Answering questions about the bank run on Silicon Valley Bank, the European Central Bank on Sunday underlined its concerns over how European banks are managing risks relating to increasing interest rates.
The ECB has recently made clear that a supervisory review found weaknesses at banks, including ignoring consumer behaviour shifts that could lead to deposit withdrawals when rates rise.
An ECB official told Investment Officer that the ECB is drawing attention to three specific publications made during recent months, with comments made by Andrea Enria, chair of the ECB Supervisory Board, which began operating in November 2014 when the ECB was given the additional task of supervising Europe’s biggest banks.
Over the weekend, it became clear that SVB had misjudged specific risks related to rising rates, which forced it to refinance. When a refinancing operation failed, creditors began withdrawing their deposits. Investors and depositors on Thursday tried to withdraw 42 billion dollars from SVB in one of the biggest US bank runs in more than a decade, according to a California filing.
‘It could become an issue’
Just before news of the SVB collapse, Enria told a Lithuanian business newspaper that rising interest rates, as normalisation of monetary policy, are a positive development for banks, but that it could become problematic as interest rates rise further. “Monetary policy normalisation has been faster and stronger than expected. So far, this has been a positive development for banks.”
“But beyond a certain point, it could become an issue, because higher inflation and higher interest rates affect borrowers’ ability to pay back their loans…,” Enria told Verslo Žinios in an interview published on 9 March.
New EU bank supervision framework
As part of the EU’s post 2008-crisis framework, the ECB is no longer exclusively focused on monetary policy. In 2014 it was given added responsibility for supervising banks. Its list of entities to supervise includes the EU’s 120 or so financial institutions that collectively hold more than two thirds of all eurozone banking assets. Thousands of smaller and medium-sized EU banks are still subject to direct supervision by national supervisory authorities.
Special attention required
Enria has also questioned the extent to which European banks are able to handle changing yield curves. Banks “must prepare for potential longer-term effects related to monetary policy normalisation. And they should pay special attention to interest rate risk in their asset and liability management,” Enria wrote in a 20 December blog post together with ECB Vice-President Luis de Guindos.
To make sure that banks are prepared for sharp changes in yield curves, the ECB last year conducted what it called “a targeted review” of interest rate and credit spread risk management practices. That review identified weaknesses and found that the European bank models were not tested often enough and were not recalibrated sufficiently, it said. The ECB is taking additional initiatives on funding risk as part of its priorities for 2023-25.
Shifts in consumer preferences
“The models banks use to manage assets and liabilities were often calibrated in environments of low rates, and don’t capture the shifts in consumer preferences and behaviours that typically take place as rates rise, such as deposit withdrawals. Also, the frequency of validation, back-testing and recalibration of those models is not satisfactory,” Enria said.
In November last year, Enria already highlighted the need for banks to pay “due attention to measuring, monitoring and actively managing interest rate risk.” At a Bundesbank event, Enria said there would be “winners and losers” because of “distributional effects” from the normalisation of monetary policy.
Rate shift ‘faster than expected’
“If we also consider that the shift in the interest rate environment has been faster than expected and is happening in a context of heightened financial market volatility and a deterioration in the macroeconomic outlook, we cannot rule out the possibility that even the central expectation of a positive effect of higher interest rates on the average European bank might have to be revised,” Enria said.
The ECB’s supervision team conducts regular stress tests. In the US, stringent rules for banking supervision under the Dodd-Frank Act that was put in place following the 2008 financial crisis were unwound during the presidency of Donald Trump. US banks with a balance sheet smaller than 250 billion dollars, such as SVB, are therefore no longer subject to such stress tests.
(This update corrects the 5th paragraph to make clear Verslo Žinios is a Lithuanian business newspaper, not Latvian.)