Can the banking sector help Europe turn around?
December 23, 2014
The European Central Bank (ECB) recently released the results of a formal review of assets held by 130 large and midsize banks in the European Union (EU). The assets under scrutiny amounted to approximately 82% of the banking sector. The review, which is based on balance sheets as of Dec. 31, 2013, revealed the following:
- Twenty-four banks failed to meet the minimum capital ratio of 5.5%, resulting in a total capital shortfall of 24 billion euros.
- Including any capital raised in 2014, the number of banks with shortfalls fell to 11, with a total deficit of 9.5 billion euros.
- Excluding banks that are already under formal restructuring plan, five banks were left, with capital shortfalls that amount to 6 billion euros.
Critics of the review program point out that tax credits were included in the capital calculations, and that the tests understated the risks posed by deflation. Nevertheless, the effort (together with an accompanying stress test) has paved the way toward the ECB’s so-called Single Supervisory Mechanism that became operational on Nov. 4 (see box below). Through the supervision program, ECB regulators can continue monitoring bank risks on an ongoing basis, and they have set April 2015 as the deadline for asset shortfalls to be covered.
The ECB’s asset review shows that the vast majority of European banks appear adequately capitalized. While this may inject a measure of confidence into the European banking sector, the EU continues to face many headwinds, both political and economic, including a lack of a political union, a need for structural reforms, and a handful of negative developments at the country level (consider that Germany — long regarded as having the bloc’s most active economy — has signaled expectations of muted growth next year).
In Italy, the economy hasn’t grown since early 2011, and France has been under the magnifying glass as ratings agencies have downgraded its government debt. So, despite the asset quality review’s positive implications, we remain cautious about potential downside risks in the region.
The Single Supervisory Mechanism (SSM) emerges against the odds
The European Commission has described the achievement of the SSM as “a work of unprecedented scale…[and] a large step toward deeper integration within the EU.” It may not be an overstatement: Bringing the program to fruition involved pulling together a wide collection of stakeholders across the EU, as well as managing the practical challenges of linking communications systems, putting together an integrated information technology framework, and assembling a new and well-coordinated staff.
- The program aims to restore trust in the European banking sector, thereby generating more lending capacity. This means that, if successful, the program will significantly improve the banking sector’s reputation around the world.
- Essentially, the SSM puts banking supervision at the EU level, giving the ECB responsibility for oversight of the entire euro-area banking sector. This means the ECB will oversee approximately 6,000 banks in all, accounting for more than 85% of total banking assets.
- The ECB will be called on to monitor and gauge risk across all banks according to a single, consistent “rulebook.”
- From a more populist perspective, the SSM seeks to ensure that European taxpayers will no longer foot the bill for ailing banks.
- The bottom line: better risk assessment and improved financial stability across the euro area.
The views expressed represent the Manager's assessment of the market environment as of December 2014, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
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