Euro Banks: Time for another check-up

The European Parliament yesterday passed legislation clearing the way for the European Central Bank to become the sole supervisor of the euro area’s largest banks next year, an early milestone on the long journey towards a euro area banking union.

Importantly, the accord clears the path for work on a (supposedly) comprehensive review of euro area banks’ financial health to commence in earnest. The ECB will only take up the new supervisory position once it is satisfied that any capital shortfalls identified by this check-up have been addressed.

The examination encompasses an ECB-led balance sheet assessment, starting shortly and expected to be wrapped up by the end of the first quarter of 2014. This will be followed by the European Banking Authority’s third attempt at a stress test in the second quarter. Assuming everything goes to plan, the ECB would assume supervisory responsibility for the euro area’s largest banks in the autumn of next year.

More detail on the first stage – the assessment of banks’ asset quality and balance sheet risks – may be revealed at the meeting of European finance ministers and central bank governors held today and tomorrow in Vilnius.

Needless to say, after two largely ineffectual stress tests in recent years and the continued fragmentation of banking systems along national lines – perhaps best evident in the wide variation in interest rates charged to businesses (see chart below) – it remains crucial for the euro area’s economic rehabilitation, particularly in the periphery, that the timetable doesn’t slide and expectations for a credible outcome are met.

Given the ECB’s (theoretical) veto, should it not be comfortable with the health of the banks it will be taking under its supervision, we are confident this process will be more rigorous than previous stress tests. In particular, we expect the assessment also to include banks’ funding structures, while effectiveness is to be significantly improved by the drive to harmonise impaired loan classification and provisioning standards.

But, as ever in Europe, conflicting national interests and compromise will limit its effectiveness, not least since one eye will inevitably be on the impact of recapitalisation on governments’ debt positions given that direct recapitalisations through the ESM bailout fund have already been ruled out. Those expecting transformative recapitalisations are therefore likely to be disappointed.

Ultimately, the process to centralise supervision with the ECB is only a baby step towards genuine banking union. Completion of the other important components, including implementation of the bail-in rules and establishment of a single resolution mechanism, remains a long way off.

Average interest rates on new loans to SMEsAverage Interest RatesSource: Datastream and Daiwa Capital Markets Europe Ltd.


Michael Symonds, Credit Analyst

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