not performing any critical function for the economy, they are not systemically relevant. I mean, this bank can be liquidated with ordinary procedures, but if a bank instead is raising a public interest problem at the European level, then you need to have the tools to resolve it in a smoother way. These are the tools which have been set up after the crisis across Europe to, for instance, split the bank into a good bank that survives and a bad bank which is liquidated, or creating a bridge bank, for instance, which connects to a new bank that can continue providing services to the relevant customers. So as you say, this is all still relatively new. I mean, your predecessor, Daniel Nui, used to talk about ECB banking supervision as a startup. But on the other hand, it is five years in, and we've now built up a lot of capacity. What are the elements that you see that need to change, and what are your personal priorities here? I must say, first of all, that I need to praise what has been done so far. It has been a startup, it has been a successful startup, in terms of, as I said, raising the bar in a number of areas and increasing the resilience of the banking sector. The first priority is, of course, to complete the job, to keep doing the final cleanup of the bank's balance sheet. We still have significant issue with non-performing loans in a number of banks. We still see that, for instance, in the area of governance, business models, banks are not where we would like them to be. So we need to continue to operate pressures in those areas. I would say that the weak point now is that banks have very low profitability, very low market valuations. And this is not good also from a supervisory perspective. You want banks to generate capital organically, to be able to raise capital in the markets. Another point on which I'm very keen is to increase the transparency and predictability of supervision. That was, I think, a very interesting point. So could you talk to us a little bit more about this transparency question? I think you, if I'm right, link it a bit to the shift from bailout to bail-in. Yeah, there are different angles of which transparency is, in my view, important. The first one, as you correctly say, is the fact that as we now have private investors first in line in case something goes wrong and they would have to absorb losses, they need to understand better where the banks stand with respect to supervisory requirements. And this means that we need to disclose more than we used to disclose in the past. Banks also need to disclose more. The second aspect is more generally that, of course, we are assigned a very delicate function, public policy function. And having these type of responsibilities, of course, requires also accountability. So we need to be more transparent ourselves as supervisors on what are our methodologies, what are the tools we use, how we use them. We need to be predictable not to surprise markets and all stakeholders have to understand well what we do, I think. I think historically banking supervision tends to be something that maybe is not heard about so often until something goes wrong, which is, of course, a challenge because you also want to communicate a sense of being helpful function. I mean, is that also part of this transparency drive or how do you see that? I don't think the dynamics will change radically. I mean, generally when everything goes right, nobody praises supervisors for doing a good job. And when something goes wrong, generally you are in the firing line because you have supposedly not done your job properly. So I think that's the dynamic which is very difficult to change. But I think that supervisors now need to communicate more with markets and with all the stakeholders. I think more generally in the academia, in the general public, there is now much more attention after the crisis than was the case before. I mean, because a lot of, as we said before, a lot of taxpayers' money has been deployed to shore up the banking sector. So it's clear that we need to be, there is more scrutiny on what we do, and we need to be more transparent just because of that. So on a personal level, does that mean you have to develop quite a thick skin if you're ready always to be blamed when things go wrong? Well, I've been in the job for a while. I think my skin is already relatively thick. But yes, probably we need to be able to really explain what we do. And sometimes what we do is very technical. The legislation has become fiendishly complex. And sometimes I read in the national newspapers a lot of reading of our actions that are maybe reflecting more national sentiments rather than a proper understanding of the underlying rules of the supervisory actions. So we need to be much more proactive in explaining what we do, in explaining why we do it, how we do it, and also to face criticisms from time to time and to respond in an open way to them. Andrea, thank you very much for your time. Thank you. Our next guest is Pien Van Erp Talman Kip, who supervises four big banks in the euro area. Pien, I want to welcome you to the show and particularly today, because I know you've got a bit of a sore throat. So thanks a lot for doing the podcast. Thank you. So let's start off with your work. You supervise these four big banks. How does that work and how is it working at a European level as such? I'm supervising four of the largest banks in the euro area. And we work with what we call a joint supervisory team. And the joint supervisory team is a team that's responsible for the supervision of a specific large bank under European or under ECB supervision. And we work together with the national supervisors within our team. So for example, if you have a large bank in one country with two subsidiaries in another country within the euro area, then the ECB and the national supervisors of those three countries will be involved in one team that is headed by somebody from the ECB. It's not just ECB people. We also have people from the national, as we call them in the jargon, national competent authorities. And then depending on which have a bank you're