Following are excerpts from a CNBC interview with Julia Chatterley and Axel Weber, Chairman of UBS.
JC: Let's kick off talking about the European banks. We're obviously going into earning season once again after what was again a tough quarter in the first-quarter in terms of volatility in the market environment. What are you expecting?
AW: We'll have a rendezvous with the market in a couple of weeks' time when we present our first quarter results. We've already give some indications that the first quarter was already challenging, these challenges continued into the year. We've seen some more brighter spots in March so overall, it's still a challenging environment but some brighter spots there and we're seeing the reporting season at the moment some of the U.S. banks have kicked off so asking for your patience till our CEO and CFO will report results.
JC: I just want to talk about investor perception of the European banking sector at this moment. We've got a whole confluence of influences that are a concern, whether it's the energy market, whether it's negative rates. Do you think investors are too bearish?
AW: I think at the moment there has been a certain correction in the market, it was largely around, not so much solvency issues, but more profitability issues in the banking system. I think it more or less started if you look back around mid-November when there was new regulation coming out of the Basel committee the FSB, Mark Carney and others have said we are coming towards the end-point of re-regulation. It's also clear that there is so much stuff still in the pipeline and that is coming out now that a lot of investors are looking and taking a new look at banks on how bank profitability will be, once all these measure are put in place. And I think we're seeing really a lot of questions in particular where banks need to build capital ratios still.
We at UBS have, at the end of last year, had a 14.5% capital ratio on an RWA basis which is industry leading so much less concerns around UBS than maybe some other players in the market and what we've seen is when the AT1 market dried up in February, we at UBS could reopen it in March with an issue. So I think there is really a strong link investors now play on how strong is the equity position the bank has and what is the financing cost for issuing all these additional instruments into the market and how does that impact on profitability. And the more sustainable and profitable your business model is the more fee-based diversified business plays a role, the better is the assessment of the investors on the various banks and I've just seen investors preparing for our AGM and I've had very good feedback on where we are in the journey of transforming the bank. So it's a concern for some in the market. To some degree I think we've partly had some of that journey behind us and we're getting quite good feedback.
JC: Do you think investors are differentiating enough between those that are in a better position and those that still have challenges to face?
AW: Probably not and you're seeing that for example there is some differentiation so if you look at the CDS spreads or the cost that we have for AT1 issuance it is below that of many other peers but you would assume in an environment where the market picks up again, that you would see a correction in the European banking market. Europe is over-banked so you would expect to see the demise of some weak players in the market and then their clients would basically start migrating to other, stronger, banks.
Now a lot of the rescue programmes that are in place, prevent that from happening so whilst all the banks are probably no longer discussing solvency issues, profitability should lead to the exit of some non-profitable banks or less profitable banks, but in a too-big-to-fail environment it's very impossible almost for large banks to be able to acquire other banks because we are already facing a reduction in our balance sheet and for very profitable banks to take over clients and businesses from others because at zero rates there is an environment where the kind of creative destruction in the banking sector just doesn't happen.
JC: This is a great point because if we look at what has tried to happened in the Portuguese banking sector with bail-in, we've had tremors in Italian banking system over banks that arguably look weak and in any other environment actually probably would need to be restructured if not closed down and actually it seems that 8 years after the collapse Lehman's, we're still not prepare to let bank fail without having fears of systemic spill-over effect?
AW: Yeah and so I think banks have worked a long way to having better capital structures and to be in resolvable, in a solvent wind-down kind of mode. We're not quite there yet. Many of the regulators want to see some further stones and some further elements put in place, and we're working on that but the general idea is, if you look at the U.S., the financial crisis is a remote memory. The U.S. stock markets is sizably higher, GDP is 10% higher that it was and so the U.S. has worked though the debt overhang by having a lot of write-offs and bad debt really written off, especially in the housing market, in particular around the sub-prime element. And the housing market has started to go up again largely because of the inventory overhang and bad debt has been written off. It hasn't happened to the same degree in Europe and so preserving structures in a very low or even negative interest rate environment, probably medium- to long-term will not serve Europe that well. Short-term, it is something that probably has less pain associated to it but medium- to long-term it basically doesn't provide the underlying growth dynamics that we would need.
JC: Is that what Italy is doing with their latest plan?
AW: I wouldn't just say it's Italy. I mean we've had very similar developments in Germany where the early rescues, which were in 2007, we had all the banks around the table and if there was a weak link, basically all the banks contributed to helping that bank continue to operate. Now we came to a point with Lehman Brothers where the distribution of money within the banking sector to prop up the weaker elements didn't really work anymore. You needed outside money from outside the banking sector and that's where the large European and American and global rescue programmes kicked in.
