Friday, March 15, 2013

15/3/2013: IMF Assessment of the Euro Area Banking Sector Risks - part 1

Today's releases of the horror flicks starring Irish financial sector are up and running, folks.

As noted in the previous note - premiering Q1 2013 article on euro area banking sector analysis from Euromoney Country Risk surveys (link: - the IMF has released today 2013 Financial System Stability Assessment Report for European Union report.

This is the first blog post on the report and associated technical papers, and it covers the Technical Note on Progress with Bank Restructuring and Resolution in Europe.

From the top-line conclusions by the IMF (all quotes marked, italics within quotes are mine):

  1. "The European Union (EU) banking system restructuring is under way, but is far from complete. Some bank restructuring has started, and the level Tier 1 capital ratios of EU banks have been substantially increased."
  2. "But system-wide, capital ratios have been met partly by deleveraging or recalibrations of the risk weights on activities."
  3. "Consolidation in the banking sector has been slow, with banks rarely closed."
  4. "Nonperforming loans are building up in banks’ balance sheets, and addiction to central bank liquidity remains high especially for banks in peripheral countries."
  5. "Despite the EBA recapitalization exercise having led to €200 billion of new capital or reduction of capital needs by European banks, fresh capital is difficult to attract in an environment where prospects for profitability are uncertain."
  6. "Several hurdles impair restructuring and resolution in Europe, and urgent progress needs to be made:
  • "First, EU bank resolution tools need to be strengthened, aligning them with the Financial Stability Board Key Attributes for Effective Resolution. Fast adoption of the EU resolution directive is welcome, but enhancements are warranted. Swift transposition should follow." [We are still ages away from having any effective resolution tools and any sort of functional regulatory consolidation, let alone functional and effective supervisory consolidation.]
  • "Second, restructuring of nonperforming loans (NPLs) should be facilitated [more on this below]. The legal framework should not slow down restructuring and maximize asset recovery. In several EU countries, such as Italy, Greece and in Eastern Europe, bankruptcy reforms lag behind in that, for instance, current practice does not allow the seizure of collateral in a reasonable timeframe. Banks should also manage more actively their NPLs, possibly allowing a market for distress assets to emerge in Europe." [Note the absence of Ireland in the list of laggards above. It is generally strange that the IMF is avoiding passing any judgement on the only case of actual reforms that has impacted only one of the peripheral countries.] 
  • "Third, further evolution of the General Directorate for Competition’s (DG COMP) practices will be needed in systemic cases to ensure consistency with a country’s macro-financial framework and support viability of weak banks, recovery of market access, and credit provision. Increased transparency would give added credibility and accountability." [Again, we are ages away from delivering on these.]
  • "Fourth, disclosure should be significantly enhanced and harmonized by the EBA, to restore market confidence. In particular, interpretable metrics regarding the quality of banks’ assets, in terms of NPLs, collateral, probability of defaults (PD) and loan recovery rates (LGD) are key for assessing the strength of banks and restoring confidence in the banking system." [see comment above]
Summary: what needs to be done is, largely, nowhere to be seen, yet...


And when it comes to much of hope of the forthcoming regulatory changes altering the status quo of the dysfunctional regulatory system, don't hold your breath, folks.

The Big Hope is on the forthcoming EU resolution directive aiming to create coordinated system of responses to any future structural financial crises. Here's IMF view on that one:

  • First, polite stuff: "A critical new EU resolution directive is in preparation. As a national approach to resolution may well not be appropriate in the EU given the importance of cross-border banking, and the failure of existing cross-country coordination mechanisms, the European Commission (EC) has taken steps to harmonize and strengthen domestic resolution regimes. This should help avoid regulatory arbitrage and make orderly resolution effective and efficient for cross-border banks. In June 2012, the Commission issued a draft directive for harmonized crisis management and resolution framework in all EU countries. The Irish Presidency will make the adoption of the resolution framework a top priority and plans to adopt it during the first part of 2013. The new national resolution regimes endow EU countries with strong early intervention powers and resolution tools. The transposition of the directive into national laws should be accelerated relative to the current deadlines (01/2015, and 01/2018 for bail-ins)."

I wrote about this Directive recently ( and was not too enthusiastic. Alas, here's IMF's less pleasing assessment, although dressed up in polite language of 'suggestions':

  • "Box 1. Proposed Resolution Directive––Risks and Areas for Enhancements
  1. Resolution of banks is undermined by the absence of a more effective EU-wide framework to fund resolution. Binding mediation powers for the EBA and mutual borrowing arrangements between national funds face inherent constraints (in particular, the EBA cannot impinge on the fiscal responsibilities of EU member states).
  2. Passage of the directive will substantially enhance the range of tools available to resolution agencies in the EU. But the scope of the directive should be widened to include systemic insurance companies and financial market infrastructures. The European Commission launched a consultation at the end of 2012 on this issue. All banks should be subject to the regime, without the possibility of ordinary corporate insolvency proceedings.
  3. The breadth and timing of the triggers for resolution should be enhanced by providing the authority with sufficient flexibility to determine the non-viability of the financial institution (including breaches of liquidity requirements and other serious regulatory failings, not just capital/asset shortfalls). There should be provision for mandatory intervention in the event a specified solvency trigger is crossed.
  4. The directive affords less flexibility for using certain resolution powers than the key attributes. For instance, it does not permit exercising the mandatory recapitalization power and the asset separation tool on a standalone basis. Also, bail-in safeguards should not prevent departure from pari passu treatment where necessary on grounds of financial stability or to maximize value for creditors as a whole.
  5. Depositor preference should be established for insured depositors2, with the right of subrogation for the DGS."

Thus, to sum up the best-hope response of the EU - it is useless, largely toothless and predominantly weak. And to add to this - it will only be fully functions in 2018! You might as well think we live in a Natural History museum, where urgency of response is differentiated by months, rather than minutes.

Next post will cover the issue of Non-Performing Loans.

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