supervising, that is then how you constitute the so-called joint supervisory team. Yes. So for example, if you have a bank with the parent company in Spain and subsidiaries in France and Italy, then you would have a joint supervisory team with people from the ECB, people from Spain, from France, from Italy, so from the national supervisors of those countries. And we work as one team. And then the smaller banks are still more of a national, they're directly supervised on a national level, but we still play a role there too. Yeah, we have within the ECB, we have direct banking supervisions. And then we have indirect supervision, as we call it, of the somewhat smaller banks. So I think about the 120 biggest banks in the euro area are supervised directly by the ECB, but all the other banks are supervised directly by their national supervisors. But the ECB has an oversight to try to ensure also consistency and supervision for those smaller banks. Now, what does a day look like for you? What does a supervisor actually do? I mean, is there any useful comparison you can make with your job? Would you consider yourself like a policewoman or a doctor or a teacher or a firefighter? And that's probably a bit glib, but maybe give us a picture of how you go about work. Maybe we are a little bit of all of that. Of course, one part of the job is to ensure that the banks comply with their regulation. So there we are, an enforcement authority also. But we focus not in the first place only on complying with rules for just complying with rules. We really try to look at the risks and identify the risks and ensure that banks address risks as good as possible. So we focus on a lot of different topics. So one very important subject for us is governance and risk control and risk management. And then within a bank, you have very different risk areas like credit risk, obviously, market risk, liquidity risk, interest rate risk, operational risk, including IT risk, which is becoming more and more important, but also business model. So we look at all those areas. So we collect a lot of data. We do a lot of analysis. We have a lot of meetings with the bank to really understand what's going on. So we also do onsite inspections where we send auditors to the banks. Also people from national supervisors are included in those teams. And those teams are really go onsite. They go to the bank. They stay there for a couple of weeks or sometimes even months to really dig into topics and see how things work in practice in the bank. So they can also really enter systems, see how people work in practice, whether policies or procedures are really followed in practice. Did they have full freedom to walk around the bank or how does that work? Yes, we normally would of course inform the bank a bit in advance. So they have to prepare and also the teams, they want to receive a lot of data and information and papers and documents. Then indeed, they go onsite and they should get free access to whatever they want to see. Of course, they go there with a specific mandate for specific investigation. So it should make sense within that mandate and that investigation to ask for that information. And then they write a report with all their findings and they send it to us to join supervisory teams. And then we follow up with recommendations asking the banks to remediate the weaknesses that were identified if we think that they are important and should be remediated. We're talking about European banking supervision here, 19 countries, many different languages. And you're also working in teams which are of different nationalities. How do you communicate with each other? What would you do about language? In principle, we speak English. Of course, there are some banks that really want to speak in their local language. So they are about the local, the national supervisor, of course speaks that language and then we ensure we have a few people in the team that can also read documents and have meetings. The head of a joint supervisory team is not allowed to be the same nationality as the bank that's being supervised. Is that right? Yeah, that's correct. Because we want to break a little bit this national bias, which you can imagine in most countries, the CEOs of the big banks and the governor of the central bank and head of banking supervision and the minister of finance. They often know each other well and we thought it's better to break this link a little bit. I think we are successful in that. The joint supervisory team coordinator should be of another nationality than at least the home country of the parent company of the bank. Maybe speaking from your personal experience a little bit, what would you say has been a highlight so far and maybe a challenge so far of this whole new world? They go probably hand in hand because what was of course very interesting was to set up this whole new European bank supervision I joined in the very beginning in April 2014. So when I joined we first had to hire a lot of people and then as of November 2014 the European Banking supervision formally started and it has been of course a challenge but also a highlight to get to know all the national supervisors, all the banks in all those different countries. We also supervise several banks in different countries to ensure a kind of European view at our level. So that's super interesting to see how supervision is done in other countries. Most of the people working here, well there are quite a number coming from the private sector as well but of course a lot come from national supervisors, the people that work now at the ECB. It's very interesting to see because you're inclined to think how you do it in your country that has the normal way to do it but then of course you see that in other country things are very differently and that's for supervision but also for the banks itself and for the banking sector. There's a lot of history behind why banking sectors are structured like they are in certain countries and that is very very interesting to broaden the view so much and to be part of this whole new project but now of course we are five years down the road