Eduardo Ávila: “The regulator uses us as an example of a bank with clear ideas”

Q: Since the 2007 crisis, regulation has changed significantly. More than anything, the crisis taught us that supervision and regulation at the time were perhaps not sufficiently strict. Do you think the lesson has been learned or will we make the same mistakes again?

A: The lesson has been learned, but it took a long time. Since the crisis in 2007-2008, the U.S. has moved much more quickly. I think Spain and Europe took longer. It wasn’t until 2012 that a firm decision was made to establish a European banking union, the most political response to the crisis. And the banking union mechanisms did not start functioning until 2014.  In other words, there was progress in terms of regulation with Basel III, which is a product of the crisis and is more or less harmonized around the world, but more comprehensive reform was delayed - like the banking union in Europe, the Single Resolution Mechanism, and a European deposit insurance scheme, which is still pending. The Single Supervisory Mechanism affects us a great deal. It isn’t just a change in regulation. It changes our supervisor. This is the body that makes decisions that directly affect an institution - like minimum capital requirements to operate - establishes measures to follow, and which has the ability to issue sanctions. In 2013, the mechanism was designed. On November 4, 2014, after a year of putting together a team, the European Central Bank (ECB) took over bank supervision.

From this day on the Bank of Spain surrendered supervisory power to Frankfurt. It has been nearly a year and a half. The same thing took place in Italy, France, the Netherlands… and in all the eurozone countries. It’s a huge step. And now that a year and a half has passed, it’s still in a running-in period. Having said that, it is an enormous project – even more difficult than establishing the euro as currency. The ECB was not a supervisor, but a monetary policy institution that had to create the Single Supervisory Mechanism from scratch, hire people, create a culture of supervision, a manual, protocols, form teams, distribute the supervision of banks, etc. It created everything from scratch and in record time.

The European single supervision is an enormous project, even more difficult than establishing the euro as currency

Q: What has this meant for banks?

A: Banks have had to adapt to the new supervisory requirements. Perhaps more than to Basel III and the CRD-IV and CRR directives entering into force in Europe on January 1, 2014, they have had to adapt to the other two mechanisms: the supervisory mechanism (November 4, 2014) and the resolution mechanism which entered into force on January 1st this year. This has led banks to make preparations to be able to meet these new supervisory requirements.

Q: What differences are there for banks between European supervision and the earlier supervision of the Bank of Spain?

A: The new supervision is forward looking. In other words, what is going to happen to you, what is your business model and where are you headed? Europe also supervises management and corporate governance issues that the Bank of Spain took less into account. We have now moved to a European supervisor’s vision that brings together the best practices of Europe - maintaining part of the Bank of Spain’s vision but focusing on new situations.

Bank of Spain professionals are now part of joint supervisory teams, directed by Frankfurt but including a competent national authority, which in this case is the Bank of Spain. Therefore, two best practices have been united: those of other countries, which are also practices from the U.S., with the practices of the Bank of Spain. A new tool is also being used: Pillar II. This tool determines the minimum capital requirements for a bank to operate. The Bank of Spain never activated this lever, although it was one of its supervisory tools. The European supervisor’s capital requirements are higher than the minimum regulatory requirements. They determine the requirements based on a risk profile and assessment they conduct after an analysis known as the Supervisory Review Examination Process (SREP). For an entire year, they examine all aspects of risk: capital, liquidity, corporate governance and the business model, the four main pillars of the SREP.

Q: How has BBVA dealt with this change?

A:  We decided to create a unit, Global Supervisory Relations, to focus specifically on the relationship with the supervisor. That’s why we are the entrance point for the supervisor, which wants to talk to the entire organization: risk, IT, business with the franchises, etc. We organize and coordinate the meetings and ensure that qualified contact people are present in order to engage with the supervisor more transparently.

BBVA decided to create a unit, Global Supervisory Relations, to focus specifically on the relationship with the supervisor

Q: In other words, you act like a conveyor belt between the supervisor and the entire Group.

