ECB urges banks to adapt risk management strategies

Euro zone banks must adjust how they manage risk as they face challenges from the end of ultra low interest rates to the emergence of non-traditional competitors that can quickly steal market share, the European Central Bank's top supervisor said.

Euro zone banks handled the recent surge in inflation and interest rates with remarkable ease and largely escaped last year's US and Swiss banking turbulence, raising the risk of complacency and fuelling calls for lenders to prepare for more difficult times.

Loan losses have remained exceptionally low, despite a near recessionary environment, but this may be down to unprecedented fiscal and monetary support that shielded banks from shocks, Claudia Buch, the ECB's top bank supervisor said on Thursday.

"This has implications for future risk assessments, as past data on loan defaults do not truly reflect the risks to asset quality that lay ahead," Buch said in the bank's annual report of supervision.

Risks withing welfare

Lenders also need to better prepare for risk related to cyber attacks, climate change and geopolitical shifts, which could all fundamentally alter their long-term business models.

"It is therefore crucial that banks adjust their risk management practices to the new environment," Buch said.

Innovation, such as the wider use of distributed ledger technology and artificial intelligence, lowers the bar for competitors, including so-called shadow banks, to enter the market, potentially pushing down margins and forcing banks to take on undue risk.

"Innovation and increased competition may improve economic welfare, but they also create new risks," Buch said. "If banks see their margins being squeezed, they may turn to potentially riskier activities."