so now things settle down a bit and we'll try to improve our supervision further going forward now that we can stabilise things a little bit. Bean thank you very much for being with us today and sharing your insights. Thank you very much, it was a pleasure being here. Let me now welcome our final guest who's Lynette Field. She's responsible for supervisory policies, crisis management and internal models here at the ECB. Welcome Lynette and thanks for being with us. Thanks for inviting me. Now there's been a lot of talk about banks facing tough times these days. There's also a lot of change obviously. There's different ways of paying for things with your mobile phone. There's even different kinds of banks and you hear words like fintechs being bandied around and banks that are not actually banks. Can you just talk us through in general terms what are the challenges and the risks that the banks are facing and also why do we care as supervisors? Yeah so that's a good question to ask a banking supervisor actually because we spend most of our time thinking about risks and looking at what might be coming over the horizon. So we're almost on permanent risk assessment mode and we recently published our latest risk map and there we identified three main risk drivers. The first of those is broad in nature so it's really thinking about the broader political and economic risks that we face in the euro area and we've seen increasing challenges here so we have economic growth projections which have been revised downwards. We see that there are still concerns about debt sustainability particularly in highly indebted countries and we've also seen increasing political fragmentation and all of those broad economic and political aspects have an impact on banks as key agents in the economy. So that would be the first main risk driver that we identified. The second is around what we call business model sustainability and the issue the fundamental issue here is that many banks in the euro area are really struggling with profitability or low profitability and they need to keep adjusting the way they do business in order to enhance their sustainability over the medium term and the third main risk that we identified is all around the subject of cyber crime and IT so banks are becoming more and more digitalized but it also brings its own vulnerabilities so vulnerabilities to cyber crime vulnerabilities to IT risk and that's something that we have to pay attention to as supervisors. I'd like to come back to the profitability question but before we do that just a quick recap so as a supervisor why does it matter that we understand what the risks are that the banks are facing at any given time? In the end the risks impact on the safety and soundness of the banking sector and our objective is supervisors to make sure that the banking sector is as safe and robust as possible which also contributes to broader financial stability perspectives so this is really what we are focused on as supervisors. Lynette picking up on one of those risks profitability which Andrea Henry also mentioned earlier can you tell us a little bit more why do we care that banks are profitable? Yes so it's a question we get asked quite often because we're not shareholders in banks so people say why do you care about profits in banks but profitability is an indicator of health of a bank that's why we are interested. Now if profits are too low then banks have problems over the longer term it's more difficult for them to go to the markets to build capital. On the other hand if profits are too high or if they're too volatile then this can be raising indicators or raising alarm bells that banks might be taking on excessive risks in order to get higher returns and then of course we are interested as supervisors in what are those risks how are the banks managing them and mitigating them and there could be additional risks coming up legal risk reputational risks which could crystallize in the future so that's why we are focusing on profitability and what we want to see is sustainable profitability and sustainable profitability in well-managed banks because essentially that means that they're going to be there for their customers and that ultimately then benefits citizens and businesses and so on. So I think you've got some numbers Lynette that can illustrate how it's been difficult recently for European banks to be profitable. I think one of the interesting I mean one of the most common measures of profitability is return on equity which is essentially income divided by shareholders equity and what we've seen for large euro area banks is a return on equity the most recent figure I think is about six percent to put that into context if you compare that to banks in the US they are showing a return on equity of 12 percent so there's a huge difference there. So that means that when we're talking about these big banks that have shares that are traded on stock exchanges the perception of people buying and selling those shares is that right now there's they're not seeing a lot of future value in those banks. That's right. Let's talk about the reasons a bit so what do you see as the main drivers of this. I think there are a number of factors at play here of course one of the factors as often mentioned is the low interest rate environment which obviously has an impact on banks capabilities for generating income from traditional banking activities so margins that they might gain on taking deposits and then lending money. So this is a factor. There's also a lot of competition both within the banking sector itself but also increasingly non-banks new competitors like fintech for example and all chasing the same customers. There's an ongoing discussion about the euro area banking sector being overbanked or having excess capacity as well and also challenges in terms of finding opportunities or progressing with consolidation and greater integration on financial markets. So that means literally there's too many banks yes obviously our job isn't to really you know sort out the bank's business models for them but what should they be doing and what can