Credit risk from the energy crisis: ECB banking supervision warns of shaky economy

Credit risk from energy crisis
ECB banking supervision warns of shaky economy

The trust of savers in European banks is “well placed,” says ECB chief bank supervisor Enria. With a broader customer base and lower interest rate risk, financial institutions in the euro area are better positioned than in the USA. Nevertheless, Enria is plagued by economic concerns.

ECB chief bank supervisor Andrea Enria is calling on the financial institutions in the euro area to be vigilant in view of the uncertain economic situation. “The first set of challenges is cyclical,” said Enria in the ECB’s annual report on supervisory activities, published by the European Central Bank (ECB) in Frankfurt. If the energy crisis is not resolved, credit risk could increase in relation to companies that are most affected by the energy issue.

In addition, the economic slowdown at the end of 2022 was accompanied by an increase in corporate insolvencies. Supervisors therefore urged increased vigilance for deterioration in credit quality. According to Enria, the institutions in the euro area have weathered the recent price turbulence in the sector in the wake of the collapse of the American Silicon Valley Bank and the crisis of confidence at the major Swiss bank Credit Suisse. “The strength of banks’ balance sheets was a key factor in weathering the turmoil,” he told the European Parliament’s Economic and Monetary Affairs Committee.

Although the institutes’ share prices collapsed, their financing and liquidity positions were not significantly affected. In addition, the events in the USA cannot be transferred directly to the large financial institutions in the euro area, said Enria. This is primarily due to the fact that the institutions monitored by the ECB are not exposed to such an extreme interest rate risk. In addition, they are not as dependent on a concentrated and unsecured deposit base as Silicon Valley Bank. Their customer base is also broader. “Right now we have strong saver confidence in European banks, which we think is well placed,” Enria said.

Borrowers could have problems

According to the supervisors, the interest rate turnaround initiated in July 2022 after years of ultra-loose monetary policy is overall positive for the sector in the euro area. If the economy continues as currently expected, further graceful rate hikes are likely to be beneficial to earnings, Enria said in the annual report. “However, if we deviate from the baseline scenario and take into account more unfavorable developments, things may turn out differently.”

Borrowers could then have problems repaying debts. The supervisor looks in particular at consumer loans, real estate loans and loans to highly indebted companies (leveraged finance). In view of the tightening of monetary policy, according to Enria, banks must also take a closer look at liquidity and financing risks.

Wardens tighten thumbscrews in a pinch

It is necessary to adapt risk management and strategic control. Some debt management strategies may be challenged by a more challenging funding environment. “There is a risk that banks will be caught flat-footed,” Enria warned in the annual report. In the EU Parliament, Enria also addressed fears that bond investors in the EU could be asked to pay more than shareholders, as was the case with the emergency sale of Credit Suisse.

“We have made it clear that this approach would not be feasible under European regulations,” said Enria. This clearly applies to bank resolution cases in which the hierarchy of claims is followed exactly. “But we as authorities would also use the same approach in orchestrated private-sector solutions.”

In terms of risk control and internal corporate management, the supervisors still see clear deficiencies at the banks. “Honestly, we don’t see enough progress in this area,” Enria said. If necessary, the supervisors want to tighten the thumbscrews here. Where progress is most needed, banking supervisors are committed to making full use of all supervisory tools and powers. This could also include targeted capital requirements or sanctions. The supervisory authority is not currently considering limiting the distributions by institutions to their shareholders. “Definitely, we’re not considering that,” Enria told MEPs.

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