Fast-forward another eight to nine years, we're still seeing fragments of fragility and we're still seeing the first round sort-of reaction to be the same that you're basically taking the entire system and help the weaker ones by basically asking the stronger once to contribute to their viability. Now a much better thing, now that banks are much more resolvable, is to open up for foreign completion, to let strong players come in and basically reinvigorate competition, it's all about reinvigorating competition. And to the degree that you create these national solutions, and a group of banks helping each other, that can only be the first step. That's only the case usually if you need to stabilise a situation. But that's not where we are. We are at the point where we actually need to open up in Europe for competition and it isn't happening to the same degree.
JC: Are banks more resolvable? Because I'd argue that fine, we've got these bail –in rules this year that have now kicked in but, what Portugal, what Italy's proving actually is that there are too many fears around bank resolutions, still it's come in too early.
AW: I think the banks are a lot more resolvable but the one thing that you see is when in Europe the European Commission becomes part of the game because there is a state-aid procedure. They're very clear that the bank that received public support also takes compensating measures by shedding some of its businesses because the lifeline that they've been given shouldn't really come as a competitive advantage for that bank. There has to be payoff, so to say, and some compensation that the bank needs to do and that usually kicks in the restructuring. We've seen for example in Germany where WestLB, which was one of the large landesbanks, received public support and in the end WestLB was wound down and disappeared from the market. Now more of that hasn't happened in Europe because we've come to the point as we got through the initial phase of the crisis, banks could move on in particular in a low interest rate environment. We're seeing some new pressures and they're not about solvency, they're more about profitability and the least profitable banks in my view in Europe will face this challenge on a continued basis so I think consolidation in the European market is going to happen, despite all attempts to try and prevent it by providing some national solutions.
JC: We need to see more banks fail and we need to see greater consolidation and fast?
AW: I wouldn't say fail, but we need more bank competition in the sense that the stronger players don't just help to support the weaker links but are actually able to take them over and integrate them into their own bank and therefore have a larger client base, create cost synergies, create more profitability and in that sense, Europe needs to move on and the banking sector needs to consolidate. If you just buy the equity of another bank and hold it as part of a national solution, the integration, cost synergies and all of these things don't happen, so profitability doesn't increase. We need a boost of European bank profitability, rather than the current status quo.
JC: So basically we're just prolonging the agony?
AW: We're kind of prolonging the steady state and that steady state is not painful, you're right.
JC: Is that at the core then of how Europe gets it's swagger back, as we call it? Actually cut to the core of the banking sector and still resolve issues that remain?
AW: I think to just focus on the banking sector is probably too narrow a focus. Transformation needs to happen in the banking sector yes, but it has to go way beyond the banking sector. The example that I always refer to is, we need a better balance of policies. At the moment, Europe is too much focused on just ultra-loose monetary policy and we're almost in a corner solution where expansionary fiscal policy or structural policies aren't really part of the game. It's very much a corner solution around monetary policy. And the phrase that the ECB or Centrals Banks are the only game in town, has become sort of a proverb in Europe that, in my view, is misguiding.
What we need, and take the example of Japan where policy framework was usually phrased around the three arrows, and the third arrow which is structural reforms, unfortunately is called the third. Now that just shows how the preference for structural reforms is namely very low on the list of policymakers. Now we all know that structural reforms have long-term benefits, but come at short-term cost. And that structural reform arrow, flies much slower than all the others. So what we actually need to do is make the third arrow the first, embark on structural reforms and only to the degree that they have, sort of, counter-effects in the short term. We need to bridge those counter effects by more expansionary fiscal and more expansionary monetary policy. So it's getting the sequence right, rather than moving to a corner solution but monetary policy is all we focus on.
JC: But who backed who into a corner? Did central bankers back themselves into a corner by stepping up each time and increasing the amount of monetary policy they provide or have the politicians backed the central bankers into a corner by not stepping up with fiscal policy?
AW: Well so the speed that I talked about can actually be extended even to fiscal and monetary policy. The long-term focus on structural reforms needs to be there. When you compare fiscal and monetary policy, fiscal policy has more of an impact but it takes longer to implement. So, in a way, monetary policy is the speedboat that can quickly decide because of the structure of monetary policy, and has a very direct impact.
So in a way, in terms of the sequence, it is right that monetary policy acts fast and when the crisis happened we reduced interest rates substantially in a very short period of time, we extended the balance sheet of the European Central Bank – all these policy reactions were right so monetary policy has an advantage in acting fast but if they're out there alone all the time and continue to act and the other players and the other policies don't kick-in, it becomes a corner solution in the sense that the longer you apply expansionary monetary policy, the smaller is the marginal impact of further easing on the economy and the bigger are the side-effects that additional easing will bring. Whereby if you had a more balanced policy mix where fiscal and structural played a bigger role, you would get, net-net, a much better positive impact on the economy.
