ertainty” due to the impact of COVID-19 pandemic on the economy. He emphasized the need for European Union (EU) banks to strengthen their balance sheets to cope with the challenges posed by the pandemic.
The pandemic has caused a severe economic downturn across Europe, and banks have faced challenges in maintaining their profitability and liquidity levels. Many SMEs, which are the backbone of the EU economy, have been hit hard by the pandemic and have struggled to repay their debt obligations. This has put pressure on banks, which may have to write off a significant portion of their loan portfolio.
The ECB has taken various measures to support banks and ensure the stability of the financial system. These measures include providing liquidity to banks, suspending dividend payments, and loosening regulatory requirements. However, Luis de Guindos has stressed that these measures are only temporary and that banks must undertake long-term reforms to strengthen their balance sheets.
One of the reforms that EU banks must undertake is to reduce their non-performing loans (NPLs). NPLs are loans that have not been repaid for at least 90 days, and they are a significant problem for EU banks. NPLs reduce banks’ profitability and erode their capital base, making it more difficult for them to support economic growth. According to the European Banking Authority (EBA), the EU’s average NPL ratio was 3.3% in the first quarter of 2021, slightly up from 3.0% in the previous quarter.
To tackle this problem, EU banks must adopt a range of measures, including improving their risk management processes, tightening lending criteria, and disposing of their NPLs. The ECB has supported these efforts by issuing guidelines on NPLs, encouraging the creation of private-market platforms for the trading of NPLs, and setting up a portal to provide information on NPL transactions.
In addition to reducing NPLs, EU banks must also address their structural weaknesses. One of these is the fragmentation of the EU banking sector, with many countries having their own banking regulations and supervisory authorities. This has led to a lack of harmonization and a duplication of efforts, making it more challenging for banks to operate across borders.
To address this, the EU has introduced several initiatives to create a more integrated and harmonized banking market. These include the Single Supervisory Mechanism (SSM), which gives the ECB supervisory authority over significant banks in the EU, and the Banking Union, which aims to create a common framework for bank resolution and deposit insurance.
Another structural weakness of EU banks is their low profitability. According to a report by the ECB, the average return on equity for EU banks was 2.1% in 2020, significantly lower than the average 7.7% for US banks. The low profitability is partly due to the low-interest-rate environment in the EU, which has squeezed banks’ net interest margins.
To improve profitability, EU banks must diversify their sources of revenue, reduce costs, and use technology to improve efficiency. They must also adapt to the changing consumer behavior, including the rise of digital banking and the demand for sustainable finance.
Sustainability is becoming an increasingly important factor for EU banks. The EU has set ambitious targets for reducing carbon emissions, and banks play a crucial role in financing the transition to a low-carbon economy. EU banks must align their lending activities with the EU’s sustainability goals, including financing renewable energy, green buildings, and sustainable transport.
To achieve this, the EU has introduced various initiatives to promote sustainable finance. These include the EU Taxonomy, which sets criteria for determining whether an economic activity is environmentally sustainable, and the Sustainable Finance Disclosure Regulation (SFDR), which requires banks to disclose how they integrate sustainability risks into their investment decisions.
In conclusion, the COVID-19 pandemic has highlighted the challenges faced by the EU banking sector. EU banks must strengthen their balance sheets, reduce their NPLs, address their structural weaknesses, improve profitability, and align their lending activities with the EU’s sustainability goals. The ECB will continue to support these efforts, but ultimately, it is up to the banks themselves to undertake the necessary reforms. Only by doing so can EU banks ensure their long-term viability and contribute to the EU’s economic recovery.
