© Gerry Huberty/Luxemburger Wort
Interview conducted in June 2020 by: Nadia di Pillo
Post-2008 financial crisis banking reforms are being put to the test amidst a global pandemic and banks are now being hailed as part of the solution.
How are the stimulus and investment efforts helping companies?
Will Luxembourg’s financial market be different after the crisis?
We discuss this, and more with Pierre Gramegna, Luxembourg Minister of Finance.
The current crisis is rooted in a public health emergency that has affected the entire economy. By contrast, the 2008 crisis was triggered by the financial sector and the banks themselves. It is very important to understand this difference because these root causes determine how the current crisis is unfolding. In other words, if the question is whether the financial sector (and banks in particular) are resilient, then the answer is yes. Banks in Luxembourg and across Europe are considerably stronger today than they were 12 years ago. For example, Luxembourg banks’ tier 1 capital ratio was just under 12% in 2008, whereas it now stands at 22%. Moreover, prudential rules are stricter today than they were back then. Banks are in a far better liquidity position than in 2008. Banks had issues with liquidity back then; this is not a problem we face at the moment. Lastly, from a purely prudential standpoint, banks are able to withstand the shock felt throughout the economy. The best evidence of this is the fact that banks are part of the solution to the current crisis.
There is no doubt that stimulus and investment efforts will be essential as gross domestic product falls across Europe and in most countries around the world, and we will have to rely on banks in this regard. In addition to stimulus schemes, in the short-term banks can offer loan repayment holidays, as they are doing in Luxembourg. Through the Luxembourg Bankers’ Association (ABBL), we have negotiated agreements with eight banks whereby they will inject liquidity into the economy and companies, and I must say that it is working extremely well.
As we speak, the banks have agreed to payment holidays worth over EUR 3.5 billion and the acceptance rate is over 95%. That means that banks are playing their part by giving companies six months of breathing space. That is fundamental, and I think it may also prompt people in Luxembourg to think carefully about the role of the banking sector in the wider economy. Having an international financial centre is a considerable advantage in this crisis.
I hear comments to that effect, but I think that it is important to remain level-headed and above all not generalise or extrapolate from individual cases. We put forward a bill that was approved by Parliament establishing a EUR 2.5 billion guarantee for State-backed loans.
Under this law, the State takes on 85% of the risk while banks cover the remaining 15%. We opted for this system because it is important that banks themselves decide whether to extend credit. Since the State is backing the loan, it is vital that somebody (i.e. a professional) assesses the company’s solvency, viability and business model.
Are applications turned down? Of course. But we should not see that as the general rule. Moreover, as far as I know, most loans are granted, on a case-by-case basis. Sometimes we hear about very high interest rates, but that is not true in most instances. Most banks are granting loans with interest rates of between 1.5% and 3%. That is the norm, although there may always be exceptions.
And we should also bear in mind that the number of loan applications is still low at present because banks have introduced payment holidays. Many entrepreneurs prefer to put off taking out a loan and ask for a payment holiday instead, which gives them time to plan for recovery.
Leading up to 2008 regulations for banks and financial services more generally had been loosened considerably. If we think back to Margaret Thatcher’s Big Bang in the 1980s, the process of liberalisation continued until the 2000s and we eventually got to the point where deregulation had run its course. The crisis was also partly due to the fact that certain financial products had become incomprehensible and hence impossible to regulate.
Thus, since 2008, a new legislative framework has been implemented. Europe was a pioneer in this regard, since most new rules were European in origin. These rules, which are a lot stricter than before, are regularly updated. A number of banks complain that these regulations are excessive. But thanks to this extensive new regulatory framework, Europe is arguably the region of the world with the most sophisticated legal framework to prevent crises. From that perspective, it is a very good thing.
The European Central Bank, which is responsible for regulating vast swathes of the European banking system, has made certain adjustments to the way it exercises its regulatory powers during the crisis, but it is important to note that the regulatory framework that has been implemented serves to safeguard financial stability, protect investors and prevent the situation getting out of hand. It is certainly tempting to opt for deregulation in a difficult situation such as this, but I think that the hard times we went through in the run-up to 2008 and during the crisis itself demonstrate the importance of having a reasonable balance when it comes to regulation.