A: Yes. We try to make sure the supervisor finds a coherent overall message from all areas.

Q: That was my next question. BBVA reports to the supervision of the ECB, but in other geographic regions, how is the supervision of the various franchises organized?

A: We have a presence in many countries like the U.S., Mexico and Turkey, where we are subject to the supervision of the local supervisor. This means there is a double layer of supervision: consolidated supervision of the BBVA Group and local supervision in each geographic area where we have a presence. The consolidated supervisor cooperates with the supervisors in each country. And at least once a year, they meet at the College of Supervisors, where they do a joint assessment of the BBVA Group’s risk, taking each of the local supervisors into account.

Q: In other words, they coordinate.

A: They coordinate. They also have their communication channels. The Bank of Spain cultivated this relationship and managed to have a trusted relationship with the supervisors in different countries. Now the ECB’s, or SSM’s challenge is to maintain the relationships that the Bank of Spain cultivated. We believe they are working on it. It’s a very important issue for us.

Q: Are there major differences between European regulations and the regulations in Latin America, for example?

A: Latin America didn’t experience the same banking crises we endured in Europe. They haven’t had the need to develop mechanisms like the resolution regulations. They are now more concerned about issues like banks promoting financial inclusion through lending. They have their road map based on standards set by the Financial Stability Board or Basel, but they have different priorities.

In Latin America, regulators are now more concerned about issues like banks promoting financial inclusion through lending

Q: Do you feel greater harmonization across countries is needed?

A: The ECB needs to spend more time cultivating this relationship and we know they are working on it, but it is a large project that takes time.

Q: It’s too new?

A: It’s new. It’s a “learning by doing” process. A Dutch supervisor is in charge of supervising the BBVA Group, together with three other banks. We also have an Italian supervisor that focuses 100% on the BBVA Group. They have a 10 person team in Frankfurt. In Spain we have 25 or 26 supervisors from the Bank of Spain that are part of the  Joint Supervisory Team (JST), together with a small team in Portugal for BBVA Portugal, and a small team in the Netherlands for  Garanti Holland.

When visiting each country it’s important to find the same messages that we send them from here at the holding company.  BBVA knows how to manage the Group in the all the countries where it has a presence and the control levels and control lines work very well.

Q: This supervisory team has to get to know the bank from scratch.

A: From scratch. The Bank of Spain knew us since the beginning. And suddenly you have to explain everything to someone from scratch – quite a challenging task. Last year we did it. Now we have to explain the new digital transformation strategy and the challenges of the strategy. You always need to show the supervisor that you are aware that strategic changes imply risks, that you are aware of the risk, and that you will manage the risk.

Q: So they are now concerned by digital regulations? Is that the next challenge?

A: I think the European supervisor’s main concern for all European banks has to do with their business model. They want it to be profitable and sustainable over time. Internationally diversified banks like BBVA have a business model with a clear competitive advantage. This advantage means that concern over our business model is not a priority for them. Having said that, we not only have a diversified model that gives the regulator peace of mind, but we also have a digital transformation strategy. They think that’s fantastic. We not only are diversified but we also have clear ideas. That’s why they welcome our strategy. The regulator uses us as an example of a bank with clear ideas, especially because of our digital transformation.

European supervisor’s main concern for all European banks has to do with their business model

Q: So part of the work is already finished.

A: The European regulator always looks at three aspects: if the business model is profitable, sustainable for three years and sustainable “through the cycle”, or in the long-term. I think we present a plan that meets these expectations.

Q: And regarding risks, is the financial sector focusing exclusively on cyber-vulnerabilities or is it keeping its eyes on other ones?

A: Well, right now we’re are facing a new kind of risk - the regulatory risk - that is emerging and has to do with regulatory uncertainty. For example, the level of Pillar 2 capital, is it going to be stable? In other words, how should we expect capital level to evolve in the future? On the other hand, we are facing other substantial regulatory uncertainties, How are the much-talked-about MREL or the TLAC going to be?

