First of all, I would like to express my satisfaction with the topic chosen by the course organisers for this edition: the sustainability of the economy. A year ago, I spoke in this very classroom about the crucial role the banking sector plays in the transition to a sustainable economy, as I am convinced of the growing importance of the process we have embarked upon towards a fairer economy that is more respectful of the environment. I am now pleased to see how, day by day, concern is growing across broad sectors of society—including journalists specialising in economic reporting—about environmental factors and others related to the sustainability of our economy.
At the risk of repeating myself, I thought it would be interesting to briefly review what has happened over the last twelve months, because during this period there have been notable advances throughout this process of building a more sustainable economy. Most importantly, these advances have been made thanks to the momentum that all sectors of society—authorities, companies and sectoral organisations—are jointly providing. Allow me to cite some recent initiatives in these three areas:
Allow me to briefly comment on some of the contributions of these three initiatives. Starting with the most topical one, the European Commission’s High-Level Expert Group (EC) published just two days ago, on 18 June, its report on the taxonomy and on green bonds and green issuances, which will have a decisive influence on shaping a sustainable European financial market. This expert group has been working since late 2016 to fulfil the mandate to prepare a comprehensive plan and introduce reforms throughout the entire investment chain, on which to build a sustainable finance strategy for the European Union (EU), closely linked to the construction of a genuine Capital Markets Union. In 2018, the EC drew up an Action Plan, from which several lines of action have in turn emerged. One of them is the publication of the two reports mentioned: one on the EU taxonomy and another on the European standard for green bonds. There is also a third provisional report that defines the indicators needed to report on progress in meeting the objectives set out in the “EU Climate Transition” and “EU Paris-alineado”, which also addresses the risk of image laundering or green washing, that is, the potential purely cosmetic use of the green label. A year ago, in this same forum, I already warned that the market will be merciless with any cosmetic practice, because—as I insisted then and time is confirming—sustainable finance is not a passing fad; it is here to stay, and therefore institutions must approach this market with a long-term mindset.
Returning to the recommendations the Expert Group makes to the EC, these proposals are of decisive importance because, on their basis, the Commission will generate several mandatory legislative initiatives for Member States. Thus, once the EU Council and the European Parliament have agreed on the Taxonomy Regulation, the Commission is expected to develop several delegated acts on it and will study the feasibility of including climate-change-related risks in institutions’ risk policies and in the calibration of capital requirements.
This taxonomy, or classification of economically sustainable assets and activities, is necessary to ensure market consistency and clarity. If Europe wants to mobilise capital for sustainable development—and it is estimated that investments of more than €180 billion per year will be needed—it must equip itself with a technically sound classification system to clearly establish in the market what is green or sustainable and what is not.
In addition, based on the experts’ report, the EC will adopt a delegated act on the content of the green bond issuance prospectus and will create the EU Ecolabel for financial products, also based on the new European taxonomy. The aim is to increase transparency and comparability in the green bond market, as well as to provide clarity to issuers on the steps to follow to launch an issuance. Likewise, the EC will amend the non-binding guidelines on financial information and will publish new guidance for companies on how to report climate-related information. These guidelines are consistent with the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCDF) and are of great importance for companies, as they guide them on how to report the impacts of their businesses on the climate and the impacts of climate change on their businesses.
Unfortunately, the Expert Group’s report was made public only a few days ago and we have not had the time to analyse it in depth, but it goes without saying that the financial industry has a strong interest in understanding what this taxonomy consists of and how climate risk may change the requirements to which financial activity is subject. It is obvious that, depending on how these issues are addressed, competitive advantages may arise for institutions—advantages that none will want to miss.
In summary, the future regulatory changes in the European Union, which will come into force in the coming years, will push large corporations, institutional investors and asset managers to integrate climate risk into their strategy and risk management, and will require them to explain all of this publicly.
