Keynote Speech by Director Ana Paula Serra in the "CIRSF Annual International Conference 2020": "Economic Recovery and Financial Stability"
Let me start by thanking Luis Morais for the invitation to participate in this conference. It is a great pleasure to participate in this panel together with Mario Nava.
As we face what some call a second wave of COVID- 19, the full impact and consequences of this unfortunate lasting pandemic on the real economy and on the banking sector are still uncertain.
I think that we all acknowledge that this time is different from the previous crisis of 2007-2008 or, in the particular case of Portugal, from the crisis of 2011-2013. Now, the origin of the crisis is external from the financial system and it affects the entire world simultaneously.
In the particular case of the euro area, banks’ starting point, in terms of capital and liquidity ratios, is much better. By the end of 2019, the CET1 ratio stood at 14.7%, the leverage ratio was 5.6% and LCR (liquidity coverage ratio) and NSFR (net stable funding ratio) stood, respectively, at 146% and 114%.
Banks were indeed better equipped and prepared to deal with this new crisis. The banking sector buffers were such that the sector was able to withstand the immediate shock and may face the downturn that will come more easily. This way, the banking sector, has so far and hopefully will continue to act as a stabilizer, enabling economic recovery.
Governments, central banks, supervisors and regulators were key to the management of the Covid-19 crisis. Several important measures implemented by national and European authorities and governments had a direct and significant impact in the banking sector and the timing of adoption of these measures was also key to sustain markets and banks.
First, payment moratoria to households, mortgage and personal loans, and to NFCs. The maturity of the postponements, principal or principal and interest, varies between 6 to 18 months, giving time to the companies and individuals to recover their cash-flows affected by the crisis. Associated to that, EBA guidelines granted flexibility to banks on the application in the prudential framework regarding default, forbearance on these payment holidays. Banks also benefited from the flexibility in IFRS9 application, adopting a forward looking judgment of distress in order to avoid excessive procyclicality.
Second, ECB and euro area NCA allowed banks flexibility in the use of P2G and capital buffers and issued recommendations to suspend the distribution of dividends for the financial years of 2019 and 2020. CRR quick fix provided banks with relevant RWA reduction and further capital releases and extra flexibility. All the measures have strengthened banks’ capital positions to provide support to the real economy and absorb losses.
This was also possible thanks to the Public Guarantee Schemes given to micro, small and medium companies and the very accommodative monetary policy measures. Let me stress in particular the role of TLTRO III and collateral framework easing measures. These were critical to assure banks’ building up of liquidity buffers used, at least partially, to grant loans and deal with moratoria. Thus, unlike in previous crises, there was no tightening of credit.
National and European policy measures have played and are still playing a very important role in containing the impact of the crisis. The short-term outlook for the European economies remains uncertain and the impact of lockdown measures were only anticipated in adverse scenarios. Yet, if the pace of recovery is similar to what we witnessed over the summer, if we are able to fight the pandemic in an effective was by early 2021, the negative effects of the crisis may somehow be contained.
While the careful unwinding of moratoria and other flexibility measures should be and is underway, supervisors have to be careful not to unwind the relevant measures too early or too fast, precipitating cliff effects, and avoiding lack of coordination that would risk diminishing the effect of measures implemented by other authorities. ECB and Banco de Portugal have already communicated the build-up of capital buffers needs to start by the end of 2022.
Supervisors recognize the need to act prudently and therefore contribute on their part to a soft landing but they need to make sure that banks are properly preparing to deal with the expected deterioration in the quality of their assets.
So, the first balance, is that the extensive regulatory and institutional reforms carried out in the EU in recent years, and more importantly in the Euro area, together with a timely adoption of micro and macro prudential measures and monetary policy measures to address the crisis caused by the pandemic, were key to ensure that the banking system was part of the solution and was able to address the paramount current challenges.
Yet while the banking sector proved to be resilient so far, there are huge challenges ahead and there are important elements in the regulatory framework that are missing and that become more evident when we turn to crisis management mode.
A more detailed answer to this question inevitably leads me to address the status in the construction of the Banking Union. An integrated framework to ensure financial stability in the euro area, and to minimize the cost of bank failures to EA citizens, implies the implementation of 3 interlinked pillars: (1) common supervision, (2) common mechanisms to resolve banks and (3) a single deposit guarantee scheme. This vision was endorsed back in 2012, by the Presidents of the Council, of the European Commission, of the European Parliament, of the Eurogroup and of the ECB. Since then, there were notable developments.
The first pillar, the SSM, is completed, and after 6 years since its beginning in November 2014 it is entering now a more mature phase. This high maturity was clearly visible in the smooth and closed coordination between ECB and NCAs through the crisis enabling to ensure full consistency of the measures that were applied both to SIs and LSIs.
The second pillar is also ongoing and advancing at a fast pace. While theoretically it applies to all banks, in practice it has shown some difficulties namely with regard to the resolution framework for smaller banks. Not all institutions meet the requirements to benefit from the regime and access the mutualized funds of the Single Resolution Fund. Therefore, they are now left with one option, liquidation, even when they are systemic relevant at a regional or national level with the resulting consequences for financial stability.
The third pillar of the Banking Union, a common deposit insurance scheme, has not yet been implemented. There has been no agreement on a fully fledged EDIS and the debate has turned to alternatives that could solve the inconsistencies and difficulties of an incomplete banking union, such as provision of liquidity to national Deposit Guarantee Schemes.
In the current context of the Covid19 pandemic crisis, the difficulties are amplified and call for a careful but urgent policy reflection on whether the existing crisis framework is sufficient to properly deal with bank failures in a systemic scenario.
It is important to revisit the resolution regime and reconsider precautionary recapitalization rules. The resolution framework could probably be well complemented by alternative financing mechanisms, increasing banking sector resilience and cost efficiency. Another important related topic that has to do with the role of preventive measures in the crisis management framework. In particular, recent experiences suggest that DGSs could also be used prevent the failure of banks, as this setting could translate into lower the costs of intervention as compared to a pay-out.
Another related and very important topic is the balance between home and host countries. While banking market integration should be pursued, with the dismantling of barriers to cross-border flows, this cannot be done at the expenses of financial stability and host DGS. In the case of significant subsidiaries, waivers of capital and liquidity requirements cannot be granted since there are no sound effective safeguards of intra-group support. While these conditions are not met, host countries’ competent authorities rightfully demand the application of prudential requirements.
These are a few issues, among others, that need to be addressed in a future updated framework.
Step by step, we are progressing and I trust that, in time, we will bring the Banking Union to a closure. The sooner the better.
Let me stop here.
Thank you for your attention.