Yves Mersch: Three challenges for the banking sector Speech by Mr Yves Mersch, Member of the Executive Board of the European Central Bank, at the European Financial Forum dinner, 2015 Cumberland Lodge Financial Services Summit, Cumberland Lodge, Windsor, 12 November 2015. *  *  *  Thank you very much for inviting me to speak to you this evening. I have been asked to give a “central bankers’ view” on the various issues being discussed at this conference, so let me lay out upfront the perspective I will be coming from. While I am indifferent to how structural changes affect individual financial institutions, I have a strong interest in how they affect the financial sector – and in particular, in a bank-based economy like the euro area, how they affect the ability of banks to finance the real economy. We need to make sure that in an environment of structural change we still have strong and sound banks. At present, euro area banks continue to struggle with low profitability driven by both cyclical and structural factors. On the cyclical side, the low nominal growth and low interest rate environment makes traditional banking activities such as retail lending using maturity transformation less lucrative. On the structural side, banks’ return on equity remains below their cost of equity, which points to a need for further balance sheet adjustment. Nonperforming loans (NPLs) in particular remain an important obstacle for banks to provide new credit to the real economy.
4  ECB (2015), Financial Stability Review, May 2015. BIS central bankers’ speeches  3  3. The regulatory challenge As I said, however, CMU is for the longer-term. For the medium-term, SME financing in the euro area will still mainly come from banks. So we need to make sure that there are no unnecessary obstacles to that process. And this brings me to the third challenge facing banks – the regulatory challenge. The regulatory agenda since the crisis has no doubt been essential. Banks had too little capital, too much short-term funding, too high leverage, and created too great a cost for society when they failed. The reforms that have been introduced so far have increased resilience and, in extremis, made banks less costly to resolve. And there is no reason why this should, in principle, diminish the ability of banks to serve the real economy – research suggests, for example, that higher bank capital has no negative impact on lending. 5 But as new regulation accumulates, we know that it can also come with costs as well. In the economics jargon, policymakers always have to be watchful that, in attempting to internalise externalities, they do not inadvertently create new externalities. The possible risks can be summarised under the headings of complexity, clarity and consistency. As regulations have built up since 2009, they have tended to introduce more complexity, and with that comes an inevitable cost in terms of compliance.