Q: The bank has already asked for more clarity regarding the MREL on a number of occasions.

A: Yes, and this is one of the questions that we still need to clarify. What will finally happen with MREL? The resolution authority, the SRM (Single Resolution Mechanism) became fully operational this year, on January 1st. The mission of the SRM is to, if there is no other option, intervene a bank and resolve it. But before that, we have a preventive resolution. In which sense? Authorities want to make sure that all banks can be resolved... that what happened, for instance, with Lehman does not happen again. Here is where they want to make sure that any bank, in the worst case scenario, can be resolved tidily, without compromising financial stability. So, they have classified banks into two groups: Smaller banks, that can be wound up without harming a country’s economy, and larger institutions, which cannot be wound up because that would generate a contagion effect. Authorities want to make sure that banks above a certain size have a resolution strategy, and, within that strategy, that they can be easily resolved.

The MREL has been established as the main resolution tool. The purpose of the MREL is to ensure you set a sufficient amount of capital aside – Tier 1, Tier 2, and what’s known as Tier 3 or additional bonds to the subordinate bonds or CoCos – to absorb possible losses. If a bank reaches the tipping point and needs to be intervened or resolved, the authority’s ultimate objective is to avoid the bailout, in other words, to avoid having to pump taxpayer money to save bank by having the bank save itself through a bail in. That is why banks will be required to issue these instruments, but there is still no consensus over them at EU level. These bonds would come before bank deposits in order of preference, and what they would do is, if required, be used as bail in tool, that is, the bond holder would lose a percentage of the bond, and this would in essence translate into a direct capitalization for the bank. The volume of bonds that we are going to have to issue is what we’re going to be told for the first time this year, using the new directive and the new supervisor. The supervisor is going to determine the amount of these bonds that each institution will need to issue. And banks face another challenge here: Figure out how much these instruments are going to demand from us and how they are going to affect our P&L accounts. Therefore, the regulatory risk is, maybe, the one banks are focusing more on nowadays, the one that needs to be addressed. Still, there are initiatives in Europe that want to modify the MREL as it has been set out, and bring it closer to the so-called TLAC, which is the version of the U.S. Financial Stability Board.

The authority’s ultimate objective is to avoid the bailout, in other words, to avoid having to pump taxpayer money to save bank by having the bank save itself through a bail in

Q: Many of these regulations are aimed at, were another Lehman to occur, preventing taxpayers from having to foot the bill of a bail out. How can we help people understand how important financial stability is for the real economy?

A: I believe that the clearest example is that when a bank is rescued, what authorities are actually doing is rescue its depositors, the families that have their money there. Imagine the effect this could have for families, uncertainty over their deposits, their savings. This is the first impact. Another impact is, if a bank is responsible for what are known as critical economic functions - for example, banks with a share in certain loan portfolios, such as the mortgage portfolio, or which are big players in the bank card market, or that play a key role as depositary and, maybe, cannot be replaced – then it is going to leave the country’s economy without access to certain sources of funding, or payment methods.

Q: But, anyhow, thanks to all these measures that are being rolled out, what would be avoided is the need to use taxpayer money on bank bailouts. That would not happen again.

A: Of course, the purpose of these measures is to have the bank rescue its own self with the bail in, which is going to be a big challenge, because we need to find investors that buy this type of bonds. And all European banks are going to go out looking for these bonds.

Q: Because they have to issued, but there is certain uncertainty regarding their price…

A: Regarding the price and regarding the amount of investors that are willing to invest. The, additionally, European banks are contributing to a European resolution fund of €55 billion, which will be the following line. In other words, losses are going to be pooled or mutualized, so to speak, in the sense that every bank in Europe is contributing to this fund. So, if a bank fails a country, after the bail in and after its own funds are exhausted, this common fund would kick into action.

