Finland Times

 

Photo AFP-Lehtikuva.

A new era in banking supervision began on Tuesday as the European Central Bank (ECB) assumed its direct supervisory role over 120 of the largest banks in the Eurozone, under the Single Supervisory Mechanism.

     

The ECB team is led by President of the Supervisory Council Daniele Nouy, who was formerly head of the French Prudential Supervisory Authority.

     

Around 1,000 additional ECB employees have been hired for the new banking supervision department. Last weekend, along with their ECB colleagues, they began the move into the new European Central Bank building in the Frankfurt Ostend district.

     

They will be deployed in work units known as Joint Supervisory Teams. These will be made up of various nationalities, and an important point to note is that the team leader looking at a specific bank will be of a different nationality to the bank being supervised.

     

The aim is to avoid so called supervisory forbearance.

     

Nouy has already faced some heavy criticism ahead of officially beginning her work. In preparation for taking over the supervision of major banks the ECB conducted its Asset Quality Review, which was accompanied by a set of stress tests conducted by the London based European Banking Authority (EBA). Together these made up the comprehensive assessment.

     

The fact that 25 banks failed the stress tests could be taken as a sign of a tough approach by the new supervisor, but 12 of these had already taken action to strengthen their balance sheets. Many market participants have instead focused on the total capital shortfall of 9.5 billion euros (11.9 billion U.S. dollars) uncovered by the Asset Quality Review and stress tests as a sign that the ECB was too lenient in its approach.

     

The ECB is answerable to the directly elected European Parliament, and on Monday 3 November Nouy appeared in Brussels before the Committee on Economic and Monetary Affairs.

     

In a briefing paper the ECB argued that "the comparatively very small amount of the total capital shortfall should per se not be taken as an indicator for a lack of rigour and credibility of the exercise," noting that "in anticipation of the comprehensive assessment, a number of banks have taken action beforehand (frontloading) and strengthened their capital base."

     

The ECB notes that from 2008 to 2013 the 30 largest participating banks raised 198 billion euros in new equity.

     

The Economic and Monetary Affairs Committee at the European Parliament itself commissioned two independent studies on the robustness, validity and significance of the AQR and stress test exercise, provided to the committee ahead of its hearing with Nouy.

     

One of these studies was conducted by Thomas Breuer, at the University of Applied Sciences Vorarlberg in Austria.

     

"The 2014 EU stress tests have a number of strengths, including that the adverse scenario considered in 2014 is more severe than the one in 2011," says Breuer. "Second, the more active involvement of the ECB side by side with the National Competent Authorities fosters equal treatment of major banks across the EU."

     

He also points to the fact that detailed methodological notes from the EBA give more guidance to banks, and that complementing the stress tests with an AQR provides more reliable data.

     

However, Breuer notes a weakness in that the stress tests were designed from a microprudential point of view on individual banks, thus choosing to neglect the macroprudential view on systemic risk. As a result the tests do not take into consideration the chain reaction of market events, where problems at one bank can trigger problems at other institutions.

     

Against this background of criticism, in the early months of its work the ECB will be keen to establish its credibility as a tough supervisor. Even for the banks that passed the stress tests, it is clear that sluggish economic growth in the Eurozone, and high volumes of poorly perfoming assets on balance sheets, mean that it will take some years for the banks to put the legacy of the financial crisis behind them.

     

Of the 25 banks that failed the stress test, 9 were in Italy, 3 from Greece, 3 from Cyprus, one in Portugal and one in Ireland. The geographical spread of banks that failed the stress test illustrates that many of the most severe problems are to be found in the so called peripheral Eurozone countries.

     

"The tests are an important first step towards leveling the playing field for Eurozone banks, but there is still a long way to go," comments Bridget Gandy, Managing Director at Fitch Ratings in London.

     

"High levels of unreserved problem loans will leave some banks, particularly in the weaker countries, still vulnerable, and asset quality is likely to remain a key rating focus in much of the region," says Gandy.

     

As it takes over the supervisory function, the ECB will be working closely with the 120 banks which it now oversees, and will be encouraging them to keep pressing ahead with the balance sheet cleaning up process.