Is the PNB Rewardz system closed?

Foreword by Christine Lagarde, President of the ECB

The financial crisis and the sovereign debt crisis have shown how quickly and severely problems in the banking sector can spread to our entire monetary union, affecting both the economy and people's lives. Politicians reacted to this and set themselves the goal of ensuring healthy banks and a resilient banking system. This is how European banking supervision was created six years ago.

In the short time since its founding, it has developed into a mature institution that has taken its permanent place as a consistently and coherently acting European supervisory authority. The risks have been reduced significantly since 2014: the stocks of non-performing loans have decreased by almost 50%, and the capitalization of banks in the euro area has visibly improved. Dealing with non-performing loans clearly shows how well a European approach could help bring crisis-related legacy issues under control, from which numerous banks in the individual countries suffered.

By advocating healthier banks, European banking supervision has also supported monetary policy. More robust banks can lend more to the economy, which in turn strengthens the transmission of monetary policy. In addition, European banking supervision encourages productive risk behavior while at the same time putting a stop to the hunt for high returns. In this way, it helps to limit the risks to the stability of the financial system and enables us to fulfill our price stability mandate with the current monetary policy course.

In the past few years, enormous efforts have been made in the area of ​​banking supervision. Nevertheless, more must be done on the part of the banks in order to master the challenges that will remain in 2020. The profitability of the institutes is still low. If this situation continues, it can affect the resilience of the entire banking sector. Banks can do their part to solve the problem by reducing their excess capacities, reducing the remaining stocks of non-performing loans and aligning their business models and IT standards to the digital age.

The other part of the solution concerns the institutional framework. This must be designed in such a way that a more efficient and more integrated banking market is promoted. The basis of the banking union - the single set of rules - is still highly fragmented at national level. In addition, the integrity of the single banking market could continue to be called into question as long as one pillar of the banking union - namely the European deposit guarantee system - is missing. This prevents further cross-border integration.

Furthermore, there are longer-term challenges such as climate change to be mastered. They affect us all and nobody can turn a blind eye to them. Climate change will affect all areas of the economy, including the banking system. It is therefore obvious that we must tackle this problem through joint action - across national borders, institutions and sectors.


Mr. Enria, at the beginning of 2019 you took over the chairmanship of the supervisory body. What is your conclusion after a year and what is still to be done?

My conclusion is: European banking supervision works. It makes sense and also useful to supervise banks at European level. Our supervisory model rests on strong pillars. After five years we are now in a more mature stage of development and no longer in the start-up phase. So we need to bring the big projects of this time to a close and focus on solidifying our approach and risk-based oversight. At the same time, we will work to further simplify procedures in order to reduce the workload for supervisors and banks. This also includes the increased use of new technologies. We also strive to act more transparently and predictably. We are still dealing with a banking sector that is poorly profitable and a banking union that is not as integrated as it should be. It is therefore also important to us to contribute to overcoming these major challenges.

Why should banking supervision become more transparent and how can this be achieved?

With the banking union, we have introduced a new model for the entire euro area. I have the impression that banks and investors are still struggling to really understand this new model. As a result, we as banking supervisors need to better explain and justify our actions and our approach. This also makes us more predictable, because after all, banking supervision should ensure stability and not surprises. The new institutional framework for crisis management stipulates that banks should first use investors to absorb losses instead of claiming state aid. Therefore, investors need to be better informed about whether certain supervisory measures could be triggered in light of the current business situation of a bank. We took a first step towards increasing transparency in January 2020. For the first time, information was published for the individual banks on the supervisory capital requirements that were determined in the supervisory review and evaluation process. We also shared more details about our methodology. This enabled credit institutions and investors to get a more precise picture of the supervisory rating of European banks.

Let's get to the banks. The issue of profitability is still an urgent challenge. Do you see light here at the end of the tunnel?

