24 October 2013

Nicolas Véron: An encouraging start for the ECB's Big Bank Review

Véron finds the ECB's announcements encouraging, even if the most difficult choices still lie ahead - primarily on how to restructure the banks which would be identified as severely undercapitalised or insolvent in next year's assessment.

A simplistic but apt description of the challenge of the 2014 bank review is... a choice between two diverging scenarios. In the first, “forbearing” scenario, the ECB would yield to the political pressure from Member States and do little better than the EBA in 2011 in terms of rigour and consistency of the assessment. Flashpoints would be avoided but the “zombification” of the euro area’s banking sector would continue, with a heavily negative impact on Europe’s future growth.

In the second, “rigorous” scenario, the ECB would resist the pressure for forbearance and expose a number of problem banks, whose restructuring will involve some public cost and political turmoil. But the corresponding clean-up would start the gradual lifting of the drag that dysfunctional credit allocation has put on European growth since mid-2007. Furthermore, only in the “rigorous” scenario can the Single Supervisory Mechanism be established on a sound basis, which is a necessary condition for further successful steps towards Banking Union, itself an indispensable (though not sufficient) component of an eventual resolution of Europe’s current predicament.

Alas, it is difficult to imagine that the assessment may be rigorous and not expose a number of significantly undercapitalised or insolvent problem banks, some of which may be quite large. If all was already well in the European banking system, the corresponding disclosures would have happened and investors would have been reassured long ago. It is also difficult to imagine a happy middle ground between the two above described scenarios. The ECB can probably not sugarcoat the assessment’s results sufficiently to avoid painful restructuring, while preserving its credibility.

Thus, the conflict between the ECB and Member States will escalate. It is likely to trigger significantly more financial market volatility in 2014 than Europe has witnessed (so far) in 2013, in spite of sizeable internal shocks this year such as the February election in Italy and the March developments in Cyprus, and external ones such as the turmoil in emerging markets and the recent US fiscal drama. The risk is of a major loss of reputation of the ECB and thus further weakening of an already fragile euro area and EU, compounded by a final loss of hope in Europe’s ability to address its now many-years-old banking problem. The opportunity is of allowing trust to return to Europe’s banks and paving the way towards a much more resilient financial system. Europe’s leaders will need to be clear-sighted about the consequences of their choices in the weeks and months ahead.

Full article

© Nicolas Véron