14 October 2013

ECB/Mersch: "A cascade of backstops"

In an interview with the FAZ, Mersch laid out the benchmark for the balance sheet assessment, and elaborated on the different stages of bail-in and bail-out in the event of a shortfall.

You don’t have much time. The first acid test, the comprehensive balance sheet assessment, will be held as part of the preparations. How will it proceed?

This plan must first be approved by the ECB’s Governing Council. You will be let in on all the details on 23 October: what form the balance sheet assessment will take; how it ties in with the portfolio selection, which we will examine in more detail; and how the balance sheet assessment in turn relates to the subsequent stress tests. It should all lead to a single result, that will be published in October next year.

What benchmark will this single result represent?

We are not primarily aiming to quantify a capital gap. The main purpose of sifting through the banks’ balance sheets is to restore international market confidence in them. The balance sheet assessment will hence be carried out in accordance with uniform guidelines. All institutions will be examined by the same methods. That is why we also have external consultants on board. Moreover, the supervisory teams in the countries will be linked to each other.

The benchmark will not be a capital gap, the capital requirement? What else will it be?

We will have a benchmark for the balance sheet assessment. That will be derived from European regulations, the Capital Requirements Regulation/Capital Requirements Directive IV (CRR/CRD IV). The main issue is the definition of capital that a bank is required to keep on deposit. The regulation contains a minimum percentage of core capital that banks, under Basel III, must keep in proportion to their risk-weighted assets. It also states that banks must maintain a capital conservation buffer as a further cushion against risks. And since we are dealing with the most important banks in all Member States, the "significant credit institutions" require an extra buffer to reflect this significance in a European context. If you add that up, you arrive at the benchmark that we will use for orientation.

In the final analysis, the most interesting point is the gap between a banks’ capital adequacy requirement and the capital that it has available.

We must apply uniform rules in Europe. It may emerge that a bank does not have adequate reserves or has not made sufficient provisions. That gap may need to be filled with capital, but it may also be removed through balance sheet deleveraging.

It will be difficult if many banks turn to the markets all at once.

Most bankers are forward-looking and are already looking for capital. If private capital does not suffice, then the European guidelines state that the shortfall must be made up through a bail-in, with shareholders and creditors bearing losses. The state may not provide any funds before a bail-in has been carried out. Before any public money flows, however, a decision must have been taken on whether a bank is viable or not. A bank that is only able to keep afloat with sustained public support does not belong in our concept of a market economy. If the bank, or perhaps just one part of it, does have a chance of survival, public funds may be used as the third line of defence; first at national level, and then – as an ultimate line of defence – at international level. If a country is unable to cope, a European safety net would be the last option. So we have a cascade of backstops.

Many taxpayers in Germany already fear that, in the last instance through a European safety net, their money, too, will be used to rescue banks.

The European backstop is the absolute final stage. If a country does not provide the funds, it must enter into an aid programme. The need to activate the European safety net, the last backstop, will not readily arise. People in some countries are more nervous than in others. In the “creditor countries”, people now feel that they are being made to pay up. We need to take these fears seriously, while not failing to appreciate that the interest rates in these countries have been lowered by the crisis and the flow of capital from the stressed countries. That facilitates investment.

Surely putting banking supervision in the hands of the ECB will lead to dilemmas and conflicts of interest if, say, the supervisors ascertain the number of sovereign bonds held by troubled banks. An increase in interest rates could put pressure on the prices of these bonds and thereby on the banks. The ECB would have a conflict and could postpone an interest rate increase that may be warranted from a monetary perspective.

It would be naïve to deny that conflicts might arise in some cases. But in 90 per cent of cases, the interests of financial stability are identical to those of price stability. To be clear: in any percentage of cases in which a conflict arises, our price stability objective will take precedence in line with our mandate.

The intention is to publish the test results of the balance sheet assessment next October. Isn’t there a danger that provisional results regarding capital gaps might leak out in advance and unsettle the markets.

That is true, that’s why we want to consistently manage the process through effective communication. We want to prevent people from drawing the wrong conclusions from partial or inaccurate results. Publication of the final results is the only approach that makes sense. Constant reports on the status quo are of little value. However, a bank’s business model will also be accorded great significance in a dynamic stress test, which will follow the rather static balance sheet assessment.

The policy-makers’ argument is that there should be no bail-out in future, but rather a bail-in. But these rules do not take effect until 2018. What will happen in the meantime?

For the interim period the Commission has drawn up rules for national state aid, which also follow the principle of bail-in. Besides, the European Parliament is doing all it can to advance the resolution rules governing the bail-in. In addition, individual countries may bring these forward independently.

The bank resolution fund should also bear the costs of resolving banks. But this fund, which should be financed by banks’ contributions, so far only exists on paper. The ECB and the EU Commission have suggested that the European Stability Mechanism (ESM) crisis fund might provide a loan. Does that mean taxpayers may end up paying for bank crises after all?

A credit line is conceivable; it would give security. However, that should certainly not be a permanent loan: it may only be interim financing that will not cost taxpayers anything in the long run. The credit should be extended on market terms; that might even be a good deal for taxpayers.

Full interview

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