Bankruptcies are a fact of life. Denying the possibility of bankruptcies would fly in the face of logic, but for the moment the turmoil facing the entire planet is a crisis in the real economy. The international financial system can extend the necessary liquidity to limit the scale of these bankruptcies and the damage they cause. As such, the global banking system, and the European system, is our best way out of the crisis.
When I look at the banks based in Luxembourg, they have very high liquidity and solvency ratios, and this gives us greater room to manoeuvre than other countries. Nevertheless, I am under no illusion. If the economic crisis extends over a long period, the number of bankruptcies will increase in many European countries and that will naturally have an impact on credit defaults and banks’ revenues. We cannot pretend that the two are unrelated.
For the moment, though, thanks to the liquidity that European countries have injected into the economy, the measures we have taken at a European level, banks’ liquidity is guaranteed and the risks of a string of bank failures are really very small.
Small financial institutions are another matter entirely. As we have seen, there has been substantial consolidation in the banking sector in every region of the world over the past two decades. This consolidation leads to greater stability in the system. Let me take Japanese banks in Luxembourg as an example. Ten Japanese banks operated in Luxembourg in the 1990s, whereas there are only five today. And yet no bank has closed shop. In other words, these banks have undergone mergers and stayed in Luxembourg. It is thus important to see the wider context. These bank mergers had no impact on balance sheets.
It’s also clear that Europe has an extremely high density of banks. We have seen many mergers over the past two decades. I believe this trend will continue, and that the crisis will probably speed up the process.
Yes, absolutely. This trend will pick up speed, as will other phenomena, such as digitisation and sustainable finance, which were already government priorities. These will be even more important in the short term and in the future. Many people believe, whether in the financial world or with regards to people’s lifestyles, that this crisis will change mind-sets and completely overhaul our way of living. Others take the opposite view. They think that nothing will change and that we will fall back into our old habits as soon as lockdowns and other measures are over.
I’m somewhere in the middle. Whether I’m thinking about the financial and economic world or our lifestyles, I believe that we will see greater momentum in two areas: digitisation and the sustainable economy on the one hand, and respect for the climate and the environment on the other. While they were already priority areas before the crisis, these two phenomena will see spectacular acceleration and serve as the twin engines of change.
Digitisation involves remote working and remote services. This calls into question the model whereby there are bank branches on every street corner and in every village, not only in Luxembourg but around the world. Digitisation is underway and this crisis has served as a catalyst. As regards remote working, our experience in Luxembourg suggests that this works very well for banks and financial services. In some banks, 80% or 90% of staff have been working remotely.
Lastly, our IT infrastructure has held up well. The volume of information and videos hosted has risen three, five or tenfold in a few weeks in some cases, meaning that the fibre optic network and the data centres we have in Luxembourg have proven that they are both effective and resilient.
That goes without saying. In Luxembourg, as in all countries, the number of branches is falling because the digitisation sweeping through the economy and the financial sector will mean that many banking services are delivered online. Banks must embrace these changes while also bearing in mind people who are “vulnerable” – not merely in a physical sense, but rather as regards the ability to cope with new technology. This is what is happening in Luxembourg and elsewhere. In Luxembourg, we have made FinTech one of our priorities. Anticipating and providing the right environment is vital, too, and this is the aim of the Luxembourg House of Financial Technology, which hosts FinTech start-ups in the Grand Duchy and connects them with the wider financial sector ecosystem. Luxembourg’s triple A credit rating gives them a firm foundation and a strong brand on which to compete as well as partner with established players.
Sustainable finance will gain added impetus because it is dawning on us, collectively, that we need to focus a lot more actively on investments that protect the planet and the environment and even favour investment policies that account for these factors. A few months ago, Europe agreed on three European regulations that define sustainable finance, including one that sets out a taxonomy defining green and sustainable activities. These rules come into effect next year, just as the European economic recovery will be getting underway.
As such, we will have the legal framework and criteria to decide, and hence distinguish between, what is sustainable and what is not. I see this as a fundamental paradigm shift. Let me explain. I think that there is a parallel to be drawn with what happened in 1985 when the European Union reached an agreement on UCITS investment funds. At the time, no region or continent had successfully adopted a corpus of shared rules. And that paved the way for the investment fund industry.
In the same way, through developments we are not aware of yet, I firmly believe that in 2021, with these rules on the taxonomy, we will see spectacular growth in sustainable finance in Europe, whether in terms of investment funds or portfolio management styles.