18 September 2012

Bloomberg: Europe banks fail to cut as Draghi loans defer deleverage

The ECB president’s decision nine months ago to provide more than €1 trillion of three-year loans to banks eased the pressure to sell assets at depressed prices. The infusion, designed to encourage firms to lend, succeeded in averting a short-term credit crunch by reducing their reliance on markets for funding. It also may be making European lenders dependent on more central bank aid.

“Deleveraging isn’t taking place, especially in Spain and Italy”, said Simon Maughan, a bank analyst at Olivetree Securities Ltd in London. “The fact that we haven’t got on with it, or very slowly, suggests that when the time comes we’ll need another ECB injection to roll over the first one, just to keep the balance sheets of Italian banks in business.”

Analysts predicted that European lenders would have to shrink more as regulators requested higher capital and investors, who became less convinced that governments would be able or willing to bail out their largest banks, demanded bigger returns for lending to those firms.

Banks across Europe bolstered capital instead of selling assets and curbing lending. They did it by retaining profit and swapping debt with other securities, such as subordinated debt, considered to have better loss-absorbing qualities, the European Banking Authority said in July. Some lenders used the ECB’s loans to purchase sovereign bonds. Under current Basel Committee on Banking Supervision rules, banks don’t have to hold any capital against government debt because it’s considered risk-free.

Basel rules require banks to maintain varying amounts of capital against assets depending on their riskiness. They allow the largest firms to use their own models to calculate how much capital they need. By adjusting the criteria or swapping assets for ones considered less risky, lenders can reduce their risk- weighted assets, even as total assets increase.

The ECB money has removed the incentive for banks to clean their balance sheets, according to Olivetree’s Maughan. “Some banks, especially in Spain and Italy, are just taking in the money that they can get from the ECB, which should be a short-term measure in order to enable them to manage while they implement structural reforms”, Maughan said. “It successfully staved off a funding crisis, but its real aim of facilitating restructuring hasn’t even started.”

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