© Gerry Huberty/Luxemburger Wort
Interview conducted in June 2020 by: Pierre Leyers
The economy is in recession, profits are plummeting, and the digital revolution is shaking up the whole financial sector. Where do Luxembourg’s banks stand in this state of flux? And how are they handling the coronavirus crisis? We get the thoughts of Claude Marx, Director General of the Luxembourg financial market supervisory authority CSSF.
Let’s face it, nobody was properly prepared. A pandemic was thought of as something that happened in some faraway place, in Asia and Africa, not here. Well, that turned out not to be true. Even though we had some warning: in a Ted Talk five years ago Bill Gates described exactly what has just happened and how to prepare for it.
First and foremost, it is good news. Luckily, it is possible to work from home in the financial sector. Banks had solid business continuity plans in place but, above all, discipline was good. Although the pandemic was not expected, the plans helped to distribute employees quickly and safely. Around 70% to 80% of all workers at financial institutions were able to continue to work from home using their laptops and tablets. I can confirm that there were no major operational incidents during the lockdown. That is one positive takeaway from this crisis: the banks were fully functional, and the CSSF was fully functional. The crisis will also speed up the shift to remote working, although one cannot compare one or two days of remote work with the same routine five days a week.
If ever we must go back into lockdown the economic consequences would be even more devastating than first time round. Based on the current scenario, Luxembourg GDP is expected to fall to -6% this year. However, since the forecast for GDP had been 3%, the actual figure is -9%. Most economists expect a V-shaped recovery, though no one knows for certain whether this optimistic scenario will play out. What is becoming increasingly likely is a recovery in the shape of the Nike swoosh logo: a steeply sloping downward line followed by a very elongated climb. Even in the absence of a second wave, Luxembourg’s economy will be hit hard by the consequences of the crisis for quite some time to come. We must overcome these difficulties. And we can. But if we must close everything again, that would be a completely different ballgame.
The major banks in Luxembourg have granted moratoriums totalling €3.7 billion. Plus, there’s a small number of new loans that were granted under the state-backed guarantee scheme. None of the banks we surveyed knows now how many of these loans will resume being serviced at the end of the moratoriums. The consensus is that it will be September before it becomes clearer what direction the economy is going. In the best-case scenario, the virus will be contained, companies will resume servicing their debts and the economy will recover. That would all go up in smoke if there was a second wave and we had to go back into lockdown.
We would face a growing number of bankruptcies and many non-performing loans. The rules are clear – a loan that is not serviced for a certain period must be classified as non-performing. Then we go from a problem with liquidity to a problem with ability to pay. This would be a global problem, not just a Luxembourg problem. That’s why the International Monetary Fund is warning of the risk of sliding into financial crisis.
If the virus proves to be seasonal and disappears in the summer or the rates of infection stay as low as they are now, then we won’t slide into financial crisis. This is the most likely scenario now. However, there are uncertainty factors that are not getting enough attention; for one, a second lockdown and, for another, our dependence on other regions of the world. Europe is not an island, much less Luxembourg. A major shock – for instance, within the U.S. financial system – can have a domino effect on Europe, as we saw in 2008.
We could see the direction things were headed. No pandemic alert was in place on 2 March, but an epidemic was under way, with hotspots. There are many employees in the financial centre who live in these hot spots. It seemed ill-advised to us to force them to come to work in crowded trains. The CSSF supervises entities with a total workforce of approximately 50,000. Including their families, we’re talking about at least 150,000 people. We didn’t want to take a risk. Rather, we wanted to do our bit to reduce the spread of the virus.
Bank profitability in Luxembourg will certainly take a hit, but less so than financial institutions in countries that have a greater focus on retail and commercial banking. There is a technical reason for this: a great deal of back-office work is done here in Luxembourg. This work is always required regardless of the current economic situation. Of course, this doesn’t shield Luxembourg banks against falling profits. Profitability was already an issue before the crisis. Recent developments will only accelerate consolidation. As I’m wont to say, we still have too many banks in Europe, including in Luxembourg.
To clarify, I don’t wish for fewer and fewer banks just for the sake of it. My point is that a bank that is not profitable is a dangerous bank. It takes excessive risks. Now, there is no such thing as a financial transaction without risk. That is the nature of the banking business. But if a bank does not make a profit or even makes a loss in its core business, then it takes on excessive risk to become profitable again. It does not follow the rules of Compliance, it takes on bad customers, it becomes a danger.
That’s the crux of the matter! A bank offers its investors one thing above all: trust. That is what it’s needed for. No one trusts a smartphone app with their money. Customers entrust their savings – often accumulated over generations – to an institution that operates to a clear set of regulations and offers security. This security comes at a price, and the price is high. I don’t like phrases such as “the regulatory tsunami”, which we often hear. Sure, the regulations cost money, oversight of the regulations costs money, plus salaries in finance are high, as are the rents. Also, investment must be made in digitalisation. The fact is that expenses are not getting any smaller. In other words, a bank must have a natural critical mass, or it cannot meet all these requirements. Above all, unless it reaches a critical mass, it cannot be profitable.
In the US, there was a phase of consolidation after the financial crisis, which followed the principle of the critical mass. In Europe, on the other hand, we curbed consolidation. The reasons are cultural in nature; consideration is shown for the employees, buildings have a traditional significance, financial institutions find it hard to break away from their historical systems, and so on. None of this is helpful in the long run. The tide of consolidation must come in if we don’t want to have a whole lot of small banks that have to take excessive risks.
Ten years ago, at a conference I said we were heading for a hundred banks. There were 150 at that time. Some industry representatives were incensed by what I said. Today there are still 127 financial institutions. Fewer banks doesn’t necessarily mean less business, or less employment. Despite the falling number of institutions, the banks’ overall balance sheet total remains stable.
It depends whether we think short term or long term. Of course, our reaction could be: we have suffered so much we cannot allow ourselves to invest time and money in sustainability on top of everything else. If this were our attitude, we would be facing disaster in the medium term. We must invest two-fold: in post-COVID economic recovery without promoting sustainability, then changeover to a more sustainable economy. We have very little time to combat global warming. If we do nothing, our planet will no longer be habitable, scientists agree. We cannot allow global warming to exceed 1.5°C above pre-industrial levels. To achieve that, we must set ambitious goals. 2030 is a deadline, and by 2050 the aim is for Europe to be climate-neutral. To that end, all policies must be re-framed – industrial policy, environmental policy and financial policy. This is a key priority of the von der Leyen Commission and it is sticking with it despite the COVID-19 crisis.
Having a sustainable economy is essential. It will take massive investment that states cannot put in without the help of private funding. What we’re talking about is promoting sustainable investment – in capital structuring, in risk assessment. There is approximately EUR 5 trillion in assets under management in Luxembourg the financial centre now. That is an enormous sum. If just some of this – let’s say 20% or 30% – is sustainably invested, then Luxembourg can make a significant contribution to the international effort that is needed to keep the planet habitable.