“Despite the stability of the banking system, I don't think the wave of consolidation is over.”

Mr. Marx, this spring we saw a number of bank failures in the US and Switzerland. To what extent did this worry you?

There are two aspects to it: the first is that neither the problems in the US nor those in Switzerland affected us. The problems were, of course, different in nature. In the case for the US banks, we’re talking about mid-sized banks that were exempt from a whole bunch of rules that here constitute the regulatory standard. What’s more, a number of the banks in question also had problems in terms of governance, risk management and supervision – issues that were treated differently there than in Europe and here in Luxembourg. So, that aspect had no effect on Europe either.

As for Credit Suisse, the situation was a little different. In its case, the main problems were of a legal nature, which led to a loss of confidence and, ultimately, to massive outflows. It’s really unusual for a global systemically important bank to experience such problems and for so much money to be pulled out in such a short space of time. This could certainly have culminated in a crisis affecting the entire banking system if the situation hadn’t been addressed in a very rapid, orderly manner. This calmed the markets such that it’s fair to say Luxembourg and European banks were unaffected by these episodes. At the same time, the events show that the European regulatory framework - which we introduced in the wake of the financial crisis - makes sense.

Does the resilience that was put to the test in this instance apply to all Luxembourg banks?

At the moment, at least, there are no signs that the opposite is the case. I think Luxembourg’s banks are on sound footing in terms of capital. Ratios are well in excess of the minimum requirements and are excellent by international standards too. This applies for liquidity, too. On top of that, you’ve got the distinctive characteristics of the Luxembourg market. Our main business here is private banking and custodian banking for investment funds, which are less vulnerable to crises at an international level. So, as things stand, I don’t see any sign of potential problems for Luxembourg’s banks. What’s more, the default rate remains very low at 1.2 to 1.3%.

Even so, we need to be cautious. There are two areas in particular that we’re keeping under close watch: property loans and lending to companies – above all, small and medium-sized ones. We mustn’t forget that we’ve just emerged from a period in which the government has provided massive support to private individuals and businesses alike. We need to see how things pan out over the medium-term. Fact is, we may well see construction companies, whose orders dry up, facing difficulties in the future. As for property loans and other lending, including to SMEs, interest rates have risen to very high levels in a very short space of time. As things stand, however, there is still plenty of collateral behind these loans, and bank stress tests have not flagged up any problems to date.

These stress tests are compounded by competitive pressures. Is the latter a bigger factor than in other countries, given the comparatively large number of banks here?

That’s very difficult to say. We have 120 banks in Luxembourg – that’s clearly a very big figure for such a small country. And, of course, there’s plenty of competition in private and retail banking.

Do we have too many banks in Luxembourg?

I’ve been saying for many years that the figure for Luxembourg is very high and that the wave of consolidation sweeping the banking sector is set to continue. We’re already seeing that now, with many banks having already transformed themselves into branches of their parent company. That’s chiefly a consequence of better use of capital within the group.

Even so, the wave of bank mergers is set to continue given the need for some degree of critical mass within the business. I don’t know what the right number of banks would be, but it’s clear that this consolidation process will continue – and not just in Luxembourg either. That’s not least down to the myriad regulations, which are becoming ever more complex to implement. I don’t just mean the ESG space and its associated rules, but also the MiCA rules, DORA rules, and so on. Small banks, therefore, will find it more and more difficult to survive simply because the regulatory requirements continue to increase.

Notwithstanding all these requirements, are there any areas where you would actually favor greater regulation?

I think you need to be really cautious on that score. The rules that were brought in after the banking crisis in 2007/2008 were certainly good and have also proved their worth. We’ve also seen that with the Covid crisis as well as the war in Ukraine - not to mention the problems that affected the US banks and Credit Suisse. Also, we shouldn’t forget that the most recent changes in international banking regulations – the Basel standards – are still relatively recent. We need to be wary of rushing into frequent rule changes because that brings about its own problems.

As such, I think it’s important to take time to implement the rules and then also assess whether they’re actually working or need improving. That’s the time to start thinking about any improvements. Right now, however, I don’t see any immediate need for action. We have a good regulatory structure.

Here we’re primarily talking about regulations designed to protect the banking system. What about rules for protecting consumers? Don’t we need to ensure even greater transparency here, including as far as all the fees are concerned?

I think our system of comparing and publishing the basic fees of competitors is a good one. It will, however, always have its limits due to the various packages via which banks offer their services. We can’t, and shouldn’t, try to stop that. You’ve always got to have a degree of competition, and the banks must have a way to attract customers.

There are a couple of other rules which we believe are very useful. When you open an account, the bank has to tell you what its basic fees are and has to send you a list of fees once a year. That’s useful, but in many cases, it’s not enough for the customer. What will certainly be very important in the future is a degree of financial education to ensure that people can manage their household budget and also understand what it means when interest rates rise by one or two percentage points. Many are unaware of how this affects their mortgage. There’s a big need for action on that front. Fact is, giving customers the knowledge they need is the best way to protect them. The CSSF has already invested very large amounts of energy in financial education.

Customers can also be overwhelmed by all the fees which were used by the banks to build up an even more profitable income stream during the period when interest rates were low. To some extent, the banks offset the reduction in their profits from interest-rate operations by increasing what they charge the customer. Given how high interest rates are, isn’t it time to take some of the pressure off customers in terms of fees rather than constantly introducing new ones?

