Director General of the CSSF
© Gerry Huberty/Luxemburger Wort
Interview conducted in June 2021 by: Marco Meng (Luxemburger Wort)
Claude Marx, Director General of the Luxembourg Financial Supervisory Authority, on the impact of the pandemic on the financial industry, cyberattacks, tech giants entering the credit market.
The CSSF supervises financial institutions, with a total workforce of approximately 50,000. Director General Claude Marx, who has headed the Luxembourg Financial Supervisory Authority since 2016, explains what changes the banking sector is facing as a result of the pandemic and digitalisation.
Claude Marx, insolvency figures are expected to increase after the pandemic. Will that also affect banks and insurers?
It is clear that the pandemic has also affected the financial sector, for instance because businesses have taken out loans from banks.
However, we do not yet know the exact scale of any potential insolvencies, which will also depend on economic development. Another important factor is when the various government support programmes come to an end.
How are things looking for banks?
The banking sector is on a solid footing, both financially and organisationally speaking. In this respect, it is important to point out that the banks are required to continuously monitor their clients’ creditworthiness. This enables loan defaults to be identified at an early stage and makes it possible to hedge against losses, thus preventing latent risks from accumulating on the books. As far as Luxembourg is concerned, last year saw an increase of EUR 600 million in the provisions set aside compared to 2019. However, this was not due solely to the pandemic, but also to new accounting rules, which require that provisions be made also for solvent borrowers. In parallel, provisions also had to be made in relation to credit moratoria (repayment holidays, etc.): once the loans start being serviced again, the provisions are then reversed.
The key point is that the equity ratios of Luxembourg banks are still very high at around 24%. The minimum level is 8%. In addition, corporate loans are generally secured by assets, so if a company becomes insolvent this only seldom results in complete default on all of its loans. So, at least for the time being, the outlook is good.
Did the pandemic itself end up doing any harm to operational business?
Despite the lockdown and having staff work from home, this did not, at any point, result in any halt to operational businesses or cause any losses, which shows that financial service providers are well-positioned here to get up and running again at any time.
Luxembourg’s financial system proved to be stable during the crisis. However, risks are likely to increase in future, above all from the Internet, for example, as a result of criminal hackers.
The Internet is indispensable for an efficient and modern financial services business. It not only offers constant new opportunities, but also entails new risks. Financial service providers are becoming increasingly more dependent on the Internet and IT, which means that the risk of cyber-attacks is also steadily growing. We have to assess these risks without slamming the brakes on digital development by imposing new regulations. We have seen that during the 2020 pandemic there were a large number of attacks, in particular phishing attacks. However, thanks to banks’ control mechanisms, the effects of these attacks remained very limited.
For this reason too, last year, we issued new guidelines on the management of IT risks and IT security, implementing guidelines of the European Banking Authority. In addition, in September, the European Commission issued its proposal for the Digital Operational Resilience Act (DORA), in order to provide a framework for financial services throughout Europe. First of all, each financial services company – including IT service providers – must have a framework in place to manage IT risks. Moreover, all attacks and IT incidents have to be reported to the supervisory authorities. Tests have to be carried out in order to establish how robust systems are. And risks associated with outsourcing to financial service providers also have to be monitored.
One response to the 2007 financial crisis was a strict regulatory framework, which was associated with high costs for banks. Does that not simply ensure that only the largest survive – and then you have the dilemma of banks being “too big to fail”?
Do not forget that the 2007 financial crisis entailed considerable costs and much suffering. The tightening of regulation through stricter capital requirements and other measures came as an answer to a crisis that had been caused by financial service providers, that had arisen as a result of major vulnerabilities within the banking system and above all within major banking groups. These rules were coordinated through the Basel Committee on Banking Supervision and were primarily developed for the major banks.
The EU then decided to apply these rules to all European banks, in most cases indiscriminately, with a small dose of proportionality. This naturally gave rise to cost pressure. This cost pressure is greater for the smaller banks as a portion of their revenue base than it is for the larger banks. However, these costs arising as a result of regulation play a less significant role in terms of profitability and overall costs. Margins have shrunk under the pressure of low or negative interest rates and slimmer commission margins coupled with high competitive pressure and greater transparency, putting clients in a much better position to compare services. In addition, costs have risen due to the high investments in IT, anti-money laundering provisions and investor protection. This makes it difficult for smaller banks to survive.
Overall, there are still too many banks in Europe, and there are also too many banks in Luxembourg. However, that does not mean that there is now less business to go around for banks, as their balance sheet totals show. As regards the issue of “too big to fail”, in the wake of the financial crisis an important regulatory framework was established in the eurozone, introduced in Luxembourg by the Law of 18 December 2015. This sets out extremely cumbersome and costly rules, although only for the “too big to fail” banks and not for the smaller ones.
In the end, there was no real cryptocurrency boom during the pandemic, with peaks followed by troughs. Will bitcoin and their ilk make the breakthrough sometime?
I do not like the name cryptocurrency because it contains the word “currency”. A currency has a specific definition, for example based on stability, as it is guaranteed by a central bank, and so on. This simply is not the case for these so-called cryptocurrencies. We have seen extremely strong movements in the price of bitcoin within a very short space of time, having climbed from USD 8,000 up to over USD 50,000 and then falling right back down again.
