Shortly after joining the ECB Supervisory Board, Martina Drvar from Hrvatska narodna banka, the central bank of Croatia, and Radoslav Milenkov from Българска народна банка (Bulgarian National Bank) discuss their priorities, the changes for their banks and European integration.
Welcoming you to European banking supervision is an important step in the history of the banking union. What is your view on progress towards European integration?
Martina Drvar: The creation of a single system for banking supervision and resolution was certainly a big step towards European integration. However, until there is a single European deposit insurance scheme, the banking union will not be complete, as the host supervisors will still have an incentive to trigger actions like ring-fencing capital and liquidity. They do this to safeguard their local deposit insurance schemes. However, such actions will ultimately hamper our progress towards advanced banking market integration. The sooner we have an agreement on deposit insurance, the sooner citizens in the EU will benefit from integrated European banks that are more competitive on the global stage.
Radoslav Milenkov: Joining European banking supervision marks a key milestone for Bulgaria, as we are progressing with integrating the Bulgarian banking sector into the European financial infrastructure. It is an event which will be extremely significant in the long term and it brings the country closer to the “core” of the European Union. In addition, we have taken important steps towards adopting the euro. So yes, European integration is here and it is happening right now.
What are the changes and benefits for your banking sectors now that you are part of European banking supervision?
Martina Drvar: Being part of European banking supervision means banks in Croatia can expect more transparent and more consistent supervision. Previously, Croatian supervisors had a strong incentive to impose measures that built capital and liquidity locally at the subsidiary level. Now that the supervisors have access to the complete supervisory assessments of our banks’ parent institutions, this incentive is weaker. With more consistent supervisory approaches, we can work on establishing good corporate governance and risk management controls, carrying out joint recovery plan dry-runs and increasing the frequency of on-site inspections. This will help enhance the stability and efficiency of subsidiaries based in Croatia and, in turn, the whole banking group. Of course, we should not forget the small and medium-sized banks. They make up a large proportion of banks in the EU and tailored supervisory attention is needed to keep them healthy. I strongly believe that banking integration should pave the way for innovative, well-capitalised and well-governed European banks, regardless of their size.
Radoslav Milenkov: Being part of European banking supervision is undoubtedly a challenge for both the Bulgarian banking system and the Bulgarian National Bank (BNB), as we need to adapt to new ways of interacting. However, at the same time, I expect that we will be able to achieve further synergies between the BNB and the ECB and that the local banking system will benefit from a consistent supervisory approach. We are collaborating more closely and we now also have access to the vast supervisory knowledge acquired in European banking supervision over the past few years, which is allowing us to apply different approaches to critical banking issues.
I do not see any particular challenges for the Bulgarian subsidiaries of EU banking groups: they have already been influenced by European banking supervision because their parent companies have worked closely with the Joint Supervisory Teams.
As a matter of fact, we are already seeing that our local banks are receiving positive assessments from foreign investors and rating agencies, and I expect this to continue.
Foreign banks dominate your local banking markets. What made Bulgaria and Croatia so attractive for EU banks?
Radoslav Milenkov: The Bulgarian financial market continues to be attractive to foreign investors because it is characterised by higher interest rate margins and higher profitability. This, combined with Bulgaria’s political and economic stability as an EU Member State, offers an attractive investment opportunity for large financial groups seeking to diversify their financial operations within the EU. As a reminder, in the wake of the 2008 financial crisis the Bulgarian banking system remained stable. There was virtually no impact from the first wave of that crisis, owing to our traditionally strong focus on reducing non-performing loans and ensuring adequate levels of provisioning and capital buffers. Bulgaria is also benefiting from its position as a key destination for IT companies providing payment and financial services to financial markets across the EU, for example. This helps banks to create integrated banking solutions and establish outsourcing hubs.
In a nutshell, banks in the Bulgarian market have a competitive advantage, and the market offers opportunities for development and growth. Our stable, predictable and consistent regulatory environment fosters further progress in banking intermediation.
Martina Drvar: In Croatia, three main factors proved attractive to EU banks: our transition to a market economy, the trade flows with the EU and high-margin opportunities. After the end of the war in 1995, the capital position of the banks needed to be stabilised. So, the two largest banks went through a state-supported rehabilitation process before being sold to Italian banking groups. Trade flows were growing steadily with some EU countries, even before Croatia became an EU Member State.
