The European Central Bank (ECB) is correct to be preparing lenders for threats that were difficult to imagine when it started regulating the industry 10 years ago, according to an official who help set up its oversight arm.
The ECB’s work to make banks ready for risks including geopolitical shocks or cyberattacks is “a reaction to the increasing uncertainties we currently experience,” said Sabine Lautenschlaeger, who was vice Chair of the ECB’s Supervisory Board from its start in 2014-2019. “The last decade was about capital. The next decade will be about operational resilience.”As the ECB’s supervisory arm readies birthday celebrations next month, top oversight official Claudia Buch is pushing lenders to consider how emerging risks, including climate change, can hurt their balance sheets or put them out of business.
Almost a year into her term, the German official runs an institution that has weathered major shocks, built a reputation for rigour and has the confidence to judge which risks it should focus on.
In the early days of ECB banking supervision, Lautenschlaeger and her colleagues harmonised the approaches of different countries, against the backdrop of an economy still recovering from a painful debt crisis. The ECB was “lucky” that any subsequent periods of stress related to individual banks, rather than the wider economy, she said in an interview this month.
Yet the banking industry would have found it “for sure more difficult to withstand” the pandemic and fallout from Russia’s invasion of Ukraine without the ECB’s previous push for higher capital and liquidity levels and better governance and risk management at banks, said Lautenschlaeger.
Still, she voiced support for what she sees as the ECB focusing “even more” on how big picture economic risks filter down to specific businesses of individual banks.
Others are critical of the ECB’s tough approach. At a recent conference in Frankfurt, Deutsche Bank AG Chief Risk Officer Olivier Vigneron said the ECB should better recognize that lenders need to take risks and deploy capital to finance the structural shifts in the European economy.
“The ECB has done a good job, but it’s a relatively young regulator,” he said. “It’s important to perhaps mature now the regulatory framework, to have a pragmatic application of that framework to understand the risk-taking and the risk appetite of the banks.”
While that’s an argument that bank lobbyists are making about regulation more broadly, it was also on display earlier this year in reactions to a wide-reaching probe the ECB undertook into loans to indebted companies, an area known as leveraged finance.
ECB officials have publicly rejected wider calls to dial back scrutiny. On leveraged finance specifically, the watchdog has said the “prudent risk management of leveraged loans is of fundamental importance to the ECB.”
Lautenschlaeger said she doesn’t know the details of that probe and that the outside world usually only sees a fraction of what moves supervisors to act on risks. Still, she says the ECB has to walk a narrow path: Ppressure lenders to address issues and “but don’t put on the bankers’ clothes.”
“I know that people at the ECB do not think they are the better banker,” she said. “But leveraged finance is an example of the balancing act. Because that leverage can very quickly turn into a problem, so the risk awareness is higher and the push of supervisors stronger.”
Previous efforts to push banks to address risks in that area have shown some success, allowing the ECB to reduce or eliminate specific capital surcharges at some banks.
Buch has been able to build on work her predecessors have done, not just on leveraged finance. Notably, that’s likely to prove helpful in dealing with banks acquiring competitors.
Banco Bilbao Vizcaya SA is already trying to buy smaller Spanish competitor Banco de Sabadell SA, while Italy’s UniCredit SpA has said a deal for Commerzbank AG is an option after it acquired a stake in the German lender.
“We all know that mergers can have beneficial effects in terms of economies of scale, scope, diversification,” Buch said earlier this month. “We also know that they can lead to higher risks and this is all clearly in our guidelines, in our rules and we look at this very carefully.”
Such deals may become more of a feature as European states sell off holdings in banks they bailed out in crises that predate ECB supervision. Yet mergers aren’t the only way for banks to bulk up, according to Lautenschlaeger.
Banks work with “more standardised products and more digital help to lower your costs,” she said. “If you want to successfully compete the next 10 years as a bank, you either have to do economies of scale or you have to be a niche bank.”