ECB embarks on the risky trip to Eurozone banking universe

Olli Rehn, Vice-President of the European Commission in charge of Economic and Monetary Affairs and the Euro, participated in the EC/European Central bank (ECB) joint conference on Financial Integration and Stability. (EC Audiovisual Services).

The Single Supervisory Mechanism (SSM) of Eurozone banks has completed its cycle of approvals by all EU institutions and comes into force as from next month. After one year from now, that is as from November 2014, the European Central Bank will be responsible for the health of Eurozone’s banking system. Under the provisions of the relevant SSM Regulation, the ECB will be directly supervising, and therefore being responsible for the quality of assets of a round number of 130 ‘systemic’ banks. The competent national authorities, aka the 18 national central banks, will be supervising the rest of Eurozone’s 6000 banks. However, before properly assuming its supervisory role in November 2014, the ECB will provide a comprehensive disclosure of recommendations for measures to be undertaken by the banks.

To realise this task, the ECB today launched an exercise containing risk assessments, asset quality reviews and stress tests for those 130 banks, ahead of undertaking its regular supervisory role in twelve months from now. During this interval, the ECB is expected to conclude the initial comprehensive assessment of those 130 banks, which account for 85% of the euro area banking system. A press release issued this morning by the ECB contains an extensive list of them, operating in the 18 Eurozone member states.

Crucial assessment

For this comprehensive assessment to be meaningful and credible though, Mario Draghi, the President of ECB, has repeatedly stressed that there has to be a mechanism in place to deal with the possible problems to be identified. Those problems may reach up to a point that a lender is found to be beyond or close to limit of repair. Consequently, the much debated Single Resolution Mechanism and Fund, which will undertake the task of resolving or recovering a failing or close to failure bank, has to be in place.

To this effect, there is an on-going and far reaching debate over a Commission’s “Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Bank Resolution Fund and amending Regulation (EU) No 1093/2010 of the European Parliament and of the Council”. In view of the urgent character for the approval of the above regulation, the interested parties have agreed that it will be ready before the end of the year. This is the one way road to accomplish the major EU project of the European Banking Union.

Coming back to the SSM, the ECB has disclosed today the targets and the methodology of this initial bank assessment operation. According to the above mentioned Press release the exercise has “three main goals: transparency – to enhance the quality of information available on the condition of banks; repair – to identify and implement necessary corrective actions, if and where needed; and confidence building – to assure all stakeholders that banks are fundamentally sound and trustworthy”. This said, it becomes evident why the ECB considers the existence of a bank resolution and recovery mechanism as sine qua non, for the assessment exercise to be credible.

Where to look

The ECB also explains the details of the comprehensive bank assessment, to be realised during the next twelve months. Again the Press release states, “The assessment will consist of three elements: i) a supervisory risk assessment to review, quantitatively and qualitatively, key risks, including liquidity, leverage and funding ii) an asset quality review (AQR) to enhance the transparency of bank exposures… and iii) a stress test to examine the resilience of banks’ balance sheet to stress scenarios”.

Obviously, if all those tests are conducted properly on Eurozone’s banking system, there have to be convincing answers to questions which are currently asked about the European banks, concerning their capital adequacy, assets quality and resilience. It’s the global financial community that poses those questions.

No doubt the next twelve months will be a very interesting period, to follow what is going on in Eurozone’s financial system. The problems will arise from the moment when there will be indications that those 130 ‘systemic’ banks cannot raise more capital in the market place, in order to cover their needs.

More capital needed

As the ECB notes, “Since the onset of the global financial crisis, euro area banks have raised around €225 billion of fresh capital and a further €275bn has been injected by governments”. It will be a disaster if the same proportion of market and taxpayers’ capital injections appear as indispensable during the next months. It is also of paramount importance to see which banks will need more taxpayers’ money.

For example the four Greek ‘systemic’ banks have already received from the impoverished taxpayers of this country more that €32bn in new capital injections. Obviously, Athens cannot repeat this generosity. The same is true for the Spanish and probably for more banks. In reality, the core question to be answered is who would pay for the new capital possibly to be needed, and what will become the banks which prove to be beyond limit of repair?