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The Irish financial regulator who led the European Central Bank’s post-crisis work on non-performing loans has warned against “complacency” as interest rates rise and urged banks to take the challenging outlook into account when setting dividends.
Sharon Donnery, who sits on the supervisory board of the ECB’s regulatory arm, told the Financial Times that even though banks are at a better starting point than the last downturn, they are dealing with a “very aggressive, very rapid increase in interest rates” that has not yet been fully passed on to households and small businesses.
“There’s a big debate now about bank profitability and the pass-through of interest rates and what that means [for dividends],” said Donnery, who is also the Irish central bank’s deputy governor for financial regulation.
“Our thinking now is very bespoke to the circumstances of individual institutions. What is their book like? And there are big questions about digitisation . . . the level of investments that firms are going to have to make.
“We would expect . . . banks to be thinking with a more medium term perspective in terms of the sustainability of their business model and the fact that there may be choppy waters ahead if there are credit issues in the future.”
Andrea Enria, the head of the ECB’s supervisory arm, has repeatedly argued against a return to the blanket dividend restrictions that were imposed on banks during the pandemic.
European bank earnings have been broadly positive this year, thanks to the growing gap between lending rates and funding costs. This has emboldened several banks, including Deutsche, BBVA and Caixbank, to announce new buyback programmes.
But analysts remain wary, fearing higher rates and the soaring cost of living will eventually trigger defaults that could eat into profits, even though bank lending rules have generally been tighter since the financial crisis.
Some are also concerned about efforts by policymakers to make banks increase their deposit interest rates.
“The banks are obviously in a stronger position in terms of capital and liquidity, but you can never be complacent,” said Donnery. “The cycle that we’re in at the moment has been a very aggressive, very rapid increase in interest rates, that has come from an environment where we expected something very different.
“We have to remain alert to think that there may be further implications down the road.”
In a wide-ranging interview, Donnery also hit back at industry accusations that the Irish regulator was “closed for business” in the aftermath of Brexit, frustrating efforts by banks to set up businesses in Ireland.
Several senior executive at international banks have privately criticised the Irish regulator for making it difficult for them to set up businesses, prompting them to opt for Frankfurt or Paris as their new EU outposts instead.
“There were a lot of firms looking at different jurisdictions, how they were going to organise themselves, where they were going to organise themselves,” she said. “In the end, of course some firms didn’t come here . . . but likewise, other firms were looking at other jurisdictions and ultimately chose here.”
Donnery said that Ireland, which is home to major operations of banks including JPMorgan Chase, Citigroup and Bank of America, had never seen it as a “competition” between different jurisdictions to win business after Brexit and that Ireland’s priority was to be a “credible regulator” with “high regulatory standards”.
Still, she said that the Irish regulator had made changes in response to industry feedback. “If we’re fair we have to say that there were some issues raised with us about the approach or sometimes the timelines and so on,” she said.
“Over the past year or two we have tried to make changes to some of our processes and [give] explanations about what we expect . . . which is really about helping industry understand where we’re coming from.”
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