I'm afraid we are still in the middle of the tunnel. As a banking supervisor, I can assure you that the banks' low profitability is a serious concern. Banks that are barely profitable cannot raise capital internally. Also, due to their low market valuations, they may not be able to meet their capital needs through the stock markets. As a result, they become more vulnerable. It is clear that it is currently far from easy for banks to make money in traditional banking. However, nothing will change in these difficult framework conditions anytime soon. The commandment is therefore: accept and adapt. Banks must accept the new reality and consider the possibility of adapting their business model in order to remain viable. The most competitive institutes are those that work cost-effectively, have - as we say - good strategic management and face digital change. Unfortunately, other banks still have some catching up to do here. For this reason we will keep a close eye on developments and put pressure on the stragglers.

Are cost savings a possible tool for banks and how can they be achieved?

One of the most important measures that banks should take themselves is to increase cost efficiency. The cost / income ratio of the institutes in the euro area is still high. On average, they spend around 65 cents to earn one euro, which is significantly more than their international competitors. However, it is crucial that savings are not made in the wrong place. For example, reducing costs in risk management is not an option. Investments in new technologies also remain important because they can help reduce costs in the future. Apart from that, some more radical proposals are also discussed. For example, banks could pool certain services that they require as standard. That way, it would be easier for banks to achieve economies of scale and thus reduce their spending. The most effective leverage is of course corporate mergers. If the right banks come together in a well-executed merger, it can also help cut costs and realign the business model.

So do we need more consolidation, i. H. more mergers, in the banking sector?

Well, it is obvious to me that there needs to be some consolidation in the euro area banking sector. Overcapacities are partly responsible for the lack of profitability. Therefore, they have to be dismantled. And bank mergers - both within and across national borders - would be useful. Mergers at national level may result in higher efficiency gains because, for example, the merger partners' sales networks overlap. Cross-border mergers, on the other hand, can help diversify the sources of income and thus also the risks. This would ultimately make banks and the financial system as a whole more resilient to shocks. I can understand that it is difficult for the individual banks to come up with good arguments for mergers due to the low profitability and market valuations. However, looking at the system as a whole, it is unlikely that the root causes of these two problems can be resolved without some consolidation within the banking sector.

Can the ECB do something about this?

The economic arguments for consolidation are quite understandable to me. However, it is not my job to drive this process forward or to slow it down. All I can do is remove potential barriers to mergers, especially if they come within my area of ​​responsibility. The ECB seems to be creating the impression on some that it is trying to prevent mergers by imposing higher capital requirements on emerging companies. I have been trying for some time to get rid of this mistake. We will explain our general position on mergers in more detail later this year. For example, how do we deal with badwill? How do we assess the capital adequacy of the merging banks? We will devote ourselves to questions like these in order to create more clarity.

Is there a chance of further integration at European level? For example, will the banking union be finalized?

The banking market is still highly fragmented nationally - even in the euro area. In large part, this fragmentation is the result of ring fencing; H. of foreclosure measures taken during the financial crisis. They have increased the fear that in the event of a bank shock, capital and liquidity could flee abroad and taxpayers would have to foot the bill. We need to make further progress here in order to complete the security mechanisms within the banking union. We have made some progress in setting up a backstop for the Single Resolution Fund. At the same time, the issue of liquidity in the event of resolution and, in particular, the creation of a common European deposit insurance scheme are still very controversial. I hope for results here soon, but I also know how difficult this debate is.

So the question arises, what else can we do? If nothing changes in the existing framework, can something be achieved within this framework? One possibility would be to take the interests of the host countries into account when it comes to determining the supervisory requirements for all banking groups. A certain geographically limited risk that persists despite diversification and netting measures on a consolidated basis could be covered by bank group-specific requirements. It would also be conceivable to stipulate agreements on the provision of intra-group financial support as an integral part of bank recovery plans. If we want integrated active and passive management in good times, we have to ensure that it also works in the event of a crisis. This is possible through credible agreements that the ECB can enforce.

Is the new European framework for crisis management helpful in this regard?

This new framework has definitely taken us a step forward. Nevertheless, it still has certain gaps at the European level. In fact, it is still largely a national framework. It is precisely this fragmentation that makes the framework less effective and efficient than it could be. In the liquidation of banks, for example, national approaches are used that continue to differ quite significantly from one another. The role of the deposit guarantee systems and the institutional guarantee systems is also not uniform, as is the policy that is being pursued with regard to the rescue of banks with public funds. The same conditions are not given. In this environment, it becomes even more difficult for the banking supervisors to use their available instruments. That is why we need a more harmonized system. We could move a little closer to the United States' approach and, for example, create an instrument at European level for enforced administrative liquidation.

