“The fact that all participants pulled together helped”

According to Claude Marx, Director General of the CSSF, Luxembourg's financial supervisory authority, the Luxembourg financial centre coped well with the pandemic, but is now facing fresh challenges.

The interview first appeared in Luxemburger Wort’s supplement Classement des Banques in June 2022 (interview by Marco Meng).

First, the financial centre had to get through the pandemic and lockdowns, then supply chain issues and high inflation due to war in Europe. At the same time, the Luxembourg financial centre wants to lead the way in sustainable finance. There is a lot to do for the participants in the industry – and for the Luxembourg financial supervisory authority – says Director General of the CSSF Claude Marx.

Claude Marx, the pandemic lasted longer than expected. How did this unusual period affect the financial centre?

In general, the financial centre got through the pandemic well. Bank balance sheets, at around EUR 970 billion, are higher than their pre-pandemic level of EUR 821 billion – one reason being that customers parked a lot of liquidity with banks. There were practically zero defaults. At 0.5 percent, credit defaults are on a par with the pre-pandemic level. So, there is really nothing to worry about here. Banks got through the crisis well, though it must be said that all the measures taken by the government, the European Central Bank and the moratorium on loan repayments helped to overcome the crisis.

As regards investment funds, there were some jitters at first, with some funds experiencing liquidity squeezes right at the start of the pandemic. However, these were quickly overcome due to the numerous measures taken by governments, central banks and regulators, among others. All of this had come together quickly. While fund total assets initially fell by 12 percent in the first quarter of 2020, by December 2021 they were 24 percent higher than the pre-crisis level in December 2019. The fact that all participants pulled together helped the financial centre to come through the crisis unscathed.

What is the current situation now that there are still supply chain issues, war in Europe and record inflation in the eurozone?

True, these are sources of stress for the economy. Energy supply and the trend in prices are major issues for companies and are reflected, for one, in the fact that investment fund assets under management fell by 5 percent in the first quarter of 2022. So we are seeing an effect, albeit limited thus far. Now it all depends on developments in the longer term.

Will higher interest rates bring inflation back down?

It cuts both ways – we have had record-low interest rates for a record length of time, which has led to record-low interest income for banks. If interest rates rise, loans will become more expensive but bank customers’ fixed assets also stand to gain, as will the interest on sovereign bonds that banks hold in their portfolios. The fact that credit facilities are getting more expensive may, however, result in fewer loans being granted.

Have low interest rates led to worrying levels of debt?

This is being closely watched, for instance, by the Comité du Risque Systémique in Luxembourg and by the European Systemic Risk Board at European level. For mortgages, a maximum loan-to-value ratio was introduced, and there are also limits for the loan-to-income ratio. Twice a year, the CSSF also conducts reviews of these measures at the main mortgage lenders.

The Banker’s Association is critical of high costs and regulations that it says are jeopardising Luxembourg. What is your view?

This argument that the regulatory costs are too high has been around for a long time. The provisions were tightened in the wake of the 2007 financial crisis but they made the banks more robust at the same time and that benefits everyone and is important for the stability of the financial centre. Regulations cost money, but they also boost customer trust. And trust is everything in the finance industry. Incidentally, these costs are not a factor in whether a bank is viable or not – that is solely down to the business model and efficiency of the bank. The question is: is the bank making less profit today because it invests a lot, or is it only earning less today because its business model isn’t good? It is estimated that complying with all the regulations costs banks in Luxembourg around EUR 380 million – out of total banking costs of approximately EUR 7.6 billion. Compliance costs therefore only account for approximately 5 percent of total costs. The regulatory regime after the financial crisis has ensured that banks are better capitalised and better prepared today to survive fresh crises such as the pandemic, which completely blindsided us.

Small banks are finding it hard to bear these costs. Does this mean size is important in the banking industry?

True, the regulatory costs are more of an issue for small banks than large banks because their profitability is affected. Luxembourg banks’ overall profit level stands at 6 percent. What’s also important is the ratio of costs to income, which is 60 percent in Luxembourg. Thus, 60 cents out of every euro they take in goes out in expenditure. For major banks in the eurozone, this metric is 64 percent, making Luxembourg a bit better in this regard even though Luxembourg is known not to be a cheap location.

One year ago, there were 126 banks, now there are 122. But it has to be said that we had or still have too many banks in Europe and we also had too many in Luxembourg. The consolidation of the banking space continues and, of course, costs are a factor in this, too. Fewer banks does not mean less business. The number of employees has also remained stable, at around 26,000.

Size is important at the moment. But could digitalisation result in there soon being a lot of specialised online banks?