The Principles for Responsible Banking
We have seen what the European authorities are doing. Let us now look at a far-reaching initiative being carried out by banks: the Principles for Responsible Banking. The project was launched as a draft on 26 November in Paris, driven by the United Nations Environment Programme (UNEP FI), and 27 founding banks, including BBVA and Banco Santander. These days, numerous financial institutions are signing up to the Principles—around fifty have already done so—and the final signing of the document will take place at the United Nations headquarters in New York in September this year. The Principles establish a global standard for what it means to be a responsible bank and represent the sector’s first global framework for embedding sustainability across all business areas, from strategy and fund management to governance, customer relationships and other stakeholders. Signing up to these principles means that the banks that sign formalise their commitment to align their business activities with the Sustainable Development Goals (SDGs) and the Paris Agreement on climate change. This is what the first Principle is about.
The second refers to banks’ commitment to identify the positive and negative impacts of their activities, so that they can enhance the former and mitigate the latter. The third Principle sets out banks’ commitment to work responsibly with customers to foster sustainable practices and economic activities that generate shared prosperity, both for current and future generations. The fourth addresses how institutions intend to collaborate with relevant stakeholders to achieve these objectives. The fifth Principle deals with leading by example, starting from each institution’s own governing bodies, and establishing, through public targets, a solid foundation to drive change. The sixth and final Principle covers an essential principle: transparency. In this area, institutions commit to periodically reviewing the individual and collective implementation of these Principles and to reporting in a fully transparent manner on the negative and positive impacts of their activity.
The major challenge now is how to truly bring the six principles into the day-to-day practice of banking institutions. Profound changes are needed in management, in decision-making processes, in organisational culture, in the development of new responsible and ethical leadership capabilities, and in employee training, among many others. Once again, and after the intense regulatory process experienced after the crisis, banks are being asked to make an extraordinary effort to adapt to this new approach to responsible banking. And adaptation will not be easy. Impact assessment is the first step in implementing the Principles for Responsible Banking. Banks often lack the information needed to carry out a specific impact assessment. Data on banks’ indirect impact on the environment and society in relation to retail customers and SMEs can be very difficult to collect. This is proving to be a major obstacle for institutions when it comes to signing up to the Principles. Institutions will therefore need more time to set long-term targets and to develop indicators and measurement systems for their activity in order to understand both its negative and positive impacts. Aligning strategy, risk management, products and services, and governance with the Sustainable Development Goals (SDGs) will also take some time.
With regard to the triple set of reporting requirements arising from the implementation guide for the Principles for Responsible Banking, the European Commission and the Task Force on Climate-related Financial Disclosures (TCDF), we trust that the authorities will be able to align their reporting requirements and keep them within reasonable limits so that this does not, under any circumstances, become a deterrent to signing up to the Principles for Responsible Banking.
Centre for Responsible and Sustainable Finance
From the private initiative sphere, I would like to highlight the creation last February of the Centre for Responsible and Sustainable Finance in Spain (Finresp), an AEB initiative that CECA, Inverco, Unacc and Unespa have joined, and to which we hope other stakeholders and institutions will also sign up. Our goal is to create an open forum for all groups interested in debating and promoting innovative financial products and services under the shared banner of sustainability. With this initiative, we have joined the network of sustainable centres that already exist around the world—there are already nine in Europe—whose purpose is to help companies meet the Sustainable Development Goals promoted by the United Nations.
Our centre in Spain is being created with a very specific purpose: to address the difficulties faced by our business fabric, particularly the small and medium-sized enterprises in our country, in adapting to the requirements of the forthcoming Climate Change Law and to the regulatory proposals recently presented by the European Commission. The Centre can play an important role in areas such as training, social and business awareness, and financial innovation, as well as in the development of market standards or the expansion of existing markets, such as responsible investment and the issuance of green bonds. For now, and for the remainder of the year, the Centre has set itself the goal of working in four fundamental areas:
1.- To begin work on raising social awareness in Spain, for which we have contacted other employers’ associations and companies that may be willing to collaborate with the Centre.
