(Bloomberg) -- European banks are not taking looming economic risks seriously enough as they enjoy the revenue-boosting benefits of higher interest rates, a top European Central Bank official said.
There is “a certain reluctance on the side of banks to seriously engage in supervisory discussions” about economic risks, ECB Supervisory Board Chairman Andrea Enria said Tuesday according to prepared remarks for a speech in Vienna. That attitude is unacceptable because “the Russian invasion of Ukraine is developing into a persistent and fully-fledged macroeconomic shock,” which requires supervisors “to exercise extreme caution,” he said.
Enria urged banks “not to blindly project forward the exceptionally low default rates we experienced in the last two years” as assumptions underlying their capital planning.
Read More: Europe's Bank CEOs Shatter Uneasy Calm as Recession Fears Mount
A number of European lenders including UniCredit SpA and Commerzbank AG have delivered upbeat predictions for profits this year, as central bank rate increases drive revenues higher. Many have also kept provisions for loan-losses steady, even though rampant inflation and a worsening energy crunch is threatening to put firms out of business and making it increasingly difficult for consumers to pay their bills.
ECB Governing Council member Pablo Hernandez de Cos earlier Tuesday likewise used the phrase “extreme caution” with regard to provisions and capital planning, signaling that the central bank is likely to frown on bumper payouts to investors in the current climate.
Enria however admitted that the ECB's authority had been eroded by previous warnings of risks that never materialized, such as an expected spike in defaults in the wake of the covid pandemic that was broadly prevented by government aid. The supervisor in early 2020 urged banks to set aside huge provisions in the face of the Covid lockdowns, which created a big drag on profits that year, and it also implemented a dividend ban that turned out to be damaging for bank valuations.
“Our estimates on the possible increase in non-performing loans in hindsight proved, to say the least, overly pessimistic,” Enria said. “We might be suffering the same fate as the boy who cried wolf in Aesop's fable and a tendency might be spreading among banks to dismiss their supervisors' calls for prudence as unjustified conservatism.”
Enria nevertheless repeated previous warnings on the risks posed by the business of lending to indebted companies, a practice that a number of banks have expanded in recent years. The central bank has said it will impose higher capital requirements on lenders that don't grapple with those risks.
Read More: ECB Says Banks Still Don't Grasp the Risk of Leveraged Loans
“In the second quarter of 2022 we observed that the more active originators continued to underwrite new transactions almost as thought it were business as usual, even as the opportunities to syndicate them were unclear,” Enria said on Tuesday. “As a result, their underwriting pipeline exposures increased as inventories could not be sold because primary markets closed down.”
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