This, in turn, prompted shareholders from other EU countries, in particular from Italy and Austria, to invest in Croatian banks that offered higher margins. According to the European Banking Authority, the profitability levels of Croatian banks are currently the fifth highest in the EU, recording a return on assets ratio of 0.9%. Our profitability makes Croatia rather attractive and we will need to find ways to preserve it in the future.
Bulgaria’s banking sector has performed quite well in recent years. What are its main risks and strengths? How have banks managed during the pandemic?
Radoslav Milenkov: The Bulgarian banking sector maintains high capital and liquidity buffers, fully in line with our conservative supervisory approach. Our banks have traditional business models but manage to cater to the needs of companies and households in a fast-changing and technology-reliant environment. We have significantly reduced non-performing loans over the last couple of years, but they remain a major source of risk and an area of intense supervisory focus.
Against this backdrop and with 2019 profits at peak levels, the banking sector entered the coronavirus (COVID-19) pandemic period in good financial health – the banks were overall in a better shape than they were back in 2008. We still had to implement measures to keep the system stable and to ensure that lending to households and companies could continue, including through loan repayment moratoria. While loans to some borrowers will ultimately become non-performing when the moratoria end, I do not expect any cliff effects.
The main risk to the banking sector going forward is that the pandemic could reverse the trend towards an improvement in asset quality. Higher loan provisioning, further pressure on margins and subdued loan demand will weigh on profitability. But our system is strong, thanks to its high capital position (which I expect to remain adequate even if risks emerge) and its stable, deposit-based funding structure which provides for ample liquidity.
Croatia now has a seat at the table for decision-making within European banking supervision. What issues should be tackled first, Martina?
Martina Drvar: There are two key topics for me: preserving lending activity and ensuring appropriate governance of digitalisation. It is critical that we assess bank losses in the aftermath of the COVID-19 pandemic, but the full extent of the fallout from the pandemic is still unclear. Proper credit risk management and reliable projections are crucial at this point, especially if we are to avoid cliff effects in the financial accounts. But there is no crystal ball. We need time to see how banks’ balance sheets will evolve. We need mutual trust and clear heads on all sides during this difficult time. Moreover, we are all observing how COVID-19 has accelerated banks’ digitalisation plans. As supervisors, we have to ensure that the digital transformation is adequately governed. Services to EU citizens should be properly maintained and in Europe we need to see further progress in supervising cyber risk and reducing our dependence on single, often foreign, infrastructure providers.
Before the pandemic, the banking sector saw quite some consolidation. Do you expect this trend to continue, Radoslav?
Radoslav Milenkov: I expect the trend of banking consolidation to continue, even during the current crisis. One thing is certain: the global banking system is much older than the cholera pandemic, the Spanish flu, SARS and COVID-19 and it is able to respond and adapt. There were several factors driving banking consolidation in recent years, as banks are under pressure in various ways, be it through squeezed profits, increased compliance and IT costs or competition from fintechs.
Economies of scale seem to be a solution and bank managers and investors alike are looking in that direction, judging from the renewed appetite for major banking consolidation in Europe despite the pandemic. Some mergers may have been delayed because of the crisis but they are not off the table. But we need to adapt the processes to new COVID-19-induced realities, especially by shifting the activities we usually carry out on-site or face-to-face to online channels. We might need to involve new players to achieve this, such as local analytics companies or lawyers.
The BNB traditionally supports consolidation if it results in sustainable business models and an enhanced capacity to meet the regulatory requirements.
Croatia’s banking sector had been quite profitable in recent years. How has profitability been affected by the pandemic?
Martina Drvar: Owing to the worsened macroeconomic outlook, most banks have already increased their loan provisions, which halved their results for mid-2020. However, this has not jeopardised their capital ratios: the system’s total capital ratio is 24.7%, putting us among the three best capitalised EU countries. And I am proud to say that our reaction to the pandemic was swift, well coordinated and well communicated. We shared our supervisory expectations (aligned with those of the ECB) just seven days after the pandemic had been declared. Moreover, Croatia managed to introduce moratoria measures that were appropriate in scale, targeting only a subset of clients. We managed this thanks to clear and prompt communication with the banking industry and without the need for any legal acts.
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