ECB Eyes Banks’ Capital Quality as Supervisory Priority
By Jeff Black and Jim Brusden
The European Central Bank may use its regulatory clout to make sure euro-area lenders are adding the right kind of capital, not just the right amount. Policy makers say banks have added almost 200 billion euros ($258 billion) of additional capital since mid-2013 to boost their resilience. Yet only about a quarter of that sum is pure equity, as banks stock up on hybrid debt and tax arrangements whose loss absorbency is largely untested. The ECB is wrapping up a year-long probe into asset valuations and capital levels at 131 of the region’s biggest banks as it prepares to assume its new role as the euro area’s bank supervisor on Nov. 4. Officials are already signaling they’ll take a tougher stance on lenders’ ability to withstand future losses. Vice President Vitor Constancio said this month that the ECB’s test is already a “big success,” since banks have bolstered their balance sheets to the tune of 197 billion euros since June 2013. Yet that total contains only 49.9 billion euros of fresh equity, according to data provided by the ECB. The remainder includes one-off provisions, capital gains from asset sales and instruments less obviously able to withstand a downturn, such as deferred tax assets, which arise when a bank books losses or credits that it expects to be able to use to reduce its future tax obligations. The U.S. “learned the hard way” about counting deferred tax assets as capital, said Karen Shaw Petrou, managing partner of research firm Federal Financial Analytics Inc. in Washington. “The less a source of regulatory capital can be quickly monetized, the less value it has a source of strength,” she said. “Allowing instruments other than common equity to serve as capital makes the rules more complex and opaque, further undermining the framework’s overall resilience.”