"EU banks' income structure" - "Asset prices and banking stability"
The European Central Bank is releasing two reports prepared by the Banking Supervision Committee: "EU banks' income structure" and "Asset prices and banking stability". The reports have been presented to the press by Mr. Tommaso Padoa-Schioppa, member of the Executive Board of the European Central Bank and Mr. Edgar Meister, member of the Board of the Deutsche Bundesbank and chairman of the Banking Supervision Committee.
"EU banks' income structure"
Drawing on a survey among EU supervisory authorities, the report confirms the increased importance of non-interest income (fees, commissions and profits from financial operations and securities holdings) for EU banks. The extensive data contained in the report range from 1989 to 1998. The main findings - which are deemed useful both to banks and to the public authorities responsible for maintaining financial stability - can be summarised as follows:
1. The composition of non-interest income is rather heterogeneous. Fees and commissions are the main component (representing, on average, 54% of total non-interest income for EU banks in 1998), with country-specific figures ranging from 35% to 72%. However, the relative importance of fees and commissions decreased from 1994 to 1998. The other three main components are: (i) net profit from financial operations (accounting for around 19% of total non-interest income in the EU for 1998); (ii) income from securities (reaching nearly 17% and showing an increasing trend); and (iii) other operating income (representing around 10%). These averages may, however, conceal important differences between countries and banks.
2. Non-interest income has increased in importance relative to net interest income. The relative share of non-interest income (as a percentage of total operating income) increased in the EU throughout the entire period. With regard to more recent years, there has been a noteworthy increase from 32% in 1995 to 41% in 1998. This evolution was a result of both increasing non-interest income and the ongoing reduction in interest income.
3. The growth in non-interest income seems to have exerted a positive effect on bank profitability. The positive impact on profitability has, however, been limited by the increased operating costs associated with the development of activities generating non-interest income. Improved profitability has also been the result of other factors such as better cost control and more efficient use of capital.
4. An inverse correlation between interest and non-interest income seems to exist in several EU countries, although to varying degrees. This may indicate that fluctuation in one source of income could, to a certain extent, offset fluctuation in the other. However, the result should be interpreted with caution, mainly owing to the fact that the composition of non-interest income has not been stable.
5. Non-interest income as a whole does not seem to be more volatile than net interest income. In particular, after taking into account loan loss provisions, non-interest income has not been more volatile than net interest income for most EU countries. Hence, the ongoing changes in the business activities of banks do not necessarily increase their income variability. On the one hand, profits from financial operations and, to a lesser extent, income from securities have demonstrated high volatility, but, on the other, fees and commissions have typically been quite stable.
6. As a result of the increased importance of activities generating non-interest income, banks' operational, reputation and strategic risks seem to have heightened. The increased relevance of these categories of risk has made banks' risk management activity, and, accordingly, the task of the supervisors, more complex and requires a focus on these other categories of risk. As regards the current review of the capital adequacy regulations, this development supports arguments in favour of specific capital requirements for other categories of risk than credit and market risks.
"Asset prices and banking stability"
The purpose of the report is to investigate the relationship between the structure of the balance sheet of banks and the prices of various assets. The report identifies the main channels through which banks would be affected by a fall in these asset prices: credit risk, market risk, reduction in commission income, re-capitalisation of subsidiaries and the "second round" effects deriving from the impact on the macroeconomic environment and banks' funding conditions.
The main finding of the report is that a downward movement in the real estate market presents a greater risk to banks than a stock price fall. EU supervisory authorities have not, however, identified a major threat to financial stability.
Even the hypothetical situation of a sudden and large stock price correction would probably have limited direct effects on banks' profitability and solvency, since banks have very limited equity investments themselves and the overall incidence of the activity of the subsidiaries specialised in stock markets is limited. Banks' credit exposure through the direct financing of stock investments does not appear very relevant. However, owing to the lack of a comprehensive analysis of the second round effects, one should not rule out the relevance of banks' stock market exposures.
Banks' real estate exposures are more significant, since property is the basic form of collateral accepted by banks and real estate lending constitutes the bulk of lending by banks and other credit institutions (62% of total lending to households and 32% of total lending in the euro area at end-June 1999). Banks' risks associated with a real estate price fall vary significantly across countries, not only due to the differences in price developments, but also to differences in property valuation and other lending practices. Banks' lending margins have narrowed in many countries and rising loan-to-value ratios are reported for a number of countries, while there is no apparent slackening of other credit standards. A factor alleviating the concerns of the supervisory authorities is that the burden of debt servicing has not risen in general, together with the increased borrowing to finance real estate investments, on account of the low interest rate level. However, the financial position of the most recent entrants into the real estate markets could be quite vulnerable.
Given their importance, banks' real estate risks are closely followed by banking supervisors, particularly in those countries where prices have grown significantly. Specific actions have already been undertaken by central banks and banking supervisors to increase the awareness of the risks and ensure that banks are not overly exposed. These actions include public communication of concerns, direct contacts with bank management, examinations of banks' lending practices, and specific supervisory measures (sensitivity analyses) to address the ability of banks to withstand significant real estate price reversals. In individual countries further supervisory measures have been taken, such as new solvency provisions covering latent insolvency in addition to current provisions on impaired assets, supervisory requests to adhere to prudent norms for loan valuation, or even the request to banks to reduce exposure to real estate or to adjust book values. However, more drastic supervisory measures, such as enforcing more ex ante provisioning, have not been deemed appropriate at the EU level.
The reports will be available on the ECB's website [Publications] and from the ECB's Press Division at the following address: