ECB published its annual report on supervisory activities for 2020. The report presents the work of ECB in the year under review as well as the focus areas for supervision in 2021. The report highlights that banks entered the pandemic crisis in much better shape than at the start of the previous crisis. Lending to firms and households continued to grow in 2020, even though there was a slowdown in the third quarter. Compared with what happened during the great financial crisis, banks reported a much more moderate tightening of credit standards following the first wave of the pandemic.
The COVID-19 crisis has heightened the risk of a further build-up of non-performing loans (NPLs) through a deterioration in the asset quality of banks’ balance sheets. The high aggregate level of NPLs in the euro area had already been identified as a matter of supervisory concern going into 2020. There is now an added risk of severe cliff effects when public support measures start to expire. The report highlights that banks must have tight loan deterioration monitoring and management strategies in place to enable them to identify risks at an early stage and actively manage exposures to distressed customers. ECB will continue to keep a close eye on how effective banks are in implementing such strategies during this crisis and will continue to engage with banks to come up with ways of swiftly tackling impaired bank assets. In 2021 follow-up activities will be focused on assessing the impact of wind-down of the national support measures on credit risk profiles of less significant credit institutions as well as the readiness of these institutions to deal with a potential increase in defaulting exposures.
Looking ahead, significant uncertainties remain in the short to medium term, given the resurgence of COVID-19 infections at the beginning of 2021. The Single Supervisory Mechanism (SSM) Risk Map for 2021 provides an overview of the main challenges for the banking sector over the next two to three years, as assessed by the ECB Banking Supervision in close cooperation with the national competent authorities. The SSM Risk Map depicts the most relevant risk drivers, which can affect supervised institutions via existing internal and external vulnerabilities, for example, characteristics of the banking system or the environment in which banks operate. In the context of the current risk scenario, the identified vulnerabilities in context of the pandemic define the supervisory priorities for 2021:
- The ECB Banking Supervision will prioritize its actions toward the assessment of the adequacy of banks’ credit risk management, operations, monitoring, and reporting practices. Emphasis will be on banks’ ability to identify asset quality deterioration at an early stage, book accordingly adequate and timely provisions, and take the necessary actions toward arrears and NPL management.
- The EU-wide stress test coordinated by EBA will be conducted in 2021 and will be an important element in gauging banks’ capital strength. It is essential that banks have in place sound capital planning practices, based on capital projections which adapt to a dynamically changing environment, particularly in a crisis situation such as the current pandemic.
- In 2021, ECB Banking Supervision will continue its efforts to challenge banks’ strategic plans and the underlying measures taken by banks’ senior management to overcome existing shortcomings. This is because profitability and business model sustainability of banks remain under pressure from the economic environment, low interest rates, excess capacity, low cost efficiency, and competition from banks and non-banks, with the pandemic exacerbating these pressures.
- Supervisory focus will remain on governance and on banks’ risk data aggregation capabilities and information systems as well as on how well they manage crisis risk. The ECB Banking Supervision will continue to assess banks’ internal controls also, with a view to mitigating money laundering and terrorism financing risks.
Further structural activities going beyond the impact of the pandemic will be conducted in 2021, especially related to the alignment of banks with the expectations stipulated in the ECB guide on climate-related and environmental risks and their preparedness for implementing the finalized Basel III reform package. In 2021, ECB will ask banks to conduct a self-assessment in the light of the supervisory expectations outlined in the guide on climate-related and environmental risks and to draw up action plans on that basis. ECB will then benchmark the banks’ self-assessments and plans and will challenge these in the supervisory dialog. In 2022, ECB will conduct a full supervisory review of banks’ practices and take concrete follow-up measures where needed. Depending on how the crisis develops, the ECB Banking Supervision may further reprioritize its activities.
Keywords: Europe, EU, Banking, Annual Report, COVID-19, NPLs, Credit Risk, Regulatory Capital, Banking Union, Basel, Climate Change Risk, ESG, Governance, Stress Testing, Supervisory Priorities, ECB
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