// . //  Insights //  European Banks Are Resilient With Strong Capital Positions


Investment funds, private equity, hedge funds, all sorts of actors are now playing a significant role in the banking sector itself. We don't have full transparency into the risks that are being taken on. There can be exposure that is correlated to the exposure on the books of the banks that we supervise
Elizabeth McCaul, Supervisory Board Member, European Central Bank

European banks enjoy strong capital levels but higher interest rates can affect their credit portfolios. Supervisors also don’t have full transparency into risks in the fast-growing nonbank financial institution sector.

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The risks that face the banking system and therefore the supervisors really relate to those uncertain aspects of the geopolitical environment, hangover effect from the pandemic and supply chain issues, credit issues that we remain quite concerned about, and of course the rising interest rate environment where rates have risen far faster and higher than I think was expected.

We're entering this period with very resilient banks. The capital levels that the institutions enjoy are solid. We are pleased with the picture of the banking sector on an overall basis, but we are not sanguine and we have been very focused on the effects, especially of the higher interest rates on the banking book, on the credit aspects.

The concern that we have is that, even though this is a picture where profitability has increased in the banking sector, lending to stronger balance sheets overall, what we remain concerned about is that there can be knock-on effects in the credit portfolio as households and businesses experience perhaps some difficulties with the higher interest rate environment. But we have really been focused in on making sure that they do look through credit analysis and have a very clear picture about risk in the credit front.

With respect to risks in the overall banking sector, one of the key risks that we're facing today is a risk that is actually outside of the supervised sector, and that is the non-bank financial institution sector. We have observed with some trepidation the growth that has occurred in this area. That is a field that is very diverse - investment funds, private equity, hedge funds, all sorts of actors that are now playing a very significant role in the banking sector itself. We don't have full transparency or line of sight into the risks that are being taken on, whether those are credit risks, derivative contracts, etc. And the concern that we have with that opacity is that there can be exposure that is correlated to the exposure on the books of the banks that we supervise that we don't see.

This picture of short-term funding of institutions is of course the business of banking. We all became very focused on this as supervisors globally in the aftermath of Silicon Valley Bank and the effects that occurred with the deposit run that occurred there. First of all, I see that situation as quite idiosyncratic on the one hand. We don't have in the European sector institutions that have exactly that business model where the technology sector was the lending sector, the deposits were held by the technology sector, social media played a very key role with that very interconnected community. But the business of banking is of course, a mismatch at the end of the day between the assets and liabilities on the balance sheet.

Managing that risk is of paramount importance. We have been encouraging our institutions to be very focused in on the liability side. We have been doing a review to make certain that institutions are diversifying their deposit base. Outsourcing is a fact of life in today's society for any corporation, and that includes banks doing business.

We are living in a technology renaissance, if you will, and that means that there's tremendous opportunity to take advantage of cost effectiveness, of ways of introducing faster processes, of ways of reaching a wider consumer base. And this is something that, you know, we fully expect institutions to be doing. And of course, they are.

Having said that, we are very focused on the risks that third party outsourcing arrangements can present to institutions. It means when there are outsourcing arrangements in place, that the institutions have to have robust risk management processes. They have to be able to ascertain that the control processes they expect of themselves are also being implemented by their third party outsourcing arrangements. And of course, what goes along with that is the increased focus that we have on cyber resiliency, cyber risk, and the resiliency of institutions in the face of cyber risk.

We really benefit today, post-financial crisis, from a great deal of learning that occurred in the aftermath of that, and also, may I say, from very prescient and strong steps that were taken by policy makers in the wake of the great financial crisis. So when we went into the great financial crisis, of course we didn't have any experience with that particular sovereign doom loop. That was a new scenario for us. We, in Europe, did not have all of the tools that would be necessary to fully supervise. We didn't have a banking union. Today we have all three of those. We have a lot of experience under our belts. We have implemented a very strong suite of tools to provide oversight, supervisory oversight to the banking sector. And we have a banking union, 10 years since the financial crisis. That's a very strong portfolio of tools that we have at our advantages.