“Credit risk is our greatest concern” Interview published in “Handelsblatt”

24.04.2020 | Joachim Wuermeling DE

Interview conducted by Andreas Kröner and Yasmin Osman.

Mr Wuermeling, how are German banks getting on in the coronavirus crisis?

German banks are still doing well, given the circumstances. They currently have capital buffers running into the hundreds of billions that they can use to grant loans as well as cushion losses from loan defaults.

Does the coronavirus crisis mean banks have to review their targets and strategies?

That’s already happening. Coronavirus is forcing all institutions to update their earnings forecast for this year. Earnings are dropping and risk provisioning is on the rise. And after the crisis peaks, many banks will have to review their strategies. The pressure on banks whose business models were already vulnerable before the crisis will continue to mount.

How risky can corporate insolvencies and loan defaults be for banks?

Credit risk is actually our greatest concern. While market and liquidity risk are leaving an immediate mark, they are likely to remain limited on the whole. The losses from loan defaults, on the other hand, make a dent in bank balance sheets only after a delay of weeks and months. I am expecting these burdens to start piling up significantly in the third or fourth quarter.

Could the coronavirus crisis evolve into the next banking crisis?

The German banking system is highly resilient today. But this question can only reliably be answered once we have more clarity: about containing the pandemic, about the economic implications, and about how well the government’s countermeasures – such as loans granted by the promotional bank KfW or short-time working benefits – ward off the negative impact on the economy and how quickly we can beat the recession. It was important for the government to act quickly with wide-ranging measures. As things stand today, the expected losses for the overall market should be manageable.

Federal Finance Minister Olaf Scholz has advised institutions to also “turn a blind eye” when it comes to lending. Are banks being too cautious?

In my view, the banks have so far been showing great willingness to ensure that the real economy is supplied with loans. But they cannot possibly bear all the risks of a shutdown of the entire economy. Even in times of crisis, supervisors expect banks to conduct risk assessments responsibly. If banks were to simply open the floodgates and lend freely, sooner or later that would lead to a bank crisis. That wouldn’t help anyone.

For many loans, the government is shouldering 80%, 90% or even 100% of the liability. Is it right to do so?

Banks are supposed to supply the real economy with loans, even in a crisis. But a responsible lending policy also requires banks to reject applications for loans if they don’t expect the loan to be repaid. If the government nonetheless wishes to help businesses for good reason, it takes on the risks for the common good. 

How do you think the banking sector is faring so far after roughly two months of the coronavirus pandemic?

Now we can see that by building up capital and liquidity buffers, we’ve learnt the right lessons from the 2008 financial crisis. The larger the buffers, the longer banks will be able to perform their tasks even in challenging times. In this respect, it was right to insist on these buffers. The second bit of good news is that the banking system is functioning under the present conditions. Consumers and businesses can access bank services even though many branches are closed. However, an individual bank or savings bank only has limited protection against a broad risk to the solvency of a large number of borrowers.

So these kinds of crises can’t be managed without government assistance?

The banking system alone cannot cope with an extremely sharp rise in credit needs in the economy. That’s why the government must step in as guarantor at the moment. We supervisors see it the same way. This is sure to be a talking point when we later come to discuss the lessons learned from the crisis.

What form might solutions take?

Instruments have now been developed ad hoc, under huge time pressure, to mobilise government aid quickly and in a targeted way. Thankfully in Germany we have established channels, in the shape of the KfW and other promotional banks, that allow loans with government guarantees to be channelled to the real economy via the banking system relatively quickly. In future, the supervisory framework for such measures must be designed to enable them to immediately take full effect.

What is your opinion of the proposal made by the ECB’s top banking supervisor, Andrea Enria, to set up a European bad bank? It could be a way of solving the problem of legacy delinquent loans before the coronavirus crisis adds new delinquent loans to the stock.

The essence of this proposal is three years old, and there were good reasons for not pursuing it at the time. Since then, good progress has been made in reducing the stock of non-performing loans even without an institution of this kind, thanks in part to the resolute measures taken by the Single Supervisory Mechanism, which Andrea Enria now chairs. So I don’t think this initiative from back then will be picked up again at the EU level.