2.- Likewise, we want to seek the support and collaboration of the United Nations and other centres similar to ours, such as the Paris-based Finance for Tomorrow.
3.- To hold the first Conference on Sustainable Finance and Climate Change, which we hope to convene in the last quarter of the year.
4.- To define a medium-term strategic plan for the Centre.
It is a little early to say much more about the Centre’s activity, as it has only just got underway. For the time being, on 30 May we held an event on “Principles for Responsible Banking and their impact on society”, which brought together an important group of experts.
What does sustainability bring to the banking business model?
So far, we have seen several initiatives developed over the last year, but now I would like to reflect on what the sustainability factor can really contribute to the business model of banking institutions. In my view, it brings two novel approaches. The first is that it reinforces the long-term vision of the banking business, and the second is that it emphasises a social and ethical approach, which already existed under the concept of Corporate Social Responsibility, but now has a deeper and broader dimension. This is so, among other reasons, because the idea of sustainability is backed by a global programme led by the United Nations that encompasses the entire planet, the entire population and all sectors of the economy. Banks are not alone in building responsible finance; they are part of a global project that includes all of humanity. For the first time in history, institutions, governments and peoples as a whole have stopped to think about what world we want to have, what world we want to leave to future generations. And the answer to that question has taken shape in the 17 Sustainable Development Goals (SDGs) adopted by the United Nations and in the Paris Agreement on climate change.
But what does all this imply for banks? This new social and ethical approach requires a radical change in the culture and mindset of organisations. It requires prioritising medium- and long-term balance over short-term objectives; giving priority to transparency over any other consideration, to the collective interest over one’s own, to relationships governed by dialogue and collaboration rather than self-sufficiency, and all of this under the overarching inspiration of creating wealth that is more sustainable and capable of being distributed fairly.
However, applying the Principles for Sustainable Banking will also offer institutions new business opportunities and the possibility of making far-reaching changes in management. For example, they will have the opportunity to integrate the risks arising from climate change into their activity, just as central banks and supervisors already do when they assess the impact of these risks on financial stability. Sustainability criteria also provide new ways of approaching and engaging with customers. This is the case for small and medium-sized enterprises, which will need significant support, guidance and financing to adapt to new environmental requirements. But above all, they offer the opportunity to engage with young people—millennials and post-millennials —who are highly aware of the challenges posed by climate change and of the need to move towards a fairer society. Young people are already an important driver of this change and will also be tomorrow’s workers, technicians and leaders, as well as the future customers of our banks. In short, they are the future, so aligning with their goals and aspirations is essential for our institutions.
As for new business opportunities, I noted last year in this same course that reducing CO2 emissions by 40% before 2030, set as a target in the Paris Agreements, will require, in Europe alone, investments close to €180 billion per year in sectors such as energy efficiency, renewable energy transmission and transport, to mention only the most obvious. There is not a single sector that does not demand this adaptation. Improving the energy efficiency needed by some 15 million homes in Spain (close to 60% of our housing stock) alone could entail investments of millions. Clearly, with interest rates so low, the cost of financing makes it possible to invest in projects with high social returns, including that Green Deal that decarbonises the economy, boosts growth and creates new jobs.
However, the scale of these investments goes beyond the capacity of the public sector, so mobilising private capital requires the involvement of the banking sector and the optimal functioning of capital markets. For this reason, it is more urgent than ever to complete the construction of the Single Capital Market. The European Commission is providing a decisive boost to attract private investment, and it is to be expected that the European authorities emerging from the recent elections will continue to lead this change and give a definitive push both to the Banking Union, with the creation of the common deposit guarantee fund, and to the Single Capital Market. Without integrated financial markets, it will be difficult to raise the multi-billion investments demanded by the ambitious objectives of the Paris Agreement.
And what are the challenges?