On the way to a common European banking market, it will probably be necessary to provide the host countries with adequate security mechanisms so that it will be easier for them to dismantle national barriers. Addressing these issues and improving crisis management may also lower the perceived initial costs of dismantling existing ring fencing structures to protect the domestic banking sector. Until then, we are obliged to examine all available options in order to promote the application of the existing legal framework in such a way that company-wide asset and liability management is strengthened in the banking union. For example, we should sound out whether the discretionary scope of the supervisors in some areas can be used (e.g. waiver of liquidity requirements at individual institution level or group-internal exemptions from large exposure requirements) in order to support company-wide asset and liability management within the banking union. This creates trust that it is possible to calculate with help within a banking group.

The banks often claim that the high level of regulation is one of the reasons for the lack of profitability. Do you think this assertion is justified?

The financial crisis brought to light the weaknesses of the regulatory framework in force at the time. Therefore, regulatory reforms were absolutely necessary. When we talk about the costs of regulation, we also have to talk about the costs of a crisis. It is true that the banks definitely bear the former, but not necessarily the latter. This was part of the original problem. I think that we have reduced the probability of a crisis at a reasonable price. In this respect, I am behind the regulatory reforms that were passed, among other things, through the final Basel III package. I have called for it to be conscientiously implemented here in Europe on several occasions.

Nonetheless, I am aware of the reporting burden expected from banks. The ECB is already making serious efforts to reduce this burden, especially for smaller and less complex institutions. However, there are still two open points. The first concerns the number of authorities requesting data from banks. Better coordination between the ECB, national supervisory authorities, national central banks and macroprudential authorities could reduce the burden on banks. However, the banks not only have to submit regular reports, they also have to process data queries related to specific events. This is the second point. Here we have to strive for better planning, prioritization and communication of the pending data queries.

Other than earnings weakness, what other problems should banks address?

Very often in our reviews we find that internal governance is a cause for concern. Best practices start with remuneration models that take account of a bank's risk appetite and extend to the transmission of accurate and up-to-date risk information to senior management. In addition, some well-known recent examples show that the control mechanisms and procedures for combating money laundering are still inadequate. One thing is clear: we expect all banks to have a framework in place to ensure good governance and effective risk management. Problems in these areas can quickly spread outside the bank and cause significant damage. A good example is operational risk. The situation here deteriorated in 2019. Most of the losses from operational risks can be traced back to behavioral risks, which in turn are often linked to governance problems. An operational risk can also arise from the IT structure. With the increasing digitization of banks, the threat of cyber risks or general IT risks, e.g. B. due to outdated systems.We take this very seriously and conduct a series of on-site IT risk audits.

Is climate change an issuefor banks and banking supervisors?

Climate change concerns us all. Therefore, many far-reaching ideas are currently being discussed. For example, it is believed that regulation should take the environment into account; That is, green investments should have lower capital requirements. Our job as supervisors is to ensure security and soundness in the banking sector. That is why our actions are always based on the risks. These risks must be carefully analyzed in order not to make hasty political decisions.

The key question is therefore whether there are business activities or assets that are more exposed to climate and environmental risks than others. The taxonomy of sustainable economic activities currently being developed by the EU is an important first step as it will enable banks to identify and report their climate and environmental risks. This in turn contributes to greater transparency. In a second step, all risks would then have to be covered that are recorded in the bank's internal risk management or in our supervisory review and evaluation process. Ultimately, they could also become part of the regulatory stress tests. We are continuing to work on all of these issues - mostly on a European or even global level. For example, the ECB belongs to the Network for Greening the Financial System, in which more than 50 institutions from all over the world are represented.


1.1 The euro area banking sector in 2019

1.1.1 General resilience of banks in the euro area

Capital and debt ratios stable at an aggregated level over the most recent reporting periods

The capital ratios have been stable at an aggregated level over the most recent reporting periods (see Graphic 1). After 17.83% in the corresponding quarter of the previous year, the total capital ratio in the third quarter of 2019 was slightly higher at 18.05%. A similar development, with minor fluctuations, can also be observed for the Common Equity Tier 1 ratio (CET1 ratio) and the core capital ratio (Tier 1 ratio).

