When the eurozone
decided in 2012 to create a banking union, it did so largely because other
ideas for deepening economic integration seemed too contentious. Ceding
sovereignty over national banking systems was an easier political sell than,
for example, handing Brussels new powers to borrow and spend.
Now, just four months
after assuming its new powers, the ECB faces an acute test of its credibility
in the shape of the latest Greek crisis.
The success of the
banking union hinges on the ECB convincing markets that it offers a decisive
break with a European past in which national authorities were seen as too
susceptible to political pressure, too willing to overlook weak bank balance
sheets to shield government balance sheets.
To break this toxic
link between banks and sovereigns that has undermined trust in the eurozone
financial system, the ECB needs to show that it can take decisions independent
of political pressures.
Most analysts agree
that the SSM has got off to a promising start. Last year’s asset-quality review
and stress test of the balance sheets of the largest eurozone banks was seen as
more rigorous than past European efforts. The ECB has also been using its
discretionary powers to push banks to improve the quality of their capital,
circumventing national opt-outs from the Basel framework that had been baked
into European rules.
Recent moves by
Spanish lender Banco Santander SA to raise capital, as well as steps to boost
the capitalization of small Italian lenders, bear the hallmarks of the new
regulator flexing its muscles.
But the Greek crisis
has put the ECB in an uncomfortable position. Prime Minister Alexis Tsipras
complains that the ECB has a noose around Greece’s neck because it won’t allow
Athens to issue more short-term bonds. The ECB has defended its position
primarily in terms of monetary policy: It says that allowing Greek banks to buy
more T-bills would amount to central-bank financing of the government,
prohibited by European treaties.
But as supervisor of
the four largest Greek banks, the ECB faces an even more delicate question:
Should Greek banks even be allowed to use scarce liquidity to roll over their
existing holdings of T-bills?
Officials acknowledge
that at a time of such acute stress, banks should ideally be cutting their
exposures to illiquid government securities. Yet they also know that ordering
banks to do so would have dire consequences for financial stability.
For the moment, the
ECB is allowing banks to roll over T-bill exposures. But some officials say
that the longer this continues, the greater the risk to the ECB’s credibility
as a bank supervisor. Meanwhile the ECB also faces another critical judgment:
Do Greek banks have sufficient capital?
The economic crisis is
already taking a clear toll on bank asset quality. Eurobank Ergasias SA, one of
Greece’s largest lenders, said last week that its nonperforming loan ratio has
already returned to comparable levels to the first half of last year, with
arrears picking up on both mortgages and commercial loans.
Default rates will
almost certainly worsen if the government starts delaying payment to its own
suppliers because of a cash crunch, as seems likely given the lack of progress
toward unlocking bailout funds.
Credit conditions are
also likely to tighten as a result of the deposit flight since the start of the
political crisis in December. Although outflows have stabilized since Athens
signed a four-month extension to its current bailout program on Feb. 20, the
Greek banks are still reliant on central-bank facilities for €100 billion
($104.96 billion) of funding, equivalent to almost 70% of Greek gross domestic
product.
That suggests Greek
banks will face a further period of deleveraging as they try to put their
funding back on a sound footing.
And if Athens pushes
ahead with a proposed new law outlawing foreclosures on some home loans, the
banks will be forced to take further bad debt charges to reflect the weaker
incentives for homeowners to honor their debts.
True, the four large
Greek banks passed the ECB’s stress test last year and so far, any
deterioration is within the range of the adverse scenario used in the test, say
officials familiar with the situation. But the snag is that a large share of
the capital held by Greek banks consists of deferred tax credits, which the ECB
has indicated it doesn’t regard as sufficiently loss-absorbing to qualify as
true core capital, since its availability depends on the ability of banks to
generate profits for decades to come.
Strip out these tax
credits and Eurobank’s core capital ratio fell to about 5% at the end of 2014,
notes Citigroup. That is far below the 10% standard for European banks.
Not surprisingly,
Greek bank stocks have lost up to 80% of their value in the past year and now
trade at deeply distressed multiples.
Some central bankers
believe that substantial capital injections into Greek banks may already be
necessary. Yet the only plausible source of capital today is money earmarked
for bank recapitalizations held by the Hellenic Financial Stabilization Fund.
To access these funds, the banks would need the approval of the European
Stability Mechanism, which in turn would require that Greece comply with its
bailout program.
If HFSF funds weren’t
available, any bank deemed to be inadequately capitalized would have to be
resolved in line with the EU’s tough new bail-in rules, which could lead to
losses for some depositors.
Of course,
technocratic officials are reluctant to take decisions with such profound
political implications. But the ECB also has an obligation to discharge its
responsibilities independently and in accordance with eurozone laws.
The longer the impasse
between Athens and its creditors continues, the greater the pressure on the ECB
to act to safeguard its own credibility. After all, that was the point of the
banking union.
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