José Manuel Campa interview with Il Sole 24 Ore: The credit sector will support the EU economy

‘In this way, the credit sector will support the EU economy, even in recession’

The results of the stress test show that the banking sector in Europe is in a relatively good condition and is able to support the economy, even in the event of a very severe recession. And this is good news. We presented a very challenging adverse scenario with high interest rates, high inflation, a sharp rise in unemployment, a cumulative 6% fall in GDP, and heavy declines in asset prices, equities and real estate. Despite this very difficult scenario, European banks have remained resilient.

The starting position of the stress test was an historically high CET1 capital ratio of 15%, the highest in the history of the EBA, which allowed the banks to withstand a high capital depletion of 459 basis points. In the adverse scenario, CET1 fell on average to 10.4%, a relatively good value, with most banks above minimum capital requirements. Here to assess the stress test is José Manuel Campa, Chairperson of the European Banking Authority (EBA) in an exclusive interview.

How do you explain the resilience of the banking sector?

Banks have done a lot in the past decade, most of the credit goes to them, but also to the regulators and supervisory authorities who have encouraged, and sometimes forced, banks to be more resilient by demanding more capital. And now there is more capital and better quality in the system, non-performing loans have decreased and credit quality has improved. All this – more solidity and greater strength – is demonstrated by the stress test. I see three aspects in this resilience: firstly, a good starting point in capital, CET1 at 15%; secondly, NPLs at the lowest level for a decade with a recovery in profitability; thirdly, the high-interest-rate scenario is positive for banks as it leads to an increase in net interest margin. Net interest income (NII) partially compensated for the very high credit losses in the adverse scenario.

How much influence does the net interest margin have on the 2023 stress test?

The adverse scenario projected losses of EUR 496 billion, which is a very large amount. The NII helped the banks to absorb these losses. In the 2021 stress test, the scenario was very different, with lower interest rates for longer; therefore, it generated lower net interest margins. This explains why, even though the losses in the 2021 adverse scenario were lower (EUR 265 billion), capital depletion was higher (485 basis points) than in the 2023 stress test.

Is high capital dispersion in European banks a sign of weakness in the system?

No, I wouldn’t say so. Dispersion exists between different business models and approaches across countries. For example, the stress test clearly showed that in countries where there are more fixed-rate loans, net interest margins are lower and loan prices have not increased as much as variable-rate loans. Another issue that emerged in the spring is the mark-to-market of fixed-income portfolios. The information on the size of these portfolios, the mark-to-market value compared to the book value and the potential losses are new information that was published concurrently on the same day as the 2023 stress tests: the potential losses amount to EUR 73 billion for banks in the sample. This is of moderate importance, less than 100 basis points of capital, and moderate if compared with the more than USD 600 billion of US banks.

‘Banks are strong’ says José Manuel Campa, Chairperson of the European Banking Authority (EBA)

One of the enhancements in the stress test this year was sectoral exposure. What was the result of that? And how do you rate the quality of the banks’ responses?

This is one of the important improvements we have made this year: the sectoral composition is particularly significant in the current economic scenario, with the combination of the Russian war in Ukraine and price movements in the energy sector. This information on exposure by geographical, company and SME segment is very useful for supervisory authorities when dealing with the banks. The response we received shows that, overall, banks have been able to respond – all of them have provided us with results, but some have had more difficulties than others. There has been a lot of interaction between us and the banks.

Thanks to the banks and regulators, the CET1 capital ratio is now at 15% and non-performing loans at 10‑year lows

Another enhancement is the top-down analysis on net fees and commission income: did it work?

We sent our numbers to the banks and they responded by upholding their theory. There is always a compromise between using the same methodology for everyone and, at the same time, taking the diversity of individual banks’ business models into account. In this case, the top-down approach is a good process.

Climate risk is not included in the stress test...

We are starting to work on a specific climate-risk stress test, with results published in the second half of next year. It won’t just be for the banking sector, but also for insurance with EIOPA and for securities with ESMA. It will be top-down and won’t give results bank by bank, only at system level. There will be an evaluation of potential climate-risk interconnections across the entire financial sector. We will also assess the soundness of the banking system to support the ‘Fit for 55’ transition.

The interview was conducted by Isabella Bufacchi

Il Sole 24 Ore (Italy)