The interview was held by Meike Schreiber and Markus Zydra.
Translation: Deutsche Bundesbank

Can you, as the banking supervisor, trust that the bankers aren’t lying to you?

Supervisors and banks have different objectives and interests – that’s something to be aware of. Moreover, a bank isn’t a monolith. It has a risk management function to sound the alarm when other units don’t pay enough attention to the risk of losses. We need to strengthen these internal forces – supervisory boards have an important role to play as well. But we mustn’t be naive; I dare say that not everyone is a fan of supervisors. That’s something we can handle.

You consider the financial system to be vulnerable, but other banking watchdogs give reassurance. Are you being overly pessimistic?

No. This is a matter on which the supervisory community is very clear. The European banking system is well capitalised; the banks are liquid. They satisfy the ratios they are expected to. But, at the same time, the system is more vulnerable than it was just a few years ago. The economy has been shaken by considerable shocks. Credit risk stayed low, however, partly thanks to comprehensive fiscal measures. Hence, there is a risk that banks might underestimate future risks. 

What risks could these be?

The German economy is undergoing transformation. Firms need to get to grips with higher energy prices, increased interest rates and geopolitical risks. Most businesses will cope well with these challenges, but some won’t. That means that credit risk is likely to mount. Interest rates are already sharply higher. This exposes banks to interest rate risk: exposures are repriced, borrowing costs pick up. That will put a strain on banks in the near term. The threat of cyberattacks has increased as well. Institutions need to do a good job of managing these risks. 

Credit Suisse complied with the relevant liquidity and capital ratios, too, yet it collapsed in March all the same. So can it happen to any bank?

If that were the case, the banking market wouldn’t work. Banking crises can materialise when flaws in banks’ risk management coincide with negative externalities, like a sudden spike in interest rates. That’s why we, as supervisors, don’t just look at capital and liquidity metrics, but also monitor banks’ risk management operations. 

Are investment banks like Credit Suisse particularly at risk?

I wouldn’t say so. The distress observed recently in the United States is a prime example that risks can lurk in classic banking business. The troubled US regional banks mismanaged their interest rate risk, mainly.

Risks often originate in unexpected places, though. Is it not true, then, that what is needed is even more capital set aside as a buffer against losses, rather than thousands of pages of rules that ultimately miss the point?

Regulation is indeed complex because it needs to provide a good reflection of risks. If the rules were simpler, banks would have to meet higher capital requirements in return. What we need to do first, though, is implement the internationally agreed Basel III capital adequacy rules in Europe as planned and not make the system even more complex by adding further exceptions. That will strengthen European banks.

“Basel III” is synonymous with stricter capital rules. The banking lobby is doing everything in its power to water down these rules. Is the industry acting responsibly here? After all, there’s a danger that taxpayers will ultimately have to come to the rescue again.

Lobbying is fine, generally speaking – we’re all entitled to say publicly where we stand. In the financial sector, however, there is something of an imbalance because the subject matter is highly complex. This gives the industry an edge that other groups in civil society find hard to match. These groups often get less of a hearing. What we need, then, is for people on the other side – people representing the interests of society at large – to make their voices heard more clearly.

It’s easy to get the impression that consultants and bankers have a vested interest in this complex regulatory system. Consultants because they stand to benefit; banks because they can make their numbers seem better than they are. Is that an unreasonable assessment?

It may be possible that consultants have little interest in more straightforward systems because their services would then enjoy less demand. As a general rule, we need models to calculate risks and capital requirements. When approving models, we already apply strict prudential standards as a way of ensuring that banks cannot understate their risks. In addition, European supervisors have conducted comprehensive assessments of banks’ models, identified deficiencies and rectified them. Basel III also reduces the influence of internal models. 

Another issue raised by the collapse of Credit Suisse is whether the too-big-to-fail problem has been resolved – that is, whether large banks can be wound up without government assistance. That didn’t work in Switzerland. What’s the point of the resolution plans that banks have been required to submit since the financial crisis?

We have already achieved a great deal in improving resolution regimes. What’s crucial is that owners and creditors must be liable for losses. That way, taxpayers and depositors are shielded. We see that these reforms are working and that risks are being priced in better. However, there are still gaps we need to close so that even large banks can be resolved if the worst comes to the worst. 

Wouldn’t it be better to be honest and say that large banks are still a danger, rather than delude taxpayers?

Resolution regimes perform an important function: they reduce the likelihood of banking crises and make it easier to manage a crisis. If banks don’t have the right incentives, if they run up losses and get into difficulties, things can get very costly for taxpayers. That’s why we should improve the existing structures if it is necessary to do so. The European rules on crisis management and the resolution of institutions are currently being revised. 

High policy rates are good for tackling inflation, but, at the same time, they bring weaknesses in the banking sector to the surface. For ECB President Christine Lagarde, though, there is no trade-off between combating inflation and preserving financial stability. What’s your take on this?

There won’t be any major conflict if both areas perform their tasks.There can be trade-offs if banks lack the robustness needed to cope with rate hikes in the short term. That is why we already highlighted interest rate risk some years ago and stepped into action – improved monitoring, more capital. Monetary policymakers must be able to raise key interest rates without having to worry about the stability of the sector. 

Many large European banks’ shares are trading at very low valuations, even though they generate profits in the billions. Does that worry you?

We certainly look at share prices as a source of important information. But they aren’t a control parameter for banking supervisors. One reason for these low valuations is the intense competition in the European banking market, which is squeezing margins. How to go about consistently convincing markets that higher prices are warranted is a matter for banks to decide.

Why don’t supervisors use share prices as a control parameter? At Credit Suisse, it was the collapsing share price that stoked the crisis in the first place.

We don’t turn a blind eye to share prices. But other indicators, like capital adequacy and risk measures, are of primary importance for us.

Savings banks and cooperative banks in Germany are worried about their institutional protection schemes, which ensure that ailing banks or savings banks support each other. Does the EU really want to abolish them?

This debate has become very heated. In Europe, no one wants to abolish institutional protection. It has worked well over the past decades for savings banks and cooperative banks. What was problematic, though, were the major crises at the Landesbanken, which ultimately made use of government funds. The European Commission is looking to incorporate national systems into the European regime in a way that retains positive elements while closing any pertinent gaps. 

When politicians propose imposing stricter rules on banks, the banks often respond by threatening that they would then be unable to finance the green transition. Is that correct?

So far, no crisis has ever been triggered by overly strict supervision. The best thing for funding the green transition is a robust banking sector. This is because equity capital enables banks to carry on supplying credit, even when times get tough. The German banking sector as a whole currently has more than €165 billion in surplus capital – that is, after deducting the regulatory capital requirements. 

Banks can lend around ten times that amount. So there’s enough money to fund green projects?

Yes, of course, although I don’t like making a distinction between green and non-green investments. If good climate policy creates the right framework conditions, any investment will also have a green element. But we can’t finance the transition through bank balance sheets alone because we’re talking about very long-term investments amid high uncertainty. Equity capital will also be needed for this. 

By the way, what do you get up to when you’re not working?

I’m an avid reader – there are many important social and political issues to read about at the moment. And when I’m not reading, I enjoy hiking.

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