Former President of the Association of German Banks Hans-Walter Peters, who just left office, has called on the ECB to refund the €26.5 billion in negative interest already paid by banks so that they can grant more loans during the coronavirus crisis. What do you think of the idea?

I see absolutely no reason to return negative interest. This is a monetary policy measure, not a targeted levy on banks. The banks need to learn to live with it.

Mr Peters also proposed that the ECB purchase subordinated bank bonds in order to strengthen banks’ capital base.

I do not believe that this would be appropriate either. On the grounds of prudence, central banks in the euro area are currently limiting their purchases to senior bonds. Purchasing the subordinated bank bonds of supervised institutions would also represent a conflict of interest for the central bank.

Are the banks generally misguided in calling for more assistance?

The relief provided up to now should give the banks enough leeway to step up lending and absorb losses. It would annoy me if proposals that have been the subject of discussion for some time were now repackaged as “crisis measures” and brought back to the table – generally counting software developed in-house as capital being one such example. This distracts us all from the actual challenge we are facing.

Pre-coronavirus, banking supervisors were calling for banks to cut costs and boost profitability. Do these calls still hold in the time of the coronavirus?

If you want to act responsibly in this crisis, you have to adjust your priorities at a moment’s notice. Our top priority is to maintain banking operations and keep the cash cycle moving – even if branches are closed and many bank employees are working from home. It has worked. And we want to ensure that banks can continue to fulfil their important economic function and grant loans without risking their stability. But in no way does this shift in focus mean that all other aspects are now irrelevant in the long run. We will revisit them once the acute crisis has been overcome.

Financial supervisors have significantly relaxed the rules for banks in the wake of the coronavirus crisis. How long should these reduced requirements remain in place?

The decisions we have made on relaxing the rules were not easy ones to make. Their sole purpose must be to resolve the crisis. No one should be under the illusion that they will be in place permanently. Of course, banks will be given the time they need to return to their normal capital and liquidity levels. But one thing needs to be clear to everyone: we will be tightening the reins again once the crisis is over.

Will adjustments also be made to banking supervision in the wake of the coronavirus crisis?

One lesson to be learned from the crisis is that we need to seriously ramp up the use of digital technologies to make it quicker and easier for us to obtain a picture of how banks are doing. At the start of the coronavirus crisis, we were talking to large banks about their liquidity in daily conference calls. Looking ahead, it would make sense to be able to directly retrieve these data from banks’ systems at any time.

How quickly can something like this be introduced?

We need to apply the digital motto “think big, start small”. In countries such as Israel, supervisors already have access to institutions’ databases to check liquidity ratios directly. In Europe, we should start by concentrating on simple metrics for which up-to-date information is important. In this way, we would be able to identify problems at an earlier stage, act pre-emptively and thus potentially prevent damage before it occurs.

What is your take on the recommendation made by the Single Supervisory Mechanism (SSM) to not pay dividends – is it appropriate, or is such a blanket approach disproportionate?

It is in the interests of financial stability for banks to be able to conserve their capital in the current situation so that they can mitigate risks and grant more loans. In my opinion, there would have been grounds for permitting dividend distributions in one or two special cases. But we need one uniform approach for the euro area.

Does the ban on dividends also apply to savings banks and people’s banks?

It is not a ban on dividends – this is not legally feasible when complying with capital requirements – but a recommendation to postpone dividend payments until the start of October. We also expect small and medium-sized banks supervised by BaFin and the Bundesbank to follow this recommendation. And we are very happy to see that this is also happening.

What will you do if an amazingly well-capitalised people’s bank wishes to make a dividend payment despite your urgent recommendation?

It is understandable that a very well-positioned bank might be tempted not to follow the recommendation. But this is a collective precautionary measure to be taken by all European banks. Given the monumental challenge that the pandemic poses for business and society across the euro area, capital needs to stay in the financial system for the time being. It is important that no bank breaks rank. So far, banking supervisors in Germany have largely succeeded in convincing institutions of the logic behind these measures.

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