 Welcome to the European Central Bank podcast bringing you insights into the world of economics and central banking. My name is Michael Steen. Today, in the third episode of our series on the economic and financial effects of the coronavirus pandemic, we're looking at the banking system. As we heard in previous episodes, our societies have had to take radical steps to save lives, effectively shutting down large parts of the economy. Banks are at the heart of economic activity, providing lending to homeowners and businesses who may suddenly find it difficult to make ends meet. Now, the ECB is in charge of supervising banks and the person in charge of that is ECB supervisory board chair Andrea Enria. Thanks Andrea for joining us on the podcast. Thank you. Good afternoon. And we've obviously been mostly working remotely at the ECB, so I'm still at home, but I think looking at the video just now, it looks like you're back in the office with a nice EU flag behind you. Can you tell us where you are and how's the lockdown been for you? Yeah, I'm in the office today because there was a meeting on the supervisory board, but it is one of the first days that I come back to the office. I've been working alone from home in the last two months and a half, and so it is really a new setting for me coming back to the office today. So it has been quite a challenging environment, but also interesting to notice how everything worked smoothly to a large extent. Yes. How do you expect working life to change once we're back to whatever the new normal looks like? Well, it is indeed impressive how smoothly this has worked. And both in terms of liaising with the staff, I've had daily meetings, for instance, with the daily management, with the COVID-19 team, I've had very frequent meetings with the supervisory board, fast decision making. I think that when we will go back, it will be a new normal. I think that we will change significantly the way in which we interact. And this will be an advantage also for the working of the single supervisory mechanism or the liaison between us and the national authorities. Because after all, it has shown that the banking union is working well. That's the first test for the banking union of a crisis. And I think that in the new working mode, we've been able to deliver very fast. Now, so as we've seen, and we've already touched on it, the coronavirus outbreak has killed hundreds of thousands of people, and it's transformed daily life and it's transformed working life. We've all observed these restrictions to try to slow the spread of the virus. And that's also had a huge economic impact. We've seen economies slow down a lot. Could you talk us through a bit what the main challenges are that banks are facing due to this economic crisis linked to the health crisis? Yeah, there has been a first phase of the crisis in which the banks have faced a sudden and substantial increase in credit demand, especially with customers drawing on credit lines. They've also experienced at the same time, the operational pressure of moving from the ordinary plain vanilla brick and mortar, let's say banking branches to a much more reliance on remote operation. So this has meant the pressure on capital, on liquidity, and also an increase in IT and cyber risk to some extent. The second phase, which is still the phase in which we are now is a phase in which banks need to take lending decisions. And that's a crucial one. The whole policy measures which have been taken, monetary policies, supervisory measures, and government support measures tend to support banks in an effort to lend to customers, to the economy, lend to households, small businesses, corporates. So how they will take decisions now in terms of balancing the need to select viable customers on the one hand, but also avoid restricting credit and lending to the economy as a whole and supporting the recovery is the major challenge they're facing right now. Okay, so there's this two sided risk really, right? So if they if they're lending to freely, they might take on lots of too greater risks, which couldn't in the long term, harm them. But on the other hand, if they don't lend enough, then that maybe exacerbates the economic situation, the problems that are being faced. Yeah, exactly. It's a fine balance. Now, on the one hand, banks might be tempted to be rather risk averse in these moments or lend less because in this radical uncertainty they face, they might be concerned that maybe the customers would not pay them back. But if they they are excessively restrictive in their lending decisions, then the the likelihood that small businesses, corporates will default will be higher. And then the the crisis will be deeper. And then eventually also the repercussions on the banks balance sheets will be tougher. So it's a delicate balance and a difficult challenge for banks to perform their functions in these difficult situation. Okay, and could you maybe just spell out why is it so critical that banks are able to to to get through that to make that balance? They they managed to both lend enough and that that they get through the this second phase of the crisis in a decent shape? Yeah, this is a very peculiar crisis. No, because in a sense with the lockdown, the distancing measures, the travel bans, important parts of our economies have been put in a freeze. So they're not working anymore. So firms really being unable to survive, die, jobs being lost. And eventually, once the crisis, the COVID-19, the pandemic is over, finding ourselves in a much lower