Graphic 1

Total capital ratio of the major institutions (transitional definition)

(left scale: in € billion; right scale: in%)

Source: ECB.

The weighted average of the fully loaded CET1 ratio of the significant institutions (SIs) remained stable at 14.1% from the fourth quarter of 2018 to the third quarter of 2019 (see Graphic 2). Compared to the corresponding period of the previous year (5.32%), the debt ratio increased slightly in the first three quarters of 2019 and stood at 5.42% in the third quarter of the year (see Graphic 3).

Graphic 2

CET1 rate of the SIs

Source: ECB.

Graphic 3

Leverage ratio of the SIs

(in %)

Source: ECB.

LCR for the aggregated group of SIs continued upward

The liquidity coverage ratio (LCR) for the aggregated group of significant institutions continued its recent upward trend, which corresponds to an increase of 4.23 percentage points compared to the same period of the previous year (see Chart 4).

Chart 4

Liquidity coverage ratio of the SIs

Source: ECB.

Stress test 2019 - ECB banking supervision carried out a sensitivity analysis on liquidity risk

In the year under review, the ECB banking regulator used its annual stress test to examine the banks' short-term liquidity risk in detail. In the Sensitivity analysis of the liquidity risk as a stress test 2019 it was examined to what extent the SIs can cope with an idiosyncratic liquidity shock. Banks' resilience to adverse and extreme shocks was assessed using hypothetical stressors that were calibrated not with reference to monetary policy decisions but rather on the basis of recent crisis situations.

ECB certified banks overall comfortable liquidity position

The majority of the 103 participating banks reported generous liquidity buffers and comparatively long survival times (please refer Chart 5). Accordingly, the median survival time in the adverse shock scenario was around six months and in the extreme shock scenario around four months (see Chart 6). Long survival in stressful conditions gives banks more time to implement their contingency funding plans.

Chart 5

Distribution of banks with a survival period of less than six months in each scenario

(Calendar days; number of banks)

Source: ECB.
Note: The survival period is defined as the period up to the day on which the cumulative net liquidity outflows first exceed the available liquidity coverage potential. The longer it survives, the greater the likelihood that the bank will survive a liquidity shock.

Chart 6

Median of the net liquidity position

(Calendar days; median of the net liquidity position in% of the balance sheet total)

Source: ECB.
Note: The net liquidity position refers to the algebraic sum of the cumulative net outflows and the available liquidity coverage potential. The survival period is the period up to the day on which the net liquidity position becomes negative for the first time.

However, there is a need for further action on some aspects

The major institutions continued to have a comfortable liquidity position in 2019. However, there are some aspects that need further prudential monitoring: a) A small number of banks reported low liquidity positions in foreign currencies (e.g. US dollars); b) individual banks provide group companies outside the euro area with net liquidity, which exposes them to ring fencing risks; c) Several banks use optimization strategies that lead to improved compliance with the liquidity ratios, but only to a temporary supply of liquidity; d) in many cases, collateral management, including the ability to quickly mobilize unencumbered liquidity reserves, could be improved; and e) banks may underestimate the negative liquidity impact of a credit rating downgrade. At the same time, the test helped uncover quality problems in the reported liquidity data. This will help improve the quality of supervisory information in the future.

The results formed the basis for the banks' annual liquidity assessments; Supervision plans follow-up exams

The test results were incorporated into the assessment of the banks' liquidity position and risk management, but had no direct impact on the regulatory capital requirements. The regulator has taken appropriate quantitative and qualitative liquidity measures to address the issues identified in the stress test. As part of the annual supervisory review and evaluation process (SREP), the supervisors discussed their findings with the individual banks. If necessary, follow-up checks are carried out for certain complaints.

LSIs also had comfortable liquidity and equity positions in 2019

The less significant institutions (LSIs) also had comfortable liquidity and equity positions in 2019. The average liquidity coverage ratio in the second quarter was over 200%, the average CET1 ratio around 17%. However, some aspects require close observation. These include, for example, significant maturity mismatches or the dependency on liquidity groups in which the available buffers of individual members are bundled.

