Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Eurozone banks must prepare for the risk of funding sources becoming “more volatile” next year, said the region’s top banking supervisor as it warned lenders against complacency amid mounting geopolitical and economic risks.
The European Central Bank, which has been supervising the eurozone’s top banks since November 2014, said lenders weathered the high interest rates, market turmoil and economic strains of 2023 well and ended the year with “solid” capital and liquidity positions, but that big challenges remained.
“The resilience we are seeing should not lead to complacency as there are still significant uncertainties and downside risks,” Andrea Enria, the ECB’s outgoing head of supervision, said in his final press conference on Tuesday before he is replaced next month by German economist Claudia Buch.
Enria said the ECB had already pressed two banks to boost their liquidity positions so that they could survive for a longer period without needing exceptional support, and asking a third to create a currency-specific liquidity buffer, as supervisors looked at funding vulnerabilities following turmoil in banking and markets in March.
The ECB has also placed extra capital demands on eight banks because of their exposure to leveraged finance, up from three banks facing those so-called add-ons a year earlier, reflecting growing supervisory concerns that banks have not done enough to address potential losses from their most indebted borrowers. The central bank did not name the lenders on which it has placed extra capital or liquidity demands.
In its supervisory outlook, the ECB noted “high uncertainty” about the eurozone’s growth prospects, as well as “tighter financing conditions and heightened geopolitical tensions”, the risk of higher food and fuel prices and “higher for longer” interest rates which “may result in renewed turbulences in financial markets”.
The assessment comes a week after data from the European Banking Authority showed rising profits and higher shareholder returns from big European lenders, which have persistently traded at valuations far lower than their US rivals.
“While rising interest rates have had a positive impact on profitability so far, banks must be prepared to cope with more volatile funding sources, higher funding costs, a potential fall in asset quality and a further repricing in financial markets in the short and medium term,” the ECB said.
ECB policymakers held interest rates at 4 per cent in December, but cut expectations for headline inflation predictions for 2023 and 2024, in a sign that economic pressures could be waning. Still, the Israel-Hamas war and continued clashes in Ukraine cloud the outlook for next year
Economic uncertainty and higher interest rates can make it harder for banks to fund their activities. Funding stresses contributed to the failures of a cluster of US banks in March this year and Credit Suisse’s acquisition by UBS a few weeks later.
The ECB said it wanted banks to address “shortcomings” in their asset and liability frameworks, which are designed to ensure that their funding needs are met. Its remedies include making sure banks’ funding sources are diverse so they are not overly reliant on deposits, short-term markets or any other kind of funding, and coming up with contingency plans for how they would deal with short-term market stresses.
It also called out shortcomings in credit risk management, which deals with how banks assess the likelihood of defaults, and “in internal governance and the management of climate-related and environmental risks”.
“From 2024, the ECB will increasingly apply escalation mechanisms and tools, possibly including enforcement measures and sanctions to ensure banks address these shortcomings,” Enria said, echoing warnings in early December of tougher action against banks that “drag their feet” on fixing flaws.