The Case for European Banks.

Author:Nouy, Daniele

David Smick: Tell us about the state of the European banking system.

Daniele Nouy: Well, the European banking system has seriously improved since the crisis. Banks have more and better-quality capital. For example, their common equity Tier 1 capital is now 13.7 percent, rising from 9 percent in 2012. This is a strong, solid development.

But there are challenges as well. European banks need to fully complete their business model adjustment, and for many of them their operational costs--and their cost-to-income ratios--are too high. Also, the low level of interest rates is hurting retail banks that earn profits through their interest rate margins. There is strong competition from non-banks such as fintechs, for example, and other banks, because we have an overcapacity of banking in Europe. Certain banks have high levels of non-performing loans which are dragging down their profits. They don't earn the returns they need, and they have to make provisions or take losses when they are selling those non-performing exposures.

That's an issue, obviously. But these problems will continue to be addressed in the coming months and years. And looking only at the overall averages for the sector doesn't make much sense. Some banks are doing very well, but other banks are doing less well and are responsible for the not-high-enough average for the return on equity and the too-high average of cost-to-income ratios. But a number of banks are doing better, and the larger ones in general are in much better shape.

Smick: Many people at the IMF/World Bank meetings this fall were deeply interested in the effect of the recent German elections on the potential for a European banking union and the potential for pro-European reforms in general. The saying is, "Macron's visions are running into Merkel's realities." Given the political coalition German Chancellor Merkel is trying to put together, are pro-Europe reforms such as banking union and the appointment of an EU finance minister now on hold? The Social Democrats, who were always pro-Europe, are now on the sideline, replaced by the Euroskeptic AfD party.

Nouy: I don't want to comment on political events because it's not my territory and it's always delicate. But I have the feeling that the prospects for completing banking union and developing the euro area further are much better than they were a few months ago. There are anti-Europe populists in all countries, but they have not gained power. I think the outlook for further banking union is good. The ambition of the European Commission is well placed. I'm pretty sure we will see further developments.

Smick: Even still, after the interesting and surprising French election, the assumption in global financial circles was that the populists were on the run. In Germany instead they won the third-highest number of seats in the Bundestag. Have the populists disrupted the pro-Europe momentum?

Nouy: Frankly, I don't think so. And I don't think there is uncertainty on issues for the European banks. I think we need to be very cautious when interpreting political developments. Personally, I see the environment as quite favorable for the time being.

What is important for the European banks is to be safe and sound themselves. Most of the big ones, the significant institutions that we supervise, are internationally active banks. They need to be well capitalized. They need to be fit for challenges such as digitalization. They need to finish adjusting their business models.

But I don't see significant problems coming from...

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