Further improvement in the asset quality of banks in the course of 2019

The asset quality of banks has improved; the proportion of non-performing loans (NPL ratio) fell continuously from a total of 4.17% in the third quarter of 2018 to 3.41% in the third quarter of 2019 (see Chart 7 and Section 1.2.2). As in Chart 8 As can be seen, the differences between banks' NPL ratios also decreased significantly over the same period.

Chart 7

Asset quality: SIs bad loans

(left-hand scale: in € billion; right-hand scale: in%)

Source: ECB.

Chart 8

Distribution of the NPL quotas of the SIs

Source: ECB.

1.1.2 General development of banks in the euro area

SIs' profitability down by Q2 2019; The cost / income ratio remained comparatively high

The earnings power of the SIs in the euro area remained subdued in the reporting year as well. The aggregate annualized return on equity fell slightly from 6.2% in the fourth quarter of 2018 to 5.8% in the third quarter of 2019 (see Chart 9).[1] Overall, the euro area SIs had a lower return on equity than US banks. In many cases it was even below the cost of equity reported by the banks. This development is also reflected in the low valuations of most listed SIs. Due to their price / book value ratio, which is well below one, it is difficult for them to increase their share capital without this leading to a significant dilution for the existing shareholders.

Chart 9

Return on equity of the SIs by source of income

(in% of equity)

Source: ECB banking supervision statistics.
Note: Third quarter data are annualized.

While the rigid cost structure remained a concern, earnings before impairments, provisions and taxes as a percentage of equity fell, but remained largely unchanged in absolute terms. Increases in trading income were also counteracted by a negative operating result or a negative other operating result.

The cost / income ratio of the SIs was still relatively high (see Chart 10). This is due on the one hand to cost inefficiencies and on the other hand to expenses in connection with restructuring and investments in digitization. In the medium term, digitalization can nonetheless enable banks to increase their cost efficiency and expand their range of products and services. Digitization also plays an essential role in the sustainability of business models. However, it has a higher initial cost and its benefits will only emerge over time.

Chart 10

Cost / income ratio and indexed components of the SIs

(in %)

Source: ECB banking supervision statistics.

After several years of downward trend and a low in 2018, impairments and provisions rose sharply again in the first three quarters of 2019 compared to the same period of the previous year. This further increased the pressure on earnings. This increase was seen everywhere, including countries with low levels of non-performing loans. The main reasons for this are the provisions for loan losses on new NPL inventories and impairment losses on non-financial assets of the banks in connection with their restructuring programs.

Like the SIs, the LSIs in the euro area continued to have low earnings power. Due to their dependency on net interest income, LSIs are particularly susceptible to the negative effects of a persistently low interest rate environment. Since they are smaller and predominantly regionally oriented, it is more difficult for them to diversify their sources of income and to reduce their costs. According to the latest data, the average return on equity of the LSIs was only 5.1% in June 2019, which is only slightly better than the end of 2018 (4.7%).[2] In contrast, interest income - the LSIs' most important source of income - continued to decline in the reporting year (see Chart 11). However, the interest result fell only slightly thanks to a simultaneous reduction in interest expenses. In line with the development of the SIs, the provisions for the LSIs rose sharply and increased by around 20% in the first half of 2019 compared to the same period of the previous year. Nonetheless, the risk costs of the LSIs remain relatively low. For example, the share of impairment of financial assets in the total loan volume was 0.1%, less than a third of the value of the SIs.

Chart 11

Development of the interest income, the interest expense and the interest result of the LSIs

(in billion €)

Source: ECB banking supervision statistics.
Note: The graph is based on a changing sample of LSIs. The data for the first and second quarters of 2019 have been annualized using a method based on the last four quarters.

The LSIs continued to seek to limit their overall spending (see Chart 12). Nevertheless, the cost / income ratio remained comparatively high at 72% in June 2019 and essentially unchanged from 73% at the end of 2018. In addition, it was still above the cost / income ratio of the SIs. Some LSIs held large holdings of NPLs, which continued to be of concern for asset quality. Overall, the cleanup of bank balance sheets slowed somewhat; the gross non-performing loan ratio was around 2.71% in the second quarter of 2019, a decrease of 11 basis points since December 2018.

