The head of the banking supervisory authority of the European Central Bank (ECB) wants to increasingly review credit and climate risks in the next few years.
(Photo: REUTERS)
Frankfurt Over the next three years, the European Central Bank (ECB) intends to focus primarily on the risks banks face from a potential spike in non-performing loans and the hunt for returns. This emerges from a blog post by the head of ECB banking supervision, Andrea Enria, and Mario Quagliariello, the director responsible for supervisory strategy.
“Our top priority is to ensure that the supervised banks emerge healthy from the corona pandemic,” says the post. It is true that the credit institutions have done well so far, also thanks to government aid for the economy. However, some leading indicators would point to a deterioration in credit quality.
This applies, for example, to loans whose default risk has increased. Even if the growth of such potentially endangered loans slowed in the second quarter of 2021, the volume is still double what it was before the pandemic. Banks are also increasingly granting loan deferrals.
However, some banks have begun to release provisions for such impaired loans. However, the ECB demands vigilance from the institutes. ECB banking regulator Enria recently warned of excessive optimism.
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“A possible deterioration in credit quality, linked to the gradual reduction in government support measures and the downside risks to the economic recovery, requires regulatory attention,” write Enria and Quagliariello.
The proportion of bad loans in industries particularly vulnerable to the effects of the pandemic has also increased. According to the ECB, this is particularly noticeable in the hotel and restaurant industry as well as in the aviation and travel sectors. But risks associated with commercial real estate loans are also on the agenda.
In addition to the blog post, the ECB published an overview of all its supervisory priorities for the years 2022 to 2024 on Tuesday, which goes into greater detail. According to this, the ECB observes “deficits” at “several banks” when it comes to identifying problem loans and urges the institutions to more resolutely classify such loans as endangered loans and to make more conservative assumptions with regard to loan collateral and the necessary risk provisioning.
Criticism of the handling of leveraged loans
The ECB is also concerned about the development of loans to highly indebted companies (leveraged loans). The banking supervisory authority wants to prevent the build-up of “uncovered risks” in this area and is urging banks to orient themselves towards the ideas of the ECB when dealing with such loans. The supervisory authority will also carry out on-site inspections to examine how banks are handling default risks, for example in the areas of prime brokerage and leveraged loans.
The ECB last expressed its dissatisfaction with the business practices of several banks in this field in January of this year. A point of contention between banks and the ECB was the question of when a company is considered highly indebted and therefore very risky.
This could also affect Deutsche Bank, which, alongside the major French bank BNP Paribas, is one of the few European institutions that is significantly active in this business.
In addition to credit risks, the central bank is particularly concerned about weaknesses in deficits in digitization and in dealing with cyber risks. Climate risks are also of growing importance for the central bank. She describes it as “one of the main challenges for banks and bank regulators in the years to come”.
From the ECB’s point of view, the institutes have made progress in taking into account such risks, but at too slow a pace.
Banks could be affected by climate change and the necessary climate-friendly restructuring of the economy, on the one hand, if they have lent money to companies with high CO2 emissions and if they have granted loans to companies that are based in areas that could be physically threatened by environmental disasters .
The ECB, which intends to carry out a climate stress test for the first time in the coming year, expects banks to develop strategies to cushion the long-term consequences of climate and environmental risks and to adequately take into account such risks.
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