It’s true that income from fees has increased. But it’s not actually the CSSF’s role to intervene in markets and tell the banks what they can and can’t charge. That’s where competition comes in – and it’s actually working. There are also a few challenger banks offering their services in Luxembourg for very low fees. Traditional banks are obviously having to adapt in response.

It should also be remembered that many banking services were free 10 or 15 years ago, though they were very labour-intensive, such as bank transfers and withdrawing money at the counter. This was offered for free at a time when interest rates were higher. And when interest rates then headed towards zero and this source of income dried up, the banks had to think of new ways to remain profitable.

In principle, it’s right that they charge for these services. And the competition needs to ensure that these fees stay at the right level. In this context, I don’t think the banks will be replaced by apps or online-only service providers in the future. People only trust technology to a certain extent; that’s why many of them prefer to stick with traditional banks.

So people tend to put their trust in the traditional bank. But will they remain faithful to it for the rest of their lives?

Clearly that’s no longer the case. Customers are no longer as loyal, and are now more likely to switch. And the fact is that the regulations have made it easier for them to do so. Customers no longer have to pay a penalty when they move banks, even if they cancel their loan. The world of banking has become more transparent, and it’s now easier for customers to compare and switch providers. And that’s a good thing. Young people in particular have no hesitation about choosing challenger banks rather than the traditional banks used by their parents. These days, you can open an account, even with a traditional bank, from the comfort of your own home. That wasn’t possible just a few years ago.

With that in mind, is the general process of digitalisation within the banking industry a curse or a blessing?

There are different sides to this as well. You’ve got to understand that many banks have profitability issues. About one in five banks in Luxembourg are not making any money right now, as measured based on the cost-to-income ratio. The cost-to-income ratio for one in every five or six banks is approximately 100. In other words, their costs are as high as their revenue. That isn’t necessarily a bad thing though, because many banks are investing massively in state-of-the-art IT systems, which are very expensive but also very important. This means banks maybe won’t earn any money for two or three years, but these are investments for the future. We also have banks that don’t earn any money because their costs have increased; they therefore need to rethink their business model in order to carry on surviving. And digitalization is inevitably a part of that. Banks that don’t invest in it won’t survive.

Some banks also see digitalization as an opportunity to work more efficiently and offer more to the customer – but also as a way to reduce staffing costs. Here, in particular, there’s a whole host of tasks that can be automated and digitalized in the future.

The same is true for the work we do. There are more and more things we need to consider and we can only manage our workload if we also digitalize our processes. We’ve already done that to some extent, but work on that is continuing. That’s very important to us, because otherwise we would have to hire more and more people to handle the new tasks. For example, we now run a fully automated central register of all bank accounts in Luxembourg. We’re also looking into the use of artificial intelligence and we’re involved in a research project with the university in which we’re seeking to use AI to analyse prospectuses in the investment funds sector.

AI is a somewhat controversial subject in banking, for example when it comes to granting loans. The prospect of AI deciding who gets a loan and who doesn’t could be a big problem, couldn’t it?

The fact that AI can show unconscious bias is certainly an issue. But I think it’s the same with all technology. It’s a waste of time asking too many philosophical questions about whether it happens or not, or whether it’s a good or a bad thing. It’s clear that the technology is at a highly developed stage and will be used in future. For me, we have several questions to ask: how do we use the technology, how do we control it, and what guidelines do we establish in order to keep the risks under control? In asset management, I’ve no doubt at all that algorithms are used to manage money. We’ve already got projects like Bloomberg GPT, which are at a highly advanced stage. We’ll see service providers appearing on the market that have lots of data and can also offer very reliable models. Our challenge will then be to keep AI under control. And if we succeed in doing that, it’s ultimately a win-win situation for everyone.

To give you an example, it was the CSSF that drew up the first ever guidelines for the use of cloud computing in the banking sector for all areas. At the time, we could have said that cloud applications were dangerous and couldn’t be controlled, and that they were a risk to banking confidentiality. But the fact is that they are now a firm component of day-to-day business. We need to create an overall framework rather than demonizing and banning technology. The same goes for the use of artificial intelligence. But that also means we need to invest a lot, especially in training staff. At the end of the day, nobody knows whether banking services will also be offered in the metaverse in the future. If that were to happen, it’s important for us to understand how it works.

What about money laundering? Do you see new opportunities for combating money laundering or will the criminals always be one step ahead, as is so often the case?

We are very active in the fight against money laundering. And the use of AI will certainly be an attractive option for financial service providers, because combating money laundering is a very laborious process and ties up a lot of resources on the IT side. Here there are systems that help with the detection of suspicious transactions or real-time monitoring. It’s also conceivable that AI will be used for control purposes in the future. However, this would not only require that we have a central register of all bank accounts and customers but also that all financial transactions are recorded within this system. In that case we could obviously use AI to identify suspicious activity. This would naturally need to be an international system in which the authorities are closely interlinked, as money launderers work internationally.

I think we’ll get there, but I also think it’ll take a while yet. Because along with combating financial criminality it’s also about protecting personal privacy. The two things can be reconciled, but it’s not that simple.