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E.C.B. Vows Thorough Review of Banks at Risk E.C.B. Vows Thorough Review of Banks at Risk
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FRANKFURT — The European Central Bank detailed the parameters of a widely anticipated review of euro zone banks Wednesday, promising that it would thoroughly examine lenders’ ability to withstand shocks and their exposure to risk. FRANKFURT — The European Central Bank on Wednesday outlined the parameters for a wide-ranging review of commercial banks that is designed to expose and fix any problems and ultimately allow credit to begin flowing normally again, a prerequisite for faster economic growth.
Mario Draghi, president of the E.C.B., said the review, which will begin in November and take a year, would be “an important step forward for Europe and for the future of the euro area economy.”Mario Draghi, president of the E.C.B., said the review, which will begin in November and take a year, would be “an important step forward for Europe and for the future of the euro area economy.”
The review of 130 large lenders is intended to address one of the underlying problems in the euro zone economy by forcing weak banks to deal with problems such as bad loans or insufficient capital. Credit remains tight in much of Europe, in part because many banks are burdened with bad loans or unable to raise money on capital markets. Without credit a vibrant recovery is almost impossible. The deep dive into bank books is part of a larger attempt to unify Europe’s fragmented banking system under the supervision of the E.C.B., so that lenders in the single currency zone play by the same rules and meet the same standards.
But there have been questions about what will happen if the E.C.B. finds banks with grave problems. It is unclear where the money would come from to recapitalize damaged banks, and European political leaders are still arguing about how to close down those that are terminally ill without creating more financial turmoil. But the E.C.B., with its credibility at stake, must show that it can succeed in eliminating doubts about European banks where other national and European authorities have failed. And it remains unclear who will pay to recapitalize weak banks or how terminally ill banks will be shut down without unleashing market turmoil.
The E.C.B. is pushing ahead despite those shortcomings. The review is scheduled to be completed in October 2014, just before the bank becomes the central supervisor for euro zone banks. “It’s a once in a lifetime opportunity for the E.C.B.,” said Harald Benink, a professor of banking and finance at Tilburg University in the Netherlands. “They have a clear incentive to be tough.”
The review of about 130 large lenders is intended to address one of the underlying problems in the euro zone economy by forcing weak banks to deal with problems such as bad loans or insufficient capital. Credit remains tight in much of Europe, in part because many banks are burdened with bad loans or because they lack confidence from investors and are unable to raise money on capital markets. Without credit a vibrant recovery is almost impossible.
The E.C.B. assessment is also a prelude to a significant expansion of the bank’s powers, which are already vast. In November, immediately after finishing the review, the E.C.B. will become the bank supervisor for the euro zone, responsible for policing the banking system and guaranteeing its stability.
There have been questions about what will happen if the E.C.B. finds banks with grave problems. No one really knows to what extent some banks in Italy, Spain, Germany and other countries may be covering up losses from bad mortgages, business loans or other investments. Estimates of potential hidden losses run into the hundreds of billions of euros.
It is also unclear where the money would come from to recapitalize damaged banks, and European political leaders are still arguing about how to close down those that are terminally ill without creating more financial turmoil.
“There is fundamental disagreement at the highest European level who is going to absorb losses and who is going to pay to resolve problems,” Mr. Benink said. “If it is not clear who is going to pay these backstops you cannot have a credible review.”
Ignazio Angeloni, an E.C.B. official overseeing the review, expressed confidence that political leaders will resolve those issues by the time the assessment is finished. “All of those elements are in the making, and they will fall into place,” he said at a news conference Wednesday.
Unlike the United States, Europe has never really forced banks to confront their problems in a way that rebuilt trust among investors. That was partly because national bank supervisors were overly protective of their own banks. In theory, the E.C.B. will be more willing to put pressure on financial institutions. There are already indications that the threat of E.C.B. scrutiny has ignited a fire under banks and national supervisors.
“We expect that this assessment will strengthen private sector confidence in the soundness of euro area banks and in the quality of their balance sheets,” Mr. Draghi said in a statement.“We expect that this assessment will strengthen private sector confidence in the soundness of euro area banks and in the quality of their balance sheets,” Mr. Draghi said in a statement.
Ignazio Angeloni, an E.C.B. official overseeing the review, said that banks will be required to hold capital equal to 8 percent of their money at risk. But the requirement will be phased in from 2014 to 2018, in line with new regulations for European Union banks. Mr. Angeloni said that banks will be required to hold capital equal to 8 percent of their money at risk, double the current level. But the requirement will be phased in from 2014 to 2018, in line with new regulations for European Union banks.
He also said that the E.C.B. will look closely at banks’ holdings of euro zone government bonds, a politically sensitive task since banks in countries like Italy are believed to hold large quantities of their own country’s bonds. Current E.U. regulations treat euro zone government bonds as if they were risk free, despite a crisis that proved otherwise. Banks do not have to hold capital against government bonds to absorb losses.
The E.C.B. said it would look at risks from derivatives and other investments that are often hard to value. And the E.C.B. will scrutinize banks’ sources of funding. One lesson of the financial crisis was that many banks were overly dependent on short-term loans that dried up after the collapse of the investment bank Lehman Bros. in 2008.
The review will also include a stress test, which gauges banks’ ability to deal with shocks such as a sudden economic downturn.
Working with national regulators, the E.C.B. will look at lenders accounting for 85 percent of the euro zone banking system. The list, which the E.C.B. published Wednesday, includes household names like Deutsche Bank in Germany or BNP Paribas in France, but also some banks that attract less attention, such as Volkswagen Bank in Germany, which provides car financing.Working with national regulators, the E.C.B. will look at lenders accounting for 85 percent of the euro zone banking system. The list, which the E.C.B. published Wednesday, includes household names like Deutsche Bank in Germany or BNP Paribas in France, but also some banks that attract less attention, such as Volkswagen Bank in Germany, which provides car financing.
Several subsidiaries of foreign banks are also on the list, including The Bank of New York Mellon in Belgium and Merrill Lynch International Bank in Ireland. Several subsidiaries of foreign banks are also on the list including The Bank of New York Mellon in Belgium and Merrill Lynch International Bank in Ireland.
If some banks need more money, the E.C.B. said, they should first try to raise money from private investors. But if they are unable to, governments will need to step in. It remains unclear whether a country like Italy, which has a number of weak banks and is stuck in recession, would be able to afford another bank rescue.If some banks need more money, the E.C.B. said, they should first try to raise money from private investors. But if they are unable to, governments will need to step in. It remains unclear whether a country like Italy, which has a number of weak banks and is stuck in recession, would be able to afford another bank rescue.
“It is essential to ensure that any banks that have viable business models, but are required to build additional capital for prudential reasons, will be able to obtain such additional resources within an appropriate time frame,” the E.C.B. said in a statement.“It is essential to ensure that any banks that have viable business models, but are required to build additional capital for prudential reasons, will be able to obtain such additional resources within an appropriate time frame,” the E.C.B. said in a statement.