01 October 2014

Reuters: Sovereign doom loop haunts EU bank stress tests

The euro zone’s nascent banking union was supposed to unpick the “sovereign doom loop” by which ropey banks endangered weak countries, and vice versa. Yet the new single banking supervisor’s exercise could tighten, rather than loosen, the state/bank co-dependency.

The euro zone’s nascent banking union was supposed to unpick the “sovereign doom loop” by which ropey banks endangered weak countries, and vice versa. Its first task was to be a rigorous test of how much capital each lender could count on in adverse scenarios. Yet the new single banking supervisor’s exercise could tighten, rather than loosen, the state/bank co-dependency.

The tests, scheduled for release on Oct. 26 with input from the European Central Bank, will subject the monetary union’s lenders to a generic macroeconomic shock. They will be required to show that their core Tier 1 equity afterwards would amount to at least 5.5 percent of their risk-weighted assets. But the ECB’s single supervisory mechanism, which will directly regulate large European banks as of Nov. 4, has acquiesced in making this “pass” mark easier, according to a person familiar with the situation.

The fudge concerns deferred tax credits, or money governments owe the banks when they have booked losses in previous years. National regulators in Europe have found a way around Basel III capital rules that require a variant of these, so-called “deferred tax assets,” to be phased out of a bank’s capital count by 2018. DTAs generally only kick in once a bank becomes profitable again – so they shouldn’t be viewed as loss-absorbing capital.

Full article on Reuters

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