Claudia Buch: European banks in challenging times

Dinner speech by Prof Claudia Buch, Vice-President of the Deutsche Bundesbank, prepared for the Workshop "New Challenges for the Euro", Villa Vigoni, 21 July 2017.

1. Setting the stage

The global financial crisis has been a watershed for internationally active banks. The banking industry is undergoing profound structural change, reflecting technological change and adjustment to the withdrawal of (implicit) subsidies in banking sectors. Strengthening banks' capital and liquidity buffers - and thus private buffers to absorb shocks that materialize - has been a core element of the post-crisis reform agenda. Such policies are aimed at reducing the probability of failure for banks, particularly systemically important firms, and mitigating the impact of failure on the financial system and the real economy. Ultimately, a credible withdrawal of implicit guarantees for institutions deemed to be "too big to fail" requires establishing procedures for the recovery and resolution of financial institutions. Adjustment to these factors is taking place at different speeds depending on the degree of friction present and the competitive situation in the respective banking and financial sectors.

The post-crisis adjustment of banks has been shaped by the interaction of initial structural conditions, shocks, policy responses, and long-term trends in financial markets. Initially, the financial crisis hit as a major shock to liquidity on wholesale funding markets. Yet, it soon became evident that some institutions and markets were affected more structurally and that many banks were, in fact, facing solvency problems. At the macroeconomic level, several shocks interacted, leading to a decline in credit demand and supply, and evolving, in some regions, into a full-fledged sovereign debt crisis. Following the initial shock in 2008 and 2009, recovery in the period from 2010 to 2013 was asymmetric. Strong capital flows vis-à-vis emerging markets were accompanied by an increasing fragmentation of euro area banking markets (Lane and Milesi Ferretti 2017). Declining capital flows have been accompanied by a shift in the structure of capital flows away from bank lending towards equity flows and, in particular, foreign direct investment (FDI) (Bussiere, Schmidt and Valla 2016). The changing patterns of global shocks explain why it was only over time that the fault lines of certain business models of banks became visible. At the current juncture, the global banking system has built up larger capital and liquidity buffers to withstand future shocks. But low interest rates and high valuations are creating an environment conducive to risk taking and to an underassessment of risks.