Chart 12

Overview of the expenses of the LSIs

(left-hand scale: in € billion; right-hand scale: in%)

Source: ECB banking supervision statistics.
Note: The graph is based on a changing sample of LSIs. The data for the first and second quarters of 2019 have been annualized using a method based on the last four quarters.

1.1.3 Main risks in the banking sector

In 2019, geopolitical uncertainties, NPLs, cybercrime and IT disruptions were identified as key challenges for banks

In close cooperation with the national competent authorities (NCAs), the ECB identifies the main medium and long-term risks for banks each year (over a two to three year horizon). On this basis, it publishes the graphic for the risk constellation of the Single Supervisory Mechanism (SSM). In 2018, the following key risk factors for 2019 and the following years were determined in this context: geopolitical uncertainties, NPL stocks and the potential increase in new NPLs, cyber crime and IT disruptions. A reassessment of risks in the financial markets, the low interest rate environment and the banks' reaction to the regulation were cited as additional risks.

Geopolitical uncertainties as a major risk to the euro area economy

Geopolitical Uncertainties were identified as a significant risk to international financial markets and the euro area economy. Heightened trade tensions and growing geopolitical uncertainty adversely affected global GDP growth, which remained subdued throughout 2019. Brexit was also still a major source of uncertainty, as both banks and regulators had to prepare for all conceivable scenarios. These developments, in combination with greater political uncertainties in some euro countries, continued to weigh on the economic outlook for the euro area, which clouded over overall in 2019.

NPL ratio in the euro area continues to decline

Although the NPL ratio in the euro area continued to decline, the high NPL stocks numerous banks in the euro area remain cause for concern. However, by implementing their NPL reduction strategies, these banks have made good progress in reducing their legacy holdings. In the third quarter of 2019, the NPL ratio of the major institutions fell to 3.41%, but was still above the pre-crisis level. Additional efforts are therefore required to ensure that the NPL strategies are pursued, especially since only modest real GDP growth is expected in the near future.

Easing of lending standards could lead to the build-up of new NPL inventories

The banks' constant search for returns could lead to one Build-up of new NPL stocks to lead. The trend towards easing lending standards, noticeable in previous years, weakened somewhat in 2019. Nevertheless, in two quarters of the year under review, banks in the euro area reported a slight easing of the lending criteria for corporate loans and house loans to households.[3] In addition, the SIs increased their activity in the market for leveraged loans and accepted a historically low level of protective clauses (covenants).

Risks of IT security and cyber crime are increasing due to advancing digitization

The advancing digitization of financial services can reduce the resilience of banks Cyber ​​crime and IT disruptions affect. Banks are increasingly reliant on digital processes and must use new technologies to increase their efficiency and meet changing customer preferences.However, this process could slow down or lead to increased costs, as some SIs are still working with outdated IT systems and have to completely rebuild their IT infrastructure. At the same time, cyber criminals, who are increasingly acting collectively, pose additional risks.

The risk of a revaluation in the financial markets remained significant

Against the background of the ongoing search for returns, there was still a significant risk of a significant in 2019 Reassessment of risks in the financial markets. Although the worsening trade conflicts caused phases of increased volatility on the financial markets, risk premiums developed cautiously throughout the year. The Public Sector Debt Sustainability While overall improvement in the euro area, some countries continued to have higher levels of debt and were therefore more susceptible to any re-evaluation of their risk of default.

Banks' profitability remains subdued

The major institutes once again struggled with low profitability because of the prospect of a persistent phase of low interest rates and a high level of competition continued to make it difficult to generate income. In 2019, more than half of SIs generated a return on equity that was below their estimated cost of equity. Despite a slight increase in return on equity in 2018, banks revised their earnings forecasts downwards, suggesting a reduction in their return on equity forecasts for 2019 and 2020. Should the macroeconomic conditions in the euro area deteriorate further, a further downward correction is even conceivable.

The key risk factors described above will - despite the changes in the risk landscape in 2019 - continue to play an extremely important role in the coming years (see section 1.6 on the risk outlook for 2020 and the following years).


1.2 Oversight priorities and projects in 2019

1.2.1 Overview of supervisory priorities for 2019