ECB Announces Schedule for Next Banking Crisis

“The ECB will complete an assessment of top banks' assets early next year, a source familiar with the matter told Reuters on Thursday. The ECB is due to become the single supervisor for eurozone banks and before it takes up the task it plans to conduct an asset quality review as part of a broader balance sheet review of the region's largest banks.”
--Reuters, Aug. 1, 2013

Europe plans to form a Eurozone Banking Union (EBU) next year. The plan provides for a Single Supervisor for big banks (the ECB), and for a Single Resolution Mechanism that would be able offer ESM assistance in failed bank resolutions. The ECB agreed to take on this thankless task on one condition: that sick banks must be resolved prior to EBU. In order to fulfill that condition, the ECB will supervise comprehensive portfolio reviews for the big banks. Unlike prior reviews which were macro and top-down, these reviews will be loan-by-loan, and will utilize third party professionals uncontaminated by local political pressures.

This situation is analogous to the nursing home agreeing to admit Grandma, so long as she can run a few laps around the track. The purpose of EBU is to break the credit linkage between Club Med governments and banks. The idea is that, once EBU is up and running, banks will be much less of a contingent liability for the governments and their debt ratios. But the plan assumes that the bad banks will be resolved now, before the linkage is broken.

There are two reasons why this plan won’t work:

1. If the reviews are honest, the recap bill will be in the hundreds of billions. By honest, I mean marking bond portfolios to market or assigning loss reserves against them. Plus the big real estate cover-up will have to end: no more refinancing with new money; no more accrual of unpaid interest; no more sanitizing toxic exposures by converting them into covered bonds. So, if the reviews are honest, and the price tags are dumped on the governments (or bondholders) the crisis will resume.

2. Even after EBU, the government credit linkage will remain because (1) the governments will still be expected to contribute in future resolutions; (2) the ESM is tiny in relation to the scale of the system; and (3) the SRM is predicated on depositor bail-ins which will destroy the banking systems, as it has in Cyprus.

The World’s Opinion Page

Help support Project Syndicate’s mission

subscribe now

Draghi is acutely aware of this problem, and he wants to know who is going to pay the big bill and how. This from Reuters:
“ECB President Mario Draghi has stressed several times that political leaders need to come up with a sufficient backstop before the ECB can embark on its asset quality review in order to cover potential capital shortfalls. So far, this issue is still not entirely solved.”

Not entirely solved? How about, entirely not solved.

http://prosyn.org/HOiHVEN;
  1. Television sets showing a news report on Xi Jinping's speech Anthony Wallace/Getty Images

    Empowering China’s New Miracle Workers

    China’s success in the next five years will depend largely on how well the government manages the tensions underlying its complex agenda. In particular, China’s leaders will need to balance a muscular Communist Party, setting standards and protecting the public interest, with an empowered market, driving the economy into the future.

  2. United States Supreme Court Hisham Ibrahim/Getty Images

    The Sovereignty that Really Matters

    The preference of some countries to isolate themselves within their borders is anachronistic and self-defeating, but it would be a serious mistake for others, fearing contagion, to respond by imposing strict isolation. Even in states that have succumbed to reductionist discourses, much of the population has not.

  3.  The price of Euro and US dollars Daniel Leal Olivas/Getty Images

    Resurrecting Creditor Adjustment

    When the Bretton Woods Agreement was hashed out in 1944, it was agreed that countries with current-account deficits should be able to limit temporarily purchases of goods from countries running surpluses. In the ensuing 73 years, the so-called "scarce-currency clause" has been largely forgotten; but it may be time to bring it back.

  4. Leaders of the Russian Revolution in Red Square Keystone France/Getty Images

    Trump’s Republican Collaborators

    Republican leaders have a choice: they can either continue to collaborate with President Donald Trump, thereby courting disaster, or they can renounce him, finally putting their country’s democracy ahead of loyalty to their party tribe. They are hardly the first politicians to face such a decision.

  5. Angela Merkel, Theresa May and Emmanuel Macron John Thys/Getty Images

    How Money Could Unblock the Brexit Talks

    With talks on the UK's withdrawal from the EU stalled, negotiators should shift to the temporary “transition” Prime Minister Theresa May officially requested last month. Above all, the negotiators should focus immediately on the British budget contributions that will be required to make an orderly transition possible.

  6. Ksenia Sobchak Mladlen Antonov/Getty Images

    Is Vladimir Putin Losing His Grip?

    In recent decades, as President Vladimir Putin has entrenched his authority, Russia has seemed to be moving backward socially and economically. But while the Kremlin knows that it must reverse this trajectory, genuine reform would be incompatible with the kleptocratic character of Putin’s regime.

  7. Right-wing parties hold conference Thomas Lohnes/Getty Images

    Rage Against the Elites

    • With the advantage of hindsight, four recent books bring to bear diverse perspectives on the West’s current populist moment. 
    • Taken together, they help us to understand what that moment is and how it arrived, while reminding us that history is contingent, not inevitable


    Global Bookmark

    Distinguished thinkers review the world’s most important new books on politics, economics, and international affairs.

  8. Treasury Secretary Steven Mnuchin Bill Clark/Getty Images

    Don’t Bank on Bankruptcy for Banks

    As a part of their efforts to roll back the 2010 Dodd-Frank Act, congressional Republicans have approved a measure that would have courts, rather than regulators, oversee megabank bankruptcies. It is now up to the Trump administration to decide if it wants to set the stage for a repeat of the Lehman Brothers collapse in 2008.