martes, 29 de octubre de 2013

martes, octubre 29, 2013

Draghi Risks Having Worst of All Worlds

By   Simon Nixon

Updated Oct. 27, 2013 7:19 p.m. ET

 

The euro zone's decision to create a banking union is in many respects as momentous as the creation of the euro. After all, bank supervision involves interfering in how resources are allocated—indeed, sometimes violently so when it comes to apportioning losses in failed banks. This is the essence of politics, a role that goes to the heart of sovereignty.

 
The ECB has never shied from spelling out the full significance of a banking union. But the same can't be said of many politicians across Europe. They have been only too happy to present its first stage—the creation of a single supervisory mechanism based at the ECB—as just another step in the evolution of Europe's single market, certainly nothing to trouble voters about.


But this gap between reality and rhetoric (or lack of it) will have to be bridged at some point. Will the euro zone acknowledge the banking unions' political implications at its birth? Or will it wait until the next crisis to grapple with the consequences, as it did with the euro?
So far, there is no clear answer. This became obvious last week when the ECB published its guidelines for a "comprehensive assessment" of the 124 largest euro-zone banks.


The ECB faces a binary choice over how it handles this assessment, which it hopes will restore trust in the banking system before it takes on its new supervisory powers in November 2014. Until the ECB decides which way to jump, the euro zone faces months of political—and potentially financialvolatility.

The ECB can opt for a maximalist approach that addresses the major structural weaknesses in the banking system that are contributing to an alarming collapse in lending: low profitability, reliance on central-bank funding, poor quality of capital. This would likely lead to a significant restructuring of the banking system, including substantial recapitalization. But it also requires tough rules to deal with banks that fail the test and a credible backstop to maintain the confidence of markets.


The alternative is a minimalist approach aimed only at boosting confidence in the accuracy of bank disclosures and demanding limited capital raising where new harmonized rules on bad debts reveal shortfalls, but leaving the industry's structure broadly unchanged. However, this approach depends on the ECB providing a new cheap funding facility to replace the two long-term refinancing operations that expire at the end of next year, thereby giving banks more time to earn their way out of trouble.


Both options remain on the table, reckons Nicolas Veron, a senior fellow at the Brussels-based think tank Breugel.

  The range of risks the ECB says it will assess is indeed comprehensive, including exposure to sovereign bonds and hard-to-value market assets, as well as risky funding structures and overall leverage. But crucially, there was no detail on methodology.

 
Similarly, the baseline capital requirement has been set suspiciously low, says Alasdair Ryan, an analyst at Bank of America Merrill Lynch. Banks must achieve a minimum 8% core Tier 1 ratio under Basel III rules, but can take advantage of transitional arrangements allowed under European law. The current euro-zone average on this measure is 12%. But what will determine the scale of any capital raising are the details of the stress tests, which may not be known for several months.


One reason for the lack of detail is that ECB has yet to appoint its new supervisory board, which will lead the assessment.

But the lack of detail also reflects the political pressure the ECB is under from national governments pushing hard for a minimalist approach, emboldened by evidence of growing investor interest in buying distressed assets from crisis-country banks.

The ECB fears the long-term risks of this approach. If undercapitalized banks continue to invest in government bonds rather than extend new loans, the euro zone will face a slower recovery.

Worse, continued heavy government bond-buying by banks will weaken incentives for governments to pursue fiscal discipline, intensifying the link between sovereigns and banks. And any revival of cross-border flows of capital and liquidityone of the most eagerly anticipated benefits of a common supervisor—will raise the political stake in the event of a future bank failure.


No one should underestimate ECB President Mario Draghi in this battle, says Mr. Veron. He has shown he is a street-wise political fighter, not least in securing the euro zone's commitment to a banking union as the price of the ECB's agreement to support government bond markets.


But the odds are stacked against him. All decisions of the supervisory board—which some estimate could number 10,000 a yearmust be ratified by the ECB's Governing Council, providing plenty of scope to push national agendas as each euro-zone member has a seat on the council for its central-bank chief. The ECB will also remain constrained by national laws and its continued reliance on national authorities as it builds up its own supervisory staff to a planned 1,000 from 100 today.

 
Nor can Mr. Draghi count on political support for a maximalist approach. German Chancellor Angela Merkel has effectively reneged on her June 2012 commitment to allow the European Stability Mechanism to invest directly in banks, fearing it would be used as a first rather than last resort. Similarly, Germany has been wary of creating a robust single-resolution mechanism, perhaps fearing it could be used to close down German banks.

 
Meanwhile any attempt to put the banking union on a more robust legal footing would require changes to euro-zone treaties, triggering U.K. demands for a wider renegotiation of the workings of the European Union that could paralyze EU policy-making for years.


The ECB risks ending up with the worst of all worlds: responsibility but not power, obliged to preside over a banking system seemingly unable to escape its flawed past. As with the euro's creation, the solution may have to wait for the next crisis.




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