productive capacity and with an economy which is much less dynamic and less strong than it was before. So the whole objective is to keep the economy alive and to avoid the in excess of insolvency. And this requires lending to these small businesses, corporates to continue paying their bills, the electricity bills, their rents, and to pay their their employees, basically. So all these measures are aimed at making sure that we help, let's say the the real economy to cross the desert in a sense of of this of this pandemic. So that's why lending is so important. But of course, in doing that, banks need also to make the difficult call of selecting those customers that deserve this support and those that instead are excessively weak and would not were weak probably even before the crisis and would not be able to survive in the longer term. So these are the difficult lending decisions that banks will need to to make in the are making in these days actually. Okay, so Jan, so let's look at that because in the in the last two episodes of the ECB podcast, we discussed our monetary policy measures with chief economist Philip Lane. And in the last episode, we also talked about a bit on the financial market impact with executive board member Isabel Schnabel. So if we just focus in on ECB banking supervision, and the response we took there, can you talk us through what measures that you put in place? Yeah, we basically took a quite comprehensive package of measures. First of all, we try to create space for the banks to land in the new regulatory framework which has been built after the last financial crisis. We have distinguished between minimum requirements that banks need to respect at all times and buffers that banks need to building good times to use in times of crisis or buffers of capital buffers of liquidity that needs to be available in case a storm arrives in and the banks are put under pressure. So what we did basically was we told banks that they could use freely these these buffers as envisaged in the original design of the reforms. We also took measures to avoid what is called prosyclicality. So the sort of an effect of the rules that might exacerbate when there is a recession, the risks, the perception of risks at banks. For instance, this is the case for accounting standards. So the way in which banks measure the credit quality of the borrowers. And we gave clear interpretation to the banks that they should look at the longer term viability of their customers, not only at the pain they are suffering at the peak of the of the crisis, and especially we gave the banks a lot of operational relief. So not try to reduce the reporting requirements to reduce the specific supervisory request that we are sending in their direction so that they can focus on the main task of the day. And so on that prosyclicality point, that's that's where you're trying to take a policy that's basically there for good reason that in good times, you want them to be cautious. But actually, to put it in very blunt blunt terms to say, well, right now there's a crisis. So you need to have a better view on whether that lending risk is actually over the long term, going to be as bad as it might look today. Does that is that too simplified? Or do you want to nuance that a bit? No, no, you're getting it right. So for instance, if if a bank now is facing a customer that has payment difficulties, but these payment difficulties are temporary, and this customer can enjoy government guarantees on the loan. Well, then we would invite the banks to take into consideration how temporary these difficulties are and how relevant the government guarantees from the governments could be in preventing losses hitting the banks balance sheets in the future. Instead, if the banks were simply taking today's picture and projecting these forward in the in the coming months and years, well, then they would probably conclude that that customer is not is not viable, and they would not lend to this customer. So the point is to have a balance view and to take into consideration also the support measures which have been granted by governments in taking the the lending decisions. Okay. And what is the advantage of doing this at a European level over the the old way pre 2014 of doing it purely nationally? Well, you know, first of all, it's clear that when national measures were taken before the previous crisis, there was a lot of use of supervisory tools to favour national champions. And these had to some extent created competition between supervisors that led to an excessive relaxation of the supervisory requirements. This time in having European supervision, this did not happen. The banks started this crisis with a much stronger level of capital and liquidity, which enabled them to to avoid becoming an element of further strengthening of the shock. So in the past, the banks have become the origin of the problem. And they helped spreading the shock throughout the economy. This time they are operating in the opposite way. There has been a shock which has come from outside the banking sector. And the banks have continued lending to their customers, enabling them to withstand the first the first phase of the crisis. That has been an incredible difference from from the past. The second difference has been that there has been a much faster reaction. It might seem difficult because and surprising because we are operating in a multi country setting also in our supervisor board. But it was very easy to get together and take a very strong decision very fast and