However, we must also look at this very closely. I do not think that this volatility has had anything to do with the pandemic. We have also seen that a lot of these extreme fluctuations have, in some cases, been triggered by various forms of racketeering, manipulation by a small number of people with large holdings. The big losers in this are small investors.
A high chance of earning a profit is always associated with a high risk. There is no getting around this. But that does not mean that we are against cryptocurrencies; our position is neutral. We do not have any principled stance against innovation. Last year, we introduced a regime for virtual asset service providers, exchange platforms, where central bank money can be exchanged for “crypto-money”: now these service providers also have to register with us – even if they are already licensed financial service providers – and are monitored by us to ensure compliance with money laundering rules. We have also been considering crypto-assets on the product side. UCITS (normal mutual funds, etc.) are not allowed to hold crypto-assets. On the other hand, alternative investment funds can do so.
The important thing is that there should be international rules for crypto-assets, rather than each country having its own regulations. This is essential also because, by their nature, crypto-assets are not something that respects national boundaries. In future, there won’t be one single body of rules for crypto-assets, and distinctions will have to be made between different types of crypto-assets. In fact, even within the class of tokens there are very different types, which behave very differently and are associated with different risks. It is also conceivable that even banks themselves might issue crypto-assets at some point in the future.
It is striking that banks’ profits have been falling overall for years, while fund assets seem to have been growing inexorably. Could a bubble be forming there?
The rise in the value of fund assets has been driven by two dynamics: rising net deposits by investors, and changes on the stock markets. This became very clear during the pandemic. In February 2020, fund assets totalled 4.67 billion, which then fell to 4.1 billion in March 2020. After this, only one year later, in March 2021, we hit a record high of 5.25 billion.
The reason for this net influx of money into funds has been low interest rates and the fact that holding money at the bank no longer offers any return. Funds therefore represent a good investment opportunity. Funds contribute to financing the real economy. This is essential today more than ever. And since Luxembourg funds are very well diversified overall, we can clearly say that this is not a bubble. Even if the increases have been spectacular, one can nonetheless say that in Luxembourg, and also throughout Europe as a whole, we are still under-invested compared to other regions such as America or Asia. For this reason, I think that the fund industry still has a very positive future.
At the start of every development there are ideas and the money for implementing them. The financial sector will therefore play a crucial role in achieving sustainability targets.
I think that the paramount issue here should not focus on introducing new rules. What we have to do is to save the planet from a catastrophe. The European Union might be criticised for many things, but here it has done something extremely forward-looking by drafting a binding rulebook in the EU Green Deal to counteract global warming. But this won’t work with public money alone. This is where “green finance” comes into play.
One very important initiative that started this year has been the Non-Financial Reporting: firms are obliged to disclose what action they have been taking from an environmental, social and governance perspective. The rules are set to be overhauled on 1 January 2022. At that point, we will have to review whether this initial sustainability classification adopted in March 2021 needs to be improved. We have been hearing from the fund industry that around 20% of funds are already pursuing a sustainability strategy in one way or another.
It is also important to avoid “greenwashing”. But we have to be realistic, as all of this is new and unprecedented. Currently, nowhere else have any rules like these been put in place. In fact, this is the most important goal: if we do not achieve this then we won’t have to bother with all of the other regulations.
Do we content ourselves with these standards or do we perhaps attempt, in Luxembourg, to introduce additional requirements somehow? I can give you a clear answer here: no. The requirements are very stringent. And this is a good thing. Businesses need time in order to implement everything properly. After this, we will get involved and monitor everything closely. This is also because the issue is extremely serious.
As regards incentives to stimulate investment in particular areas, that is not yet on the agenda, I think that the focus for now should be on risk, especially the risks associated with the failure to invest in sustainable products. Various types of risks are becoming apparent for financial service providers. If we do not invest sustainably, do not think sustainably and do not put our businesses on a sustainable footing, we will end up with a business problem in future, not only in gaining new clients but also in attracting young staff, because young people will use sustainability as a very important criterion when selecting where to work.
Couldn’t some rules be relaxed for investments in the low-carbon economy?
Some people are currently thinking about explicitly incorporating sustainability requirements into banks’ capital requirements. However, some level of relaxation is also conceivable, although this would have to remain limited in scale. We must not lose sight of the fact that the overall aim of regulation is to ensure financial stability as well as investor and consumer protection, and this is also the case for sustainability.
What would happen if financially strong tech companies such as Facebook, Google or Amazon were to enter the financial sector?
I cannot exclude the possibility that this might happen. The most likely scenario would be for them to become involved in microfinance. And a couple of them are already doing so, for instance offering a limited range of products to small and medium-sized companies in America. We must not underestimate this for one core reason: big data. If a bank nowadays knows 50, 60 or even 100 things about one of its clients, the major tech firms often know thousands of things.
This allows them to use automated credit-scoring models to accurately predict the solvency of people looking for a loan. This would genuinely represent serious competition for the retail banks. It is therefore very exciting to think about what the financial services sector will look like in the future. However, on the positive side we also see that the major banks for their part are upgrading, modernising, digitalising and becoming more efficient. This is how major banks are responding to the current challenges.