JC: There are other spill-over effects though too potentially. Do you have sympathy with Wolfgang Schaeuble suggestion that monetary policy is fuelling populism in Germany?
AW: I think what the Germans have a very strong focus on is, if you look at these policy combinations, we've seen reforms in Germany in the past. If I just go back to Schroeder, who did a lot of labour market reforms, and we're really seeing the benefits of those. So take this situation that Germany was in in 2002, both labour market and pensions reforms, and then over the next 10 years you've seen a continuous decline of German unemployment rates as a result of these reforms, even when the financial crisis set in. So Germany is one of the few countries where the unemployment rate continued to fall even in the financial crisis after the strong rebound initially so the trend continued. That just shows you that reforms pay off if you look at them on a, sort of, decade basis.
If you look at the first one or two years, actually Schroeder lost the elections because of the push back and some of the negative impact, the immediate impact of some of these reforms. Now, unfortunately, European policymakers have taken the wrong lesson from that. The real lesson they should have taken is, if you take a medium-term perspective, reforms pay off. The lesson they took is if you do reforms short-term it basically might undermine your political viability and you might lose the election. So that is, in my view, the wrong lesson but unfortunately, many European policymakers seem to have taken that, and the debate in Germany is really more about how can we get more balanced European policy response where structural reforms, that are badly needed in the periphery - and we haven't really seen them enacted in many countries, we're seeing first reforms but we're not seeing a bold reform agenda – that in Germany people want a lot more of these structural reforms to happen throughout Europe and less monetary policy being responsible for everything.
JC: But what about in Germany itself, because of all the countries in the Eurozone in particular, Germany actually has the most fiscal latitude to actually do more in terms of alternatives to monetary policy and yet, it's criticised for not doing more so it seems very difficult to criticise the impact of monetary policy and not step up and try and match with more on the other side, when you have the room.
AW: I absolutely agree. As long as Europe is made up of a common monetary policy and individual fiscal and structural policies, each country needs to get the right policy mix for itself. Now, what I don't subscribe to is that Germany should have more expansionary fiscal policy, for the sake of Europe. Germany can probably do a lot to improve its own situation by doing more structural reforms. We haven't actually seen a lot of reforms enacted in Germany over the last decade, and some of the reforms we've seen unfortunately have been a roll-back, relative to some of the reforms seen in 2000 so I think Germany cannot exclude itself from the international demand, that they need to become better at long-term structural reforms that improve the underlying growth rate in Germany and using, where available, fiscal space to support these structural reforms aimed at improving growth outlook for Germany.
Where I do think the debate is somewhat mixed is there seems to be an idea that Germany needs to expand its fiscal policy because they are the only country in Europe to have room and to create growth outside Germany by German fiscal policy. That's a very hard mechanism to enact because fiscal policy, because it's national, tends to work on the domestic economy, rather than in Europe so I think while some of this debate is true, Germany could do more for its own benefit and that would benefit Europe indirectly at least. But I think the whole discussion about Germany should do more and help Europe grow, is a bit in the wrong direction, it needs a better mix from all countries to use fiscal reforms and structural reforms and if they have no fiscal space they need to make more structural reforms. So in a sense when I talk about this balance in the three policies, if you have monetary policy that is expansionary in place, there is no reason not to have structural reforms. And to the degree you can support that by expansionary fiscal policy, if you have latitude for it, that's a better policy mix.
JC: But to go back to the point about Wolfgang Schaeuble, if you want to influence the domestic economy and domestic sentiment as well, to tackle populism and concern than again they could do more.
AW: Every country could do more. And I think if you look at the debate in Germany it's much less about using fiscal policy. That's not the big concern in Germany. In Germany it's more around structural issues. Take for example the unfortunate refugee situation; take for example the whole migration debates we're having – Europe is still, when I said before in the U.S., the crisis is a remote memory. In Europe, it's still the reality now and Europe is plagued by a number of crises that interplay and that reinforce each other. There is the whole debate about the UK being less committed to Europe going forward; there is the whole debate about whether monetary policy, fiscal and structural policy in the Eurozone are well-aligned and some countries like Germany think there is too much reliance on monetary policy and there should be other polices and other countries feel that they should be allowed to use fiscal space despite the fact that they don't have any space so there is a whole debate that is at the moment very difficult and on top of all of that we have these political issues that tend to bifurcate our countries and our populations, almost middle down the road – across parties, across families and that's not a good environment mix in Europe and so what Europe needs to do is sort of get its vision of what Europe is all about back. And at the moment what we're seeing is there is so much caught up in crisis management and fighting the underlying issues that nobody actually takes their head take their head off the ground and looks ahead and says 'look, this is what Europe could be all about' and it's good for Europe it's good for the world economy to have a more integrated Europe but that kind of gets lost in the fire-fighting that they are all involved in at the moment.