Q: Can you still envisage a future scenario that would catch everyone off guard, with institutions failing across the globe?

A: I think that this risk will always exist in the sector, although it is now much more unlikely than ever, without a doubt. Capital levels are higher, the supervisory bodies are poised to develop the best practices in Europe, and to have a vision with better tools and pay closer attention to this situation. The national bias, something for which Europe was often criticized, does not exist anymore. Supervisors were always suspect of protecting their banking system. The single European supervisor guarantees that that bias will be eliminated.

Q: But, has it really been eliminated?

A: Yes, we believe so. And that’s one of the key advantages it offers.

Q: Another one of the topics you mentioned, and which is steering heated debates, is the Single European Deposit Guarantee Fund, which is the big pending issue, so to speak. Do you think it will become a reality?

A: I do believe so. In my opinion, the SSM, the SRM and the resolution fund as much harsher decisions than this last piece of the puzzle. Actually, much like the resolution fund, its ultimate purpose is also to somehow mutualize losses.  And I believe that we will see it through.

Q: Some countries want to link it to the holding of sovereign debt by institutions. Do you think that makes sense?

A: That’s another one of the big regulatory risks that we still need to clarify: The treatment of sovereign debt, which is being debated.

Q:  Regarding overregulation, on some occasions, BBVA has called for a regulatory pause, to evaluate what has been done, and avoid going overboard. Do you think that the sector is overregulated? How do you see the future?

A: I believe that the regulatory push has been excessive, in the sense that the resulting regulation, the one we have now, is extremely complex. I believe that, indeed, we all should take the time to digest the single rule book, the CRR, the CRD-IV and the BRRD. In fact, we expect to start running into similar issues when the BRRD is rolled out later in the year. The BRRD is the resolution directive that will probably lay out some regulatory pieces that nobody has ever tried out yet.

The regulation we have now is extremely complex. I believe that, indeed, we all should take the time to digest it

Q: A pause at global level.

A: Yes. And then there are other reforms that still need to be tackled, and that’s something that BBVA Research is definitely following very closely, such as the structural reform, which is still pending. And we have another revision around the corner, the so-called Basel IV, which also generates a lot of uncertainty. And this has effects over the economy. Indeed, we need a regulatory pause to see what happens.

Q: And regarding digital regulation, is there any work being done in that front

A: Something has to change in the regulatory framework. From a supervisory standpoint, what we need to figure out is, with the current framework, a way to explain that our projects are safe to the European regulator. We already did in year 2012 with the Bank of Spain, when we started using Google Mail. That was a clear example about the key role that the supervisor plays, and that we need to take these steps at all the levels of risk control and security that are required to make sure it works. And the supervisor is there to guarantee it does. In the digital segment, maybe the biggest challenge in the short term is to provide the reassurance supervisory authorities need, to explain that we have adopted all the measures required to ensure that all the steps in our cloud computing journey have been perfectly devised.

Q: And, besides digital risk, what other challenges do you see ahead or worry you at a global level?

A: I’m worried about low margins, the extremely low interest rates. In this climate, I envisage a scenario of increasing commissions, more consolidation, cost synergies, bank mergers.... the type of things that every is seeing right now as something necessary. We have our international diversification, which is the key factor that sets us apart from other purely local players.

Q: When do you think that Europe will start loosening regulations, that there will be a sustained model and that we won’t have to talk about new acronyms, new Basels every single day?

A: Once we digest Basel IV, which is unstoppable and will set the new standard, in 2019… We still need to see the MREL stabilize; the TLAC and MREL model has to be defined and the resolution authority needs to start making decisions. I believe that we will start seeing more stability in 2019. Until then, we still need to see if this low margin situation and if the uncertainty of the SSM regarding the business model of banks, which is the main risk they are identified, can be solved. In the meantime, we may see more M&A in the banking sector. We will see if by 2019 we are more consolidated, if the regulations are completely defined and things can start settling down a bit.