Costs are rising faster than income. One way of addressing this is to digitalise. Some are using digital tools such as Roboadvice, others are modernising their back office using the blockchain, others are using a digital interface to communicate with the customers, yet others are investing in the digitalisation of their reporting, and some are doing all these at once. We, the supervisory authority, do not stipulate the measures a bank has to take. However, banks that miss the boat on digitalisation will not be around tomorrow, and the same is true of green finance. Employees’ job descriptions will change in the process. For example, data analysts will be required in the future, and there are hardly any at the moment. These are a few of the challenges we are now facing.

Has Brexit given rise to a new competitor as a result of laxer rules in the UK?

The EU relies on the London financial centre but London is more reliant on the Single Market. In my opinion, the UK will never stray far from the European standards, as a minimum standard of equivalence is required for the British to do business with Europe and vice versa, and for both parties to have close business relations. I have been reliably informed by my counterparts in London and the Economic Secretary of the Treasury John Glen and business representatives that there is no intention in the UK to adopt a policy of dumping through little regulation. It wouldn’t work in any case. We are working very closely with the London financial centre, and the aim is to keep it that way.

Is the CSSF involved in the sanctions against Russian companies and citizens?

Very much so. For the sanctions to work, they have to be implemented, and it is our job to supervise this. The Ministry of Foreign and European Affairs is responsible for coordination with other member states of the EU; the Ministry of Finance is notified of frozen assets and answers questions about the sanctions. We are responsible for supervising the financial service providers, for making sure that the matter is handled right and for clarifying the sanctions for the financial service providers. We are in contact with all the banks that freeze assets and, if necessary, we also work with law enforcement if we suspect that the sanctions are not being correctly implemented. We also did some on-the-spot checks in the case of participants where we believe the risk of sanctions not being correctly implemented was greatest, but we have not had any major problems on that front so far. The implementation of the sanctions is working. The exposure of banks in Luxembourg with regard to Russia is, however, relatively low, amounting to EUR 4 billion in assets.

Operating in Luxembourg are two banks with Russian owners – East West United Bank and Gazprombank International – and one Russian asset manager. If they were to get into difficulties, the deposit guarantee fund would be able to provide coverage. If all three were no longer viable, it still wouldn’t be a systemic risk.

Sanctions are only one strand of the Russia problem. As far as financial stability is concerned, what I am most worried about are cyber-attacks. In the 12 months prior to the Russian invasion of Ukraine, the country was the subject of a string of serious cyber-attacks. We ourselves have not experienced a major attack in recent months, but there have been many minor attacks, and we know that the small attacks are often only a means of testing how robust the subject is and what defence mechanisms they have in place. We have therefore called upon the participants in the financial sector to take the greatest care in this regard, because we believe that this is the greatest risk to them in relation to the war.

What is happening with green finance? Didn’t the Luxembourg financial centre want to gain an edge with green finance? Some say progress is being made; others say much of it is just greenwashing.

I absolutely disagree with the statement that Luxembourg is greenwashing. Green finance is part of the EU Green Deal’s goal, which is very important and highly ambitious. This set of policies cannot be compared with others, because it concerns no less a subject than saving the planet. The sole aim is to reach the Paris climate goals. All the regulations and sustainable investment policies were drawn up in record time, partly because the target dates of 2030, 2035 and 2050 are just around the corner. Never before have guidelines been shaped into valid rules so quickly.

Of course, many finer rules are still lacking, as well as data to be able to implement everything correctly. I expect many of the finer points to be provided for this year and then financial service providers will only have a narrow time frame to implement them and we, the CSSF, will check that they have been implemented correctly.

It is easy to argue that ESG is not perfect but one must remember that we do not have political consensus on all points; for instance, whether nuclear power is sustainable or not. What we at the CSSF expect from participants is that they prepare as much as possible. This is a challenge not only for the industry but also for us as the supervisory authority. We have to train our employees as well and we also need the requisite databases. For banks, this means that those who miss the boat risk their future.

Does green finance involve a steep learning curve for banks and CSSF employees?

Yes, it does indeed involve a steep learning curve for everyone. There’s major hype around green finance products, but not many know what is actually involved, both on the consumer side and on the industry side. For this reason, we want to launch a campaign this year to explain to the general public what sustainable finance products are and what investors need to look out for.

Before we in Europe and Luxembourg get people to invest sustainably, we have to get them to invest in the first place. And trust in the financial markets and controls over the financial market are hugely important for us to be able to do that. Of course, this is one of the aims of the European capital markets union: for smaller companies to get access to capital, not just through borrowing, but also on the capital markets.