JC: So you're saying that actually we need to have a bit more perspective on the future than still focusing on the now?
AW: Absolutely, that's what leadership is all about. European leadership should give European people an idea that Europe is worth having and worth fighting for. Now, what unfortunately has happened over the recent years is that in some of these crisis fighting and fire-fighting modes, European politicians have lost their populations. The populations don't buy into some of the visions that everyone used to be very positive about Europe. And so what Europe needs to do is take their own people on board again and give them a view of Europe that is a positive one where Europe can actually for its own benefit become much more influential and much more powerful and we're just not seeing that happen.
If you look at the U.S. there is a lot of discussion about the fourth industrial revolution and how the U.S. can benefit from all this new technology, from artificial intelligence, from automisation and they're embracing these new technologies and they're making it work in the day-to-day. In Europe, you don't have the tech companies anymore like 10 years ago that would be part of this transformation, so Europe needs to embark on a vision. And I think this is the right time to do it because it's more important when you actually start losing sight of a sort-of, 10 year agenda.
The Lisbon agenda ,which was the last time Europe focussed on an agenda, by now when you read it, nobody buys into that anymore and so they needs a new agenda. They need a new vison for Europe and unfortunately what we are seeing is more is more isolist (isolationist) behaviour, more backward-looking behaviour so instead of ratcheting in the kind of integration Europe has achieved, there is a setback to European integration with more inward looking policies, with more divisive polices and with people actually trying to re-erect fences and borders which I think all goes in the wrong direction.
JC: What does Brexit mean in that case? If, in the situation that the UK votes to leave the EU, what happens to that environment within Europe that you've just described? What does this mean for Germany as well?
AW: Well so I think there are a number of areas. First, what you're seeing in the market already is, because it is such a close call and I don't want to in influence at all the British debate, it's such a close call so you start seeing markets attach risk premia to British assets, to British corporates, to British equities and to the pound and the market is getting nervous that we will see a lot more volatility over the summer depending on where that vote goes. And quite honesty, you would also see that, independent of where the vote goes, the debate is unlikely to go away over the summer. You're having another debate about the Greek problems coming back – they had disappeared of the headlines of the newspapers but the problems haven't been solved and so here at the IMF meetings in Washington, there is a lot of debate in the corridors about how to go back to a sustainable programme for Greece.
Now we've had that debate almost every time when I have been to the IMF for last couple of years. On top of that you get this very difficult refugee situation in Europe. So thing in Europe don't look as if they are brightening up over summer and that of course is a very dangerous environment because I think the world economy is at, is about to turn a corner. U.S. growth is pretty solid. Some of the other markets around the world have seen massive monetary policy stimulus and are about to look brighter next year. It's a slight improvement, it's not strong growth but at this point in time, the slight improvements we're about to see can easily be derailed by a lot of volatility emanating out of Europe or out of China or out of other regions around the world so it's a fragile recover and that fragility can easily be impacted upon by discussion about Britain or about Greece. More importantly, whatever is decided in Britain, Germany and Britain on many issues, had very similar interests and were much aligned. And therefore Germany has made that clear, the chancellor has made that clear, Britain is a very important partner in that project.
In terms of size of population, Britain is about to overtake Germany in Europe so it's the largest European country by population, not by GDP. so having the British 'in' is a very important issue for the German population and if you look at a European debate without the British it would be a debate between Germany, Italy, France and the other member countries and I think we would lose a lot of colour in that debate, be it the attitude towards capital markets, be it the entrepreneurial orientation that the British and German societies have and all of these discussions would be much more difficult. So I think that's where the fragility around some of these political debates that could impact not just on Europe but beyond is really a concern in a situation where growth is fragile and can easily be derailed by such discussions.
JC: One quick questions on Brexit - you mentioned the impact it has on UK assets and I know the Bank of England said a 10% fall in trade-weighted sterling attributed to the Brexit debate but we saw yearly highs for the FTSE this year and actually the bond markets look relatively unmoved so do you think as we get closer towards the referendum if the polls stay as tightly matched as they are we see more concern priced into UK assets?
AW: I think that's a likely development and we've seen it in many discussions including the Swiss referenda where the closer you get to the referendum, if it's still a close call by the time you're a couple of weeks away then basically people start hedging and people start looking in to basically making sure that whatever way it swings, they're not caught in the middle and so I think over time as that volatility continues to be there, if it doesn't go in one direction or the other, we're likely going to see more impact and so that's the fear.
And I think you saw that also every time when there was discussion around Greece. When the discussion was three months away, it didn't really impact on markets but when it was clear that the Troika would meet and there was a Friday meeting and the outcome for the EU depended on whether Greece would stay in the union or not on that Friday, the markets took a very, very bad hit on those days. So, yes, I think the closer events get the more market nervousness we will see around the outcomes.