Panayiotis Rougalas
Geopolitical tensions have significantly increased operational risks, particularly in the areas of cyber and digital threats, as well as risks related to money laundering and sanctions compliance. "All of these require special attention from financial institutions and supervisors," notes José Manuel Campa, Chairperson of the European Banking Authority (EBA), in an interview with «Κ». Mr. Campa emphasizes that, due to banks' reliance on digital solutions, cyber and Information and Communication Technologies (ICT)-related risks remain by far the most significant operational risk factor. He also points out that pressure on interest rate revenues is expected to rise, prompting banks to focus on alternative revenue sources to maintain profitability.
Q: How do geopolitical tensions and economic volatility challenge the forecasting and managing of banks’ financial performance effectively?
A: Geopolitical tensions and risks can negatively impact both financial markets and the real economy through various channels and pose challenges to manage risks and financial performance effectively. Banks are affected by their direct exposures to geopolitically risk countries, but also to second-round effect of exposures to sectors affected by geopolitical risks. Beyond the potential impact on credit risk, geopolitical risks can also manifest for banks in the form of market risk, liquidity risk, and other risks.
Geopolitical tensions have significantly increased operational risk, in particular cyber- and digital risks as well as anti-money laundering and sanctions compliance risks. All these call for close attention from financial institutions and supervisors.
Cyber and ICT risks have grown further with a notable escalation in cyber threats and attacks in the latter part of 2023 and the first half of 2024 during a time of rising geopolitical tensions. As heightened geopolitical risk is expected to persist, it is important that banks maintain strong capital and liquidity positions to withstand potential shocks, especially amid elevated macroeconomic uncertainty.
Q: In relation to operational risks, what can we say about the increasing importance of digital resilience within the banking sector?
A: Due to banks’ reliance on digital solutions, cyber and ICT-related risks continue to be by far the most prominent driver of operational risk. Despite continuous investments in ICT security infrastructures, the share of banks having experienced cyber-attacks has steadily increased over the recent years.
Thus, being digitally resilient has become more and more important. To this extent, the introduction of the Digital Operational Resilience Act (DORA) is a key milestone to address cyber and ICT-related risks.
The complete implementation of DORA should contribute to safeguard stability and integrity of the EU financial system and ensuring continuous provision of financial services to consumers and safety of their data.
Q: Although NII saw substantial growth in 2023, it is expected to stabilize or decline in 2024. Rising funding costs and competition for deposits will likely compress margins. What should the banks consider navigating through this new reality?
A: Strong NII since the interest rate rising cycle started has been the main driver of increasing profitability. Return on Equity reached 10.9% in Q2 2024. The growth of NII slowed down lately due to the stabilisation of interest rates, which is now followed by central banks’ interest rates cuts.
The pressure on NII is expected to increase and incentivises banks to shift their attention to other sources of income to support their profitability levels. Banks are expected to increasingly prioritise enhancing their net fees and commission income to support profitability. NII is likely to decrease, while operational costs, as well as the cost of risk might continue to be high.
Banks expect that retail deposits will be a key focus area in their funding mix going forward. This may limit the scope to reduce deposit rates, although decreasing deposit rates are a natural result in times of interest rate reductions by central banks. It will be important that banks diversify their revenue sources in this environment. This includes generating more income from fees and commissions.
Q: A major challenge about your recent climate stress test is the lack of granular, comparable, and consistent climate risk data. How do you plan to address this issue?
A: Data quality has always been a central issue for climate stress testing. Our experience with the recently published Fit-for-55 Climate Scenario Analysis, confirms that data gaps could significantly hinder the comparability of results. However, several measures have been adopted in parallel by policymakers, which give me reason for optimism of future progress.
The EBA is contributing to this process by enhancing the supervisory reporting framework, which fosters standardisation and transparency in climate-related disclosures.
Additionally, the ESG Pillar 3 disclosures we have introduced aim to improve the consistency and transparency of climate risk reporting within financial institutions.
An equally important development is the increasing emphasis on transition plans. These plans outline how corporates and financial institutions aim to align their strategies with net-zero targets and broader climate goals, and at the same time manage the risks that may face in transition to a more sustainable economy.
The EBA Guidelines on ESG risk management set supervisory expectations on risk-based banks’ transition plans and the key elements these plans should include. This would provide crucial forward-looking insights, helping us assess not only current risks but also the credibility of entities' climate strategies.
Together, these frameworks and tools offer a strong foundation for closing data gaps and ensuring our climate stress tests are built on reliable, comparable, and actionable data, enhancing resilience across the financial system.
Q: One source of complexity is that climate stress test scenarios also account for the economic and technological shifts needed for climate transition, making the modeling significantly more challenging. How do you reflect on that?
A: Uncertainty on climate policies remains. The complexity of climate stress test scenarios mostly comes from the need to model the economic and technological shifts needed for the climate transition. These shifts are by nature uncertain, as they depend on evolving policies, market dynamics, and the pace of technological innovation.
Technological uncertainty, in particular, presents us all with significant challenges. Future breakthroughs in renewable energy, carbon capture, or electrification are all difficult to predict, yet these innovations will prove critical if we are to make the required transition. Changes in the economic landscape, such as shifting global trade patterns or industry adaptations, add further layers of uncertainty. Furthermore, uncertainty on climate policies is another key element that could pose challenges in the design of climate scenarios.
To address these complexities, the use of multiple scenarios and increased granularity is essential. Diverse scenarios allow us to capture a range of plausible futures, reflecting varying assumptions about policy, technology, and behaviour. Greater granularity—across sectors, regions, and timeframes—provides a clearer view of how these shifts might unfold and interact. For instance, the EBA, in collaboration with the ECB and other ESAs, applied highly detailed scenarios in the recently published Fit-for-55 climate analysis. This approach facilitated the quantification of combined macro-financial and climate shocks on the financial sector, while also assessing cross-sectoral impacts.
While challenging, this approach helps us manage uncertainty, improve decision-making, and ensure stress tests remain robust and actionable in the face of a complex transition.
We need strong collaboration between EU institutions, the ECB, and regulatory bodies. These will be essential to building a resilient and future-ready financial system.
Q: Identifying and quantifying exposures to sectors vulnerable to transition risks, is difficult due to variations in data collection methodologies and the evolving definitions of “green” and “brown” assets. How do you expect to overcome this?
A: Let me start by highlighting that we have seen substantial advances in classification systems in Europe over the past years, especially in terms of the definition of green activities.
Now coming to the question on how to assess transition risks, it is clear that standard classifications or sector allocation is not enough, it is important to distinguish between different counterparties. This is where we still see significant challenges not only in data availability, but also in deciding which datapoints are the most relevant to collect.
It is important that the effort regarding data availability and risk measurement are pursued going forward. The recent data from Pillar 3 ESG disclosures shows that around 70% of banks corporate exposures are to sectors highly contributing to climate change. It is, therefore, crucial that banks go deeper in this analysis to understand the risk of specific counterparties and manage it effectively.
