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Banks are too complacent about the excessive risks that accumulate in the markets for leveraged loan and equity derivatives and, as a result, can expect higher capital requirements, warned the head of supervision at the European Central Bank.
Andrea Enria said on Friday that he was concerned about “market complacency and excessive risk-taking” by banks, adding that there were “signs of leverage, financial complexity and opacity creating the potential for a dangerous combination of risk factors “.
ECB officials said the speech indicated that the supervisor had lost patience with several larger eurozone lenders, such as Deutsche Bank, which have rejected your calls so that they can curb the riskiest loans.
“Where we see shortcomings, we will take supervisory action,” Enria said in an online address addressed to graduates in finance and economics from the University of Naples.
“In key areas such as leveraged financing, where banks have not sufficiently implemented previous supervisory guidelines, we plan to deploy the full range of available supervision tools, including minimum capital requirements that are proportionate to the specific risk profile. of each bank. this becomes necessary, “he said.
The head of ECB oversight said earlier this week that he would lift the lid on bank dividends and share repurchases later this year. Friday said banks “remain resilient” while “uncertainty has eased and, according to all indicators, the economic system is on a path to recovery.” The ECB is due to publish the results of its bank stress tests on 30 July.
However, despite this more optimistic outlook, Enria said: “In our view, the specific signs of increased risk have become evident in the risky asset segments of leveraged debt and derivatives related to the equity, which justify intensive supervision “.
Great support provided by governments and central banks has protected the financial system from the consequences of the coronavirus pandemic, he said.
But he said this may have fueled complacency and warned of the risk of a “sudden correction in asset prices” when that support is withdrawn, especially “if investors expect inflationary pressures to persist and revise their expectations on the position of monetary policy “.
“Renewed tensions around risky assets would again expose the entire ecosystem of non-bank entities and funds to liquidity risk arising from investor amortization as well as credit and valuation losses,” he added.
The United States Federal Reserve warned in May that some asset valuations are “high relative to historical norms” and “may be vulnerable to significant declines in the event of a risk of falling appetite.”
Although the ECB has called since 2017 for banks to restrict their leveraged lending (the practice of financing private equity groups and other buyers of corporate assets), Enria said she had seen a further deterioration in underwriting standards. “by the most active banks in this area. .
In the fourth quarter of 2020, he said more than half of the leveraged loans from these banks had debt equal to more than six times the earnings before interest, taxes, depreciation and amortization and that they were covenant-lite, eliminating the usual protections for investors. no pact.
Last year, Deutsche Bank rejected a request from the ECB to suspend key parts of its leveraged financing operations due to concerns that it was not properly monitoring risk in this area, where it is one of the main European lenders. Deutsche declined to comment Friday.
Enria also expressed concern about the way in which banks “worryingly” did not curb the market risks of 15 million euros of euro area equity derivatives that allow investors to leverage the stock markets .
He said the risks in this market were underlined by the collapse of the family office of Bill Hwang Archegos in March, which left some banks with “practical marginalization nurses” heavy losses. Credit Suisse lost $ 5 billion for the loan granted to Archegos and Nomura lost $ 3 billion.
Referring to “the broader problem of the opacity of the shadow banking sector and the degree of interconnection in financial markets,” Enria said “it is necessary to renew the regulatory and supervisory dialogue globally, as new solutions may be needed “.
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