Frank Elderson: Interview with Delo

8 October 2024

You hold two high positions in the European Central Bank: you are a member of the ECB’s Executive Board as well as the Vice-Chair of its Supervisory Board. You are responsible for both monetary matters and banking supervision in the euro area. Can you explain your dual role at the ECB?

Let me clarify that, at the ECB, decision-making on monetary policy and banking supervision is separate, and for good reason. We want these two functions to pursue their specific objectives and we want to avoid potential conflicts of interest.

That being said, it is important for each side to be aware of what the other is thinking and to understand how the decisions being taken affect the other side. Let me give you a couple of examples. During our strategy review in 2021 we explicitly recognised the importance of safe and sound banks for our price stability mandate, acknowledging that financial stability is a precondition for price stability. Moreover, banks that are safe and sound are able to effectively pass through our monetary policy.

So in the governance of the ECB there is a bridge between the two sides. And I currently occupy this bridge as a member of the Executive Board, which has six members including President Lagarde, as a member of the Governing Council and as Vice-Chair of the Supervisory Board. In practice, this means that I inform the Executive Board about what was discussed in the Supervisory Board, and I debrief the Supervisory Board on the decisions taken by the Governing Council. In short, my role is to help ensure that the ECB does not carry out these two separate tasks in isolation.

What is the purpose of your current visit to Slovenia?

The ECB’s two decision-making bodies – the Supervisory Board and the Governing Council – will meet in Slovenia in the space of a week. The Supervisory Board will meet for its regular retreat to discuss strategic issues, while the Governing Council will hold its next monetary policy meeting here. Our colleagues at Banka Slovenije are kindly hosting both events.

Turning to banking supervision, how are banks’ activities and lending affected by the current environment of weak economic growth and deteriorating economic trends, which include increasing bankruptcies in some euro area countries? How resilient is the banking sector in Europe?

European banks are resilient. They have sufficient and adequate capital and liquidity buffers which enable them to absorb losses and withstand shocks. But they should not be complacent, especially in the context of the worsening geopolitical environment, which could have direct and indirect effects on banks. Near-term growth prospects have deteriorated and are subject to high uncertainty because of these rising geopolitical risks. And banks also face several medium-term, more structural challenges.

In this context, our supervisory priorities, which we update every year, help us focus on both the near-term and medium-term challenges faced by banks. We want to ensure that banks are resilient not only today, but also in the long run. As part of our priorities, we want to increase their resilience to sudden macroeconomic and geopolitical shocks and to accelerate the remediation of shortcomings in the governance and management of climate-related and environmental risks. At the same time, banks need to make further progress with their digital transformation and build up their operational resilience.

In short, banks are resilient, but we should not be complacent amid these longer-term challenges, which we will address through our supervision over the coming years.

What lessons have the ECB and the Eurosystem learned from the last financial crisis in order to be better prepared for a possible new crisis, which will not necessarily originate in the banking sector itself, but in companies connected to it?

Since the global financial crisis we have created strong pan-European supervision – the Single Supervisory Mechanism. The financial reforms implemented after that crisis have strengthened banks without compromising their lending capacity. Several things have happened since the global financial crisis: we have had a pandemic, Russia’s invasion of Ukraine, an energy shock and high inflation. So European economies have been exposed to unforeseen challenges. We also witnessed turmoil in international banking markets last year, which exposed fragilities in banks’ risk management and internal governance.

The European banking sector has shown itself to be resilient in the face of these challenges. Take non-performing loans, for example, which have fallen significantly in the European banking system. In 2015, their share was 7%, while in 2023 it was below 2%. That is a big step forward. And as I said, capital and liquidity indicators are now much higher than they were a decade ago. But as supervisors, we should never be complacent, especially given the new risk drivers, such as energy prices, cyberattacks, climate and nature-related risks and geopolitical risks.

Turning now to current developments in the European banking sector, where UniCredit Group’s intention to take over the German bank Commerzbank has recently made headlines. What is your view as euro area banking supervisor?

Let me first say that I cannot comment on individual banks, so my answer will be more general.

We have been crystal clear that cross-border consolidation can be an instrument for further integration of the European banking sector, and we stand by that. Consolidation can also help address long-standing issues in the European banking sector, such as low profitability.

Nonetheless, mergers always carry risks and, as supervisors, we assess them carefully, always applying the limitative criteria set out in Article 23 of the Capital Requirements Directive. Our job is to ensure that every banking transaction – whether at cross-border or national level – results in a banking group that can comply with supervisory requirements in the foreseeable future.

What is your view of the banking sector in our country? What is your message to Slovenia?

Thanks to the reforms implemented after the great financial crisis, banks in Slovenia have come a long way, and in the right direction. When the crisis hit, the Government had to support the three largest banks with a recapitalisation of €3.5 billion. And, naturally, it has taken several years for lending to strengthen. More recently, the privatisation of state-owned banks increased competition in the sector, and this has attracted international banks. Slovenian banks are now well-capitalised, highly profitable and are above the euro area average for profitability, mainly on account of very high net interest margins. Some of this progress can also be attributed to the work of supervisors, including those at Banka Slovenije, with whom we work very well.

So, like in the rest of Europe, your banks are robust but they will continue to face a number of headwinds stemming from the macro-financial environment, geopolitical shocks and challenges related to the green and digital transitions.