giving certainty to the market and avoiding, you know, banks cherry picking between different jurisdictions. So it has been a unified response. It has been very fast. And this has helped markets to see that there was an immediate policy response, which was not the case in the past, where every authority went out on its own course of action. And you've talked already about this. You want the banks themselves to be walking this tightrope between lending enough but not lending recklessly. How do you manage collectively then to make sure that you're sort of not being too generous to the banks and allowing too much risk to build up? Look, I mean, there could be a misperception here that we have been, you know, changing the stance of supervision. Actually, what we have been doing has been exactly in line with the design of the regulatory force which have been designed and put in place after the last crisis. So the idea that supervision should become less prosyclical, that supervision should also be able to increase the safety of the banks in good times, but also allow them to deepen the buffers, use capital, use liquidity to support the economy when a bigger recession like the one we are experiencing right now comes. But we have been shifting our focus. I mean, instead of running the, for instance, the usual supervisory processes as we did in the past, we focus them much more on the specific risks that the banks are facing during the COVID-19 crisis and on their ability to manage those risks. Changing the topic very slightly, but also something that's particularly to do with the crisis that you mentioned at the beginning of our conversation. The sudden change in people not being able to go into bank branches, everyone working from home, has created this sort of something that some people might call a sort of forced digitalization and that comes with its own specific risks for banks, which are maybe not always famous for having the newest computer systems. And it's something that I think you've looked at a bit from a supervisory perspective. Can you tell us about that a bit? Yes, I think that this is an opportunity, I would say, also for the banks. So we have been arguing for a long time before this crisis that banks which have been more effective in terms of refocusing their business model, investing in new technologies, adopting digital distribution channels with their customers and being more effective in in terms of reducing costs and cutting sometimes also branches and being the banks for several years now, which have proven to be more profitable. We have always argued that banks should focus on these on these tasks. And now what you call Michael forced digitalization has offered an opportunity to them to focus more on these topics. So I hope that instead of coming back to the old normal, they will also take this opportunity to rethink their way of operating and to reconsider their use of technologies also in their day to day operation. And there were many banks, let's be honest, that has been for a long time a major supervisory concern. Many banks that were not even able to aggregate data that were dispersed in different databases. This has been a big issue in the past. OK. And whilst they're doing that, one other thing I guess they should look at and that you've highlighted as well as the risk of cyber attacks and cyber risk generally, right? Because if more things are online, there's obviously more vectors for attack. Yeah, this has become a priority for the ECB supervision at least for two years. We have this as one of the top priorities in our risk map. So we have been focusing a lot on IT and cyber risk. We have had a number of on-site examinations. We have an incident reporting system, which has become more and more effective and which we're using also now in the COVID times. At the moment, we have noticed a little bit of increase, but not a major, let's say, regime change in terms of cyber attacks, which means that banks have been preparing more. But you know, there are indeed risks that we have identified specifically in this crisis that will need to be to be covered going forward. For instance, many, many banks have been outsourcing IT functions to emerging countries where the ability to work remotely has proven to be much more limited than in their home country. So this has generated some hiccups in the functioning of the systems during the crisis. So there are a number of lessons from which we need to learn also on IT risk and cyber risk going forward. Thank you, Andrea. And we wish you all the best as you oversee this journey of the banks across the desert of this crisis. Thank you. Thank you very much, Michael. This brings us to the end of this episode. We've seen that banking supervisors across Europe are working closely with banks to ensure that they can continue to fulfill their key tasks as lenders. And they will play an important role in helping us come out of the crisis. As usual, we'll link to related information in the show notes, including our new web pages with an overview of the measures we have taken to counter the economic impact of the pandemic. Do also listen to episode four of the ECB podcast with Andrea Enria and other supervisors where we delve a bit deeper into what banking supervision actually entails. We'd love to hear your feedback and thoughts for future episodes via social media. You can use direct messages and comments. You've been listening to the European Central Bank podcast with Michael Steen. 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