04 December 2013

Nicolas Véron: ECB's big moment

Europe’s Banking Union project has had many doubters since it started to be widely discussed in the spring of 2012. What is not in doubt, however, is its transformative nature. In June 2012, EU leaders chose – in a galloping hurry, as usual – to move towards the centralisation of bank supervision across eurozone countries, with this authority entrusted to the ECB. The consequences have only gradually become apparent to most and they represent both an opportunity and a risk.

The opportunity is to re-establish trust in European banks, reboot the pan-European interbank market, end dysfunctional credit allocation and start reversing the vicious circle between bank and sovereign credit. In an optimistic scenario, the ECB’s 12-month process of “comprehensive assessment", including an asset quality review (AQR) and stress tests of around 130 credit institutions covering 85 per cent of the eurozone’s banking assets, will trigger triage, recapitalisation and restructuring that financial history suggests is a prerequisite for systemic crisis resolution.

The risk is that, if the assessment fails to be consistent and rigorous, the ECB may find its reputation so damaged that the credibility of its monetary policy – and the perception of Europe’s ability to get anything done – could be affected. After all, this exercise is unprecedented in scale and scope, which means the ECB has little prior experience. At the same time, the political fallout is potentially poisonous in most of the states concerned.

Thus, much is at stake in next year’s balance sheet review, and the scene is set for an escalating confrontation between the ECB and Member States in the months ahead. The ECB has pointedly made clear that it will form an independent judgement on the capital strength of the banks examined, without necessarily following the views of national supervisors.

It has also noted that the AQR can be expected to reveal significant new information – which, after all, is the whole point of it. A number of banks that, until now, had been deemed sound by national watchdogs may be found by the ECB to be undercapitalised, or even insolvent. In such cases, restructuring will inevitably be painful for the corresponding national governments, both politically and financially, leading them to plead for forbearance. The tension can be expected to generate more market volatility in Europe in 2014 than was seen in 2013.

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