they do to improve the situation. Banks need to invest in technologies and we are seeing increasing digitalization and that's something which will or can bring cost efficiencies. Digitalization allows banks to offer new products new services in new ways but it also opens banks to risks like vulnerabilities to cyber crime and IT. They become more more dependent on third parties. The other area where we have seen that banks can improve their profitability is through really putting emphasis on their strategic focus. So we did a thematic review of profitability which was published at the end of 2018 and one of the things that we saw also that our supervisors who looked at individual banks saw was that the banks which were really putting emphasis on their strategic steering, loan pricing, cost allocation for example they were the ones who tended to do the best in terms of profitability so really having that focus can make a difference to a bank. Now one thing I know that you've worked on a lot is of the challenge that Brexit has caused and it's been something where as supervisors we've had to do a lot of work haven't we? Yeah it's been one of our major focus areas and priorities in the last years. We've approached Brexit very much from an operational perspective. What we've been trying to ensure is that banks are ready and that we are ready as supervisors because it also has an impact for us but also you know how will banks operate in a post-Brexit environment. What is the problem well challenge of Brexit from a banking supervision point of view? So Brexit basically in very simple terms means that banks won't be able to operate in the same way that they have done in the past so if I give you a bit of context what we have in the European Union is in very simple terms what we call a banking passport so banks which are licensed in the EU can operate so if they're licensed in one member state they could operate in all of the other member states so the banking passport has basically allowed a lot of EU headquartered banks you know running business in the UK and vice versa in a very cost efficient way and you also have a number of international global banks coming from for example the US, Japan, Switzerland which have used the UK as a kind of entry point for Europe as a hub if you like for their European activities. Banks have been relying on you know having different activities, businesses, infrastructures run out of the UK or run into the UK which is of course a major financial centre and things will be different when the UK leaves the EU so there will no longer be the passport simplifying quite a lot no but EU headquartered banks won't be able to offer their services in the same way in the UK UK banks will not be able to offer their services in the same way in the EU this means essentially that banks need to get authorisations or licences in order to be able to continue their activities. So to put it in a nutshell you're essentially trying to make sure that a customer of a euro area bank can still expect the same sort of services irrespective of you know whether that bank was maybe in the UK or had a big business in the UK after Brexit. What we're trying to make sure is that they're properly authorised and supervised and that what they're doing makes sense from a risk management perspective from a supervisory perspective so that's what we've been focusing on and one of the key issues that we have been discussing with banks is the way that they structure their business in terms of is it appropriate is there substance in their activities in the in the EU? I see so can you explain why why does it really matter that the bank doesn't just stick their name on a letterbox say in Frankfurt but still have the business maybe in London? One of the key discussions that we have had in a Brexit context we have had instances of banks which were of course banks keen to reduce costs or to keep costs to a minimum as a result of Brexit but that had come initially with some ideas of opening something in in the EU which would be more or less a letterbox if I could call it that but maintaining you know the substance of their activities and the risk management of those activities in the UK and that's something that we as supervisors don't like at all. Does that mean that there's also been a lot of and we read about it every now and again bankers moving wholesale to different parts of the euro area and actually I should also say do we particularly mind where they move to or is that we're neutral on that? Well in terms of where they move to inside the EU or the euro area of course we are absolutely neutral so that for us as a European authority so part of the plans of the banks have involved or have included plans to move people infrastructures and systems to transfer assets and now what we are pushing the banks is to implement those plans because we did a lot of work in order to get agreement with the banks about how they would operate, how they would move, what resources they would move, what assets they would move and over what timelines. The plans that we agree with the banks quite often have timelines the end 2020 so you know that is not very far away now and also I think banks have plenty of other challenges on the horizon to deal with so it would be really good for them to implement their Brexit plans and you know in line with the timelines that we agreed. Okay so even so on all these things your work is obviously far from done including on the Brexit one. Lynette thank you so much for joining us. You're welcome it was a pleasure. That brings us to the end of this episode I want to thank Andrea Enria, Pien van Erp, Talman Kip and Lynette Field for joining the conversation and giving us their insights. Do also look in the show notes for links to related papers and publications from the ECB. We'd love to hear your feedback and thoughts for future episodes via social media you can use messages and comments. You've been listening to the European Central Bank podcast with Michael Steen. If you like what you've heard please subscribe and leave us a review. Until next time, thanks for listening.