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Banks review risks sparking new eurozone panic
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The eurozone is set to return to growth next year but the single currency bloc may not have put its crisis behind it as efforts to shore up its banks could boomerang.
After beating back market panic that the eurozone was set to break up, eurozone nations moved in 2012 and 2013 to put their finances on a stable footing and strengthen the banking sector.
A new pact puts their finances under stricter control, with an obligation to cut the high debt levels seen as one of the reasons behind the crisis.
Eurozone leaders also moved to create a banking union, to reinforce lenders and reduce the likelihood wobbly banks would force countries into bailouts.
However, it risks doing the opposite as lenders are given a thorough check-up but individual countries are left on the hook for the costs of treatment.
In the hot seat will be the European Central Bank, which is conducting in-depth reviews of the top 130 or so eurozone banks before taking over as their supervisor at the end of 2014.
Lax supervision by national regulators has long been a concern of the market, and the ECB could well find that numerous banks are undercapitalized or even insolvent.
Top euro area banks are set to generate twice as many loan losses on average in the years to come than their non-euro counterparts in places like Britain and Switzerland, according to a recent study by Moody’s ratings agency.
As each country will have to pick up the bill separately, the ECB may find itself under pressure from member states to avoid sparking a banking crisis the like of which has already forced Ireland, Spain and Cyprus to seek bailouts.
“The tension can be expected to generate more market volatility in Europe in 2014 than was seen in 2013,” Nicolas Veron of the Bruegel Institute think tank said recently.
The ECB, which has been credited with rescuing the euro by calming markets, could find itself unleashing the next panic if it conducts a rigorous review of banks widely seen as necessary for a sustainable recovery of the eurozone.
“The ECB will be in no position to demand that banks raise capital if there is no backstop,” said Wolfgang Muenchau in a recent Financial Times commentary.
Eventually there will be a common 55 billion euro (US$75 billion) fund to help close down banks, but following opposition from Germany, the eurozone didn’t create a transitional joint mechanism, or “backstop,” to help recapitalize or wind down lenders.
But if the ECB finds banks are in bad shape then eurozone states could find themselves with the same choice of ruining their finances or seeing banks collapse.
They could try to tap the bloc’s ESM bailout fund, as Spain did for its banks, but the money would come with tough conditions.
However, Veron believes the ECB cannot afford to fudge the review. “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,” he said.
The agreement reached by eurozone leaders in December 2013 on banking resolution has been widely criticized as a complicated collection of half measures.
Not only will it take a decade for the joint resolution fund to fill up, at 55 billion euros it “looks too small to deal with major systemic crises,” said economist Christian Schulz at Berenberg Bank.
However he said there may be methods behind the imperfections.
“Tough bail-in rules and a shaky backstop should incentivize the ECB as a supervisor as well as national governments and the banks themselves to do everything to avoid a new crisis in the first place.”
But analysts also worry that banks may prepare for the ECB review by selling off commercial assets and government bonds, and scale back on granting loans, which would only worsen the prospects for recovery.
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