As can be inferred, the transition to a low-carbon society will completely overturn the foundations of our economy and, given the magnitude of this change, we ask ourselves whether this is the best time for our banks to take part in it. Perhaps one is never ready to make changes that involve leaving our comfort zone, but the truth is that this movement is unstoppable. What is more, it is urgent, as the warming of the planet is advancing inexorably, and so are its dire consequences for the environment. Therefore, we cannot ask for time as we would in a basketball game, but we can demand an orderly and agreed transition, as I have requested on other occasions, that does not put financial stability at risk and does not entail a sudden stagnation of economic growth. The aim is to achieve a major “social contract”, that Green Deal I referred to earlier, which allows the costs of the transition to a sustainable economy to be shared fairly among all those involved: governments, companies, consumers and the financial system.
Secondly, it is only fair to recognise that banking institutions are facing a new front while they are still dealing with the aftermath of the crisis. Their income statements, affected by a prolonged period of low interest rates, leave little room to address the most pressing issues: restructuring, technological transformation and shareholder remuneration. The question we now ask is how to reconcile that medium- and long-term strategic vision, which requires a sustainable banking business project, with the urgency imposed by pressure to improve profitability and carry out digital transformation. How will institutions take on new investments and regulatory burdens when they are still absorbing the enormous and complex regulation issued after the crisis? It is not easy to answer these questions, but we will all have to find the right balance to move forward in this transition without imposing unbearable burdens on companies.
A reflection on regulation
Allow me, in closing, to spend a few minutes talking about the challenges our banks face today. We could say that we are in the final stretch of the regulatory process opened after the crisis. The major rules on solvency, liquidity, resolution, markets, products and governance are already in force and, consequently, this could be a good time to reflect on what has been done well and what has not been done so well and needs to change. As this reflection is very broad and could take us a long way, and you are already waiting for the Q, I will focus on four aspects of regulation that concern us:
Let us take a quick look at them. As for the limits of the solvency ratio, we wonder what they are at any given time. At present, it is a combination of the standards set by prudential regulation (a Common Equity Tier -1 CTE1- of 7%, plus what the supervisor additionally requires according to each institution’s risk profile under Pillar II) and what the major banks in the euro area set. A somewhat unclear combination, because some of these large institutions are competing with an advantage over our banks. Spanish banks, of course, meet the minimums set by regulation and exceed them, but they remain below the euro area average. This is justified by the business model of Spanish banking, which is heavily focused on retail lending, and by the way our banks are internationally diversified. These two aspects largely justify a higher asset density which, together with goodwill deductions, negatively impacts capital ratios. By contrast, our banks have better leverage ratios, higher profitability and efficiency rates, and greater recurrence and stability in results than other European banks.
Despite this, the truth is that current prudential regulation does not recognise the value of Spanish banks’ business model, and it could be argued that supervision does not either. The stress tests carried out by the European Central Bank (ECB) and the European Banking Authority (EBA) in 2018 reveal the great resilience of our institutions, as they are able to generate margins on a recurring basis in adverse cycle circumstances and thus record a lower impact in terms of both static and dynamic solvency. The crisis experience itself has confirmed that the international diversification model of the major Spanish banks makes it possible to withstand a global crisis as severe as the one experienced without a single quarter of losses. However, these better results of Spanish banking are not faithfully reflected in supervisory requirements, as would be expected under the Pillar II framework, and the resilience of our banks does not receive the expected recognition in terms of capital requirements.
In summary, the business model of Spanish banks is more resilient than that of other institutions focused on investment banking, with more volatile businesses, but which can improve their solvency ratios because a large part of their business is off-balance-sheet. Ultimately, I believe it would be interesting for supervisors to have the courage to treat different banking models differently when requiring capital, using the discretion offered by Pillar II. There is no doubt that this would provide an incentive for more stable business models over riskier ones—exactly the opposite of what happens now. And, more importantly, a change in criteria in this direction would imply an increase in credit to the productive economy, precisely from those banks that are financing companies, entrepreneurs and families.