As mentioned, our central bank will host a Governing Council meeting next week. Do you expect a new interest rate decision at this meeting?

We will come to Slovenia with an open mind, so I am looking forward to the trip to Ljubljana and to a very genuine and open discussion. Before the meeting, we will take note of all the data and analysis and, as we have said many times before, we will take a meeting-by-meeting approach. A number of recent indicators suggest that downside risks to economic growth are already materialising, so we will need to carefully assess whether this has any implications for our inflation outlook.

What is very clear, however, is the direction of travel in the period ahead. If our projections that inflation will converge towards our 2% target in the second half of 2025 continue to be confirmed, we will continue to gradually ease our restrictive policy stance. At the same time, we need to maintain flexibility regarding the pace of adjustments. This will depend on incoming data, on the economic situation and on inflation. The latest data will of course be taken into account in whatever decision we take in Slovenia.

What specific downside risks to growth do you have in mind?

Economic growth came in at 0.2% in the second quarter, falling somewhat short of our projections. We look at a broad range of data, but we have seen that households are consuming less than anticipated and firms are less keen to invest than we had projected.

What is your view on the exact nature of inflation in the euro area? In particular, services price inflation remains very persistent. Why?

We expect inflation to decline to our target in the second half of 2025. Headline inflation is projected to average 2.5% in 2024, then 2.2% in 2025 and 1.9% in 2026. Services inflation remains strong but, according to our projections, we will see a deceleration going into the new year.

We always look at the upside and downside risks surrounding these projections. Geopolitical tensions could raise energy prices, shipping costs and other transport costs in the short term, which could also lead to disruptions to global trade, which would push prices up. Inflation could also increase if wages rise more than expected or if profit margins increase, and extreme weather events and the climate crisis could increase food prices. However, there are also downside risks to inflation, such as lower than expected demand or an unexpected deterioration in the economic environment in the United States and globally.

At the ECB, you are also responsible for monitoring the effects of climate change, in addition to the dual tasks mentioned at the beginning. This year we saw the catastrophic effects of floods in some central European countries, and last year we experienced them in Slovenia as well. Greece, Spain and other parts of southern Europe are ravaged by catastrophic droughts and fires. Can the ECB and national central banks contribute more effectively to mitigating the effects of climate change? After all, you have the power – you have monetary policy and banking supervision in your hands...

I am very aware of the consequences of floods, and of those last year in Slovenia. They caused €10 billion of damage and more than two-thirds of the country was affected. Some places in the Koroška region were cut off from the world and most roads were completely submerged. Recently, we have seen similar things in several other EU countries.

When talking about climate, nature and the ECB, I always say that we are not climate policymakers. We are not involved in climate policy. This is a task for governments, who implement legislation and policies like the European Climate Law and the EU “Fit for 55” plan, for example.

But this topic is also extremely relevant for our mandate, because extreme events like flooding, wildfires and summer droughts also lead to financial risks for banks and the wider economy. In our banking supervision, we check whether banks are adequately managing their climate and nature-related risks. We also take climate and nature into account in our macroeconomic projections.

Are you in favour of introducing more decisive measures that would offer banks more targeted incentives to grant loans for more environmentally friendly or “greener” purposes?

It would be speculative to talk about possible measures that we might hypothetically take in the future. What is clear is that any measure we implement must be consistent with our primary objective of price stability. Our current monetary policy stance is restrictive, so a green lending facility would be something for us to consider in the future, in another phase of the cycle.

That being said, climate change is part of our monetary policy strategy, and we have committed to regularly reviewing our climate-related measures to ensure that we continue to support a decarbonisation path that is consistent with the EU’s climate objectives. For this, within our mandate, all options are on the table. If we were to design new instruments in the future, it’s fair to assume that they would include climate considerations.

In terms of global competitiveness, the EU is falling behind the United States and China. Former ECB President Mario Draghi recently presented a very ambitious plan to increase European competitiveness, including investments of up to €800 billion per year. In his opinion, this money could also be raised through European borrowing, so common European debt. What is your take on this proposal and Mr Draghi’s other recommendations?

We welcome the publication of this report, how concrete it is and its call for urgent action. Competitiveness is critical for sustainable growth, improving the living standards of citizens and boosting economic resilience, especially in the current environment of heightened geopolitical fragmentation. We strongly support this urgent call for coordinated action at the European and national levels. It is now a matter of turning these proposals into concrete measures.

Meeting the strategic investment needs identified in the report requires completing the capital markets union, which we have been advocating for a long time.

The private sector will not be able to finance all of these investment needs alone. European initiatives, including financing through common European funds, could help finance common European public goods such as defence, public procurement, energy grids, disruptive innovation and cross-border infrastructure. Under the right conditions, the potential issuance of common European debt could help bridge the financing gap.

Finally, a new European Commission is expected to start its work in a few weeks’ time. How do you see your cooperation, including on the common objective of making Europe more competitive?

I am very much looking forward to continuing our excellent interactions with the European Commission, both with the outgoing Commission and the incoming one. There are a number of common European initiatives that we both have a very strong interest in. I have already mentioned the capital markets union. Further progress could be made on that, as well as on finalising all aspects of the banking union. And we know from the ECB’s stress tests that the longer we take to complete the green transition, the more it will cost us, so we would very much welcome further progress on that front as well.