INTERVIEW | Elke König: The fire brigade that wants to ensure European banks can be resolved

Clouds had been gathering since 2007 with the emergence of sub-prime loan losses in the US market but nothing could prepare the world for what was to come.

The unimaginable happened in September 2008 when Lehman Brothers crumbled, sending shockwaves in the banking sector.

The sub-prime loan losses had exposed the high risks banks were taking when loaning money to each other and the fall of a major institution like Lehman caused panic.

The reverberations could be felt far and wide, snowballing into a major financial crisis that hit large and well established banks in the US and Europe, some of which faced bankruptcy.

The crisis forced governments to intervene with large bailouts, precipitating the worst the worst economic crisis since the Great Depression of the 1930s.

In Europe, government bailouts saw countries getting crushed by soaring public debt that necessitated hurtful austerity measures and the introduction of EU-wide rules to avoid a repeat of the banking crisis.

The recovery has been long, painful and remains tenuous but according to Elke König, who heads the Single Resolution Board, an independent EU agency, the banking sector and supervisory authorities are in a much better position than they were 10 years ago.

König’s job did not exist in 2008. The SRB she chairs was created in January 2015 as part of the EU’s drive to create a single banking union.

I meet König at the Panorama Restaurant in Valletta where breath-taking views of the Grand Harbour unfold in front of us. The weather is glum, a grey sky hangs overhead.

She is in Malta to visit the Malta Financial Services Authority, which is the national focal point for the SRB.

“The SRB is like a fire brigade that was created in the aftermath of the 2008 financial crisis to ensure that banks of systemic importance to EU member states are resolvable,” she tells me.

The long and short of her job is to ensure that if a large bank is going to fail, the burden is not carried by taxpayers as was the case a decade ago.

The SRB works with banks to help them draw up resolution protocols and have the organisational capabilities to react appropriately if a crisis hits.

“These protocols and the organisational arrangements are important, especially if we have to take control of a failing bank,” she says.

Banks have been beefing up their capital requirements over the past few years with shareholders feeling the pinch through low, or no, dividends, as a result.

But according to König this is not just about having adequate capital requirements.

“Capital build up has increased over the years as new requirements were imposed but it is also important to have the necessary structures in place to enable an orderly resolution if a crisis hits. This is a multi-year project and I am not sure whether we will ever reach the point where we can just sit back and relax,” she says.

The SRB had its baptism of fire in 2017 when Spanish bank Banco Popular was on the brink of failing. Shareholders had been trying to sell the bank for 18 months, to no avail.

The Spanish government had recapitalised the banks in the wake of the crisis that hit the country in the previous years.

“Banks fail, like any other business, and they should be able to withdraw from the market if that happens but in an orderly fashion”

But in 2017, Banco Popular was going under and the SRB stepped in with its tools to ensure an orderly resolution.

“We used our tools to sell the bank, almost overnight. But we were also lucky because there was an interested buyer. The decisions were taken in Brussels by us but they were implemented by our Spanish counterparts, who were fully prepared and knew how to go about the process within the context of Spanish laws,” she says.

Banco Popular was sold for €1 to Banco Santander, a Spanish bank, and the following morning, the bank opened its doors to continue its operations.

Speaking at the time, König defended the success of the resolution because financial stability was preserved, no taxpayers’ money was used and the operation had no impact on Spain’s public debt. The SRB had passed its first major test.

She looks back at that experience with pride. “In the summer of 2017, the framework worked well and it showed the importance of having an ongoing dialogue with our counterparts in the member states,” she adds.

Throughout our conversation, König makes constant reference to stability as an important aim of the SRB’s job. Why is stability important, I ask?

“Banks were so intertwined when Lehmann Brothers failed in 2008 that the clock stopped ticking. Trust was breached and with a banking system that was so interconnected, everything stopped functioning,” she replies.

At European level a decision was taken for derivatives to go on stock exchange platforms, she adds but the risk of contagion remains if a bank fails.

“There is an all-round feeling that banks are the lifeline of an economy so one bank failure can trigger a market fear, which could see people withdrawing funds from their bank even though there is no valid reason to do so. This is why acting fast to restore stability is important,” König says.

However, she cautions against using financial stability as an excuse to say that a bank cannot fail.

“Banks fail, like any other business, and they should be able to withdraw from the market if that happens but in an orderly fashion,” König says.

Politicians sometimes speak of stability as a threat to jobs and growth but König disagrees.

“The two are inseparable, otherwise you are building your house on sand if one comes without the other,” she insists.

She explains that the SRB has a number of tools at its disposal when intervening to resolve banks.

In cases involving big banks, the most likely tool is a “bail into”, where equity is written down and liabilities are converted into equity, she says.

“If this cannot be done by the bank’s own funds, we can use the Single Resolution Fund. The idea is to create stability immediately,” König explains.

Another tool is the outright sale of the institution, similar to what happened with Banco Popular. “This is the best option but you need to find a buyer within the same country interested in acquiring the name or the brand. This is ideal for a mid-sized bank,” she says.

A third option is creating a bridge bank wherein the good business is carved out and transferred to a new company that is well capitalised. The new, ‘good bank’ will try to be sold over the following two years.

König is, however, realistic in her outlook and insists solutions are not miracle cures.

“Before we came into place in 2014, Banco Espirito Santo, a Portuguese bank, had its good portfolio carved out to save it but the ‘good bank’ still lost money,” she says, adding that failure is also a fact of life.

“When a bank fails it inevitably always causes losses but we want to ensure that stability is preserved and countries are not burdened with the problems witnessed in 2008,” she says.

Malta has three systemic banks – HSBC, Bank of Valletta, and MeDirect (formerly Mediterranean Bank) – which means they are directly supervised by the European Central Bank.

The SRB has a broad framework that has to be translated into a working document for the individual banks supervised by the ECB.

Criticism has often been levelled towards European institutions for applying a one-size-fits-all approach in the banking sector that puts the likes of Bank of Valletta in the same boat as German giant, Deutsche Bank.

König acknowledges the criticism but insists the underlying principle is that irrespective of the bank’s size, it should be resolvable. “Where it differs is the way this is conducted, which is different for small and big banks.”

She says that the fact that BOV is so much smaller than Deutsche Bank should not mean that European institutions ignore it.

“My concern is the country more than the bank. A bank may be small within a European context but very big in a country context, and our job is to safeguard the country, irrespective of whether that is Germany or Malta,” she adds.

In the aftermath of 2008, has the financial services industry learnt its lessons?

She pauses for a second and replies: “Does industry applaud all the lessons learnt, or do its homework? Well, some need more support than others but industry believes that 2008 should not happen again.”

I leave König with one final thought on the strength of the banking sector in Europe as institutions grapple with muted profits in a low interest environment and increased regulatory burdens.

“European banks are posting average profits and are not where we would like them to be,” she says.

König attributes this to the low interest environment, the legacy of clearing up problematic balance sheets and the transformation of the sector as innovative technologies disrupt the market.

“Banks have to find the balance between their traditional business and new technology. They need to adapt but if I were to look at where we are now in terms of supervision, we are in a far better situation than 10 years ago,” she says.

The grey clouds have not abated but the rain holds. König looks outside and with a smile adds: “The sun does not always shine and we need to fix the roof but we are not in a situation where the roof is falling down.”