On 28 January 2020, the European Central Bank (“ECB”) held a press conference in Frankfurt on the Supervisory Review and Evaluation Process 2019 (“SREP 2019”). It highlighted a number of interesting developments in the Eurozone.
In short, the SREP reports where a bank stands in terms of business model, governance and risk management, capital, and liquidity. In the ‘SREP Decision’, the ECB sets the minimum levels of capital and liquid assets a bank must hold. Importantly, the ECB also sets out the weaknesses that the bank must remedy within a certain time frame.
The Chair of the ECB Supervisory Board, Mr Andrea Enria, who recently succeeded Madame Daniele Nouy, covered four themes in the press conference Frankfurt:
Allow me to share with you my key take-aways regarding the first three based on his remarks and the Question and Answer session that ensued:
For the first time ever, the ECB is publishing individual bank’s SREP results (known as “P2R”). [See here]
Extract from the Table published by the ECB (current as at 30 January 2020)
Mr Enria explained, “the publication of SREP outcomes will shed more light on that state of European banks. We should have banks that compare their own position with that of their peers and allow investors to make more informed decisions.”
Andrea Enria, Chairman of European Banking Authority (EBA),photo by Andrzej Barabasz, is licensed under CC BY-SA 3.0
Of special note is how British banks have fared in what has become known as Brexit Syndrome. Ulster Bank and Barclays find themselves in the uncomfortable company of the Italian and Greek banks which fared disastrously in the last decade.
When questioned if the Supervisory Board see a specific risk in Brexit banks, Mr. Enria replied, “I would rule out most energetically that we’re using (this) as a tool to ask banks to have more capital post-Brexit because we want to ring-fence. The Pillar 2 requirements are set with respect to the specific risk profiles of the banks so there is no homogenous Brexit category which deserves a high capital requirement, not at all.”
With respect to the second theme, the stabilisation of the supervisory capital requirements in the Eurozone as a whole, two interesting elements stand out:
If we zoom in on individual banks, what do we see when we look at P2R?
Well, disparity to say the least with P2R ranging from 0.75% to 3.50%. The differences are staggering and that is only P2R.
Whilst supervisory capital requirements have, on average, remained stable, the ECB continued to impose so-called ‘qualitative measures’. 91 out of 117 banks directly supervised by the ECB were imposed remedial actions to address weaknesses noted by the ECB.
Almost a third of remedial actions banks must now take refer to internal governance. In fact, the score for internal governance worsened across all business models, a continuing trend from previous years. 76% of banks received an internal governance score of 3 (with ‘4’ being the worst supervisory score), which marks them out as a medium-high risk.
If we dig deeper, qualitative measures were imposed by the ECB to address (a) severe weaknesses in internal control functions, (b) lack of effectiveness of the management body, (c) risk management deficiencies, including as relates to risk data aggregation and reporting capabilities (also known as ‘BCBS 239’) -- an issue that Mr Enria defined as a litmus test of greater problems within a bank.
I was also interested to hear that the deterioration in scores for operational risk also reflects the fact that IT and cyber-risks have increased for most banks. As a result, the ECB “will maintain a heightened focus on such risk by carrying out onsite inspections dedicated to IT.” I invite you to have a look at the Paper my colleagues issued last year on that matter.
During the press conference, Mr Enria went on to discuss another key area of concern which is the low level of profitability of European banks. Many of these banks currently do not earn their cost of capital, even according to their one internal estimates, which Mr Enria describes as “a little bit optimistic.”
This is reflected in low valuations and price to books for European banks. From a supervisory standpoint, this means lower capacity to raise equity in markets with challenging economic conditions.
From the press report prior to the conference, the ECB revealed, “some banks reported material losses mostly linked to conduct risk events.”
In response to a press question on the topic, Me Enria enlightened the room confessing that the pipeline of conduct risk from misselling and old practices — supposedly taken care of with the tightening of the supervisory framework — is yet to dry up. “We still see a number of cases related to money laundering, for instance, so this is an area where we are putting a lot of attention.”
To sum up, I am afraid we are not yet out of the woods...