And this gives me the opportunity to move on to the second point, concerning the possible conflict in the objectives of the policies carried out by the European Central Bank (ECB) in its dual role as the main executor of monetary policy and as prudential supervisor of credit institutions. In its first capacity, the ECB applies a policy of low, even negative, interest rates with the aim of encouraging the supply of credit. With low rates, demand for credit from consumers and companies increases, pushing banks to lend more. But that same institution sends a restrictive message by requiring very high capital ratios, thereby constraining institutions’ ability to increase the flow of credit to the real economy. This simultaneous “push and pull” strategy not only confuses credit institutions, but also restricts financing possibilities for European companies and families, which obtain 75% of their credit from the banking sector. Or, from another angle, the low level at which the ECB has set interest rates is seriously affecting banks’ ability to generate results and, with it, the possibility of increasing their solvency ratios. The ECB itself acknowledged, in its latest financial stability report, that average return on equity (ROE) will fall this year below 6%, a level not seen since 2006, and will remain there at least until 2021, although this timeframe could be extended further in view of the ECB’s recent announcement postponing the expected increase in benchmark interest rates.
That said, I would like to briefly refer to something you have heard me say on other occasions, but which remains important despite being repeated. We need a change of approach—a change of “mindset”—from the authorities so that they stop regulating according to the type of institution and do so based on the activity. We all know that companies of very different origin and nature, not subject to banking regulation, are carrying out the same activity as banks. Regulatory arbitrage carried out by so-called shadow banking was at the origin of the 2007 international financial crisis and may now once again be putting financial stability at risk, as well as the protection of financial consumers. There is also an additional reason to call for this change of “mindset” from our authorities: current regulation cannot withstand the technological innovation in which we are immersed. We need flexible rules that encourage, or at least do not hinder, financial innovation in this field. Fundamentally, we need new players from the technology sector who are entering financial activity to do so under the same rules of the game and the same level of requirements as banks. Despite the soundness of this demand, little or no progress has been made in this area. We remain subject to competition that, if not unfair, is certainly unequal, as there is no reciprocity of obligations and rights, as occurs in the matter of access to customer data.
Finally, it is urgent to undertake an in-depth review of the entire body of regulation in order to identify and eliminate its undesirable effects and, above all, to simplify that legislative tangle that imposes brutal costs on institutions and is difficult or impossible to comply with. I still wonder whether anyone has read the 1,887 pages of the Basel III agreement or the more than 5,000 pages of MiFID II. By the time one has finished reading the last page, Basel IV or MiFID III may already have entered into force. Jokes aside, this need to simplify regulation has been recognised by the authorities themselves, as in the case of the Systemic Risk Board, which asked a Scientific Advisory Committee to review what was regulated after the crisis. This Committee has recently published the conclusions of its work, among which stands out the call to move towards legislation that is robust and efficient from a cost perspective and also adaptable so that it does not become an obstacle to innovation; that is capable of accommodating the diversity of financial institutions and business models that exist; that is proportionate in costs and bureaucracy to the problem it seeks to combat; and that ensures that failing institutions can exit the system without threatening the stability of the whole.
I do not want to close this address without noting that Spanish banks, like those in the rest of the world, are under great pressures and challenges of all kinds, such as increasing profitability, adapting to an increasingly demanding regulatory framework, strengthening capital levels, and the challenges arising from the transition to a more sustainable economy with a greater presence of new technologies. Despite the difficulty of this environment, we can say that, as things stand today, we have a solvent and efficient banking system that fully fulfils its role as a financier of the economy. What is more, it is a sector that tops the ranking of European banks in aspects as vital as liquidity, efficiency and profitability. In summary, Spanish banks are today a first-rate pillar of strength for our economy, which we must preserve and improve if we want to successfully navigate the uncertain times ahead. It is the responsibility of a healthy society to recognise the fundamental role of banking as an agent that creates opportunities and as a driver towards an economy that is fairer and sustainable over time.
José María Roldán, Chairman of the Spanish Banking Association
