Mario Draghi’s plan to shine a light on the balance sheets of euro-area banks is forcing lenders that are short of capital out of the shadows.
Draghi, the European Central Bank president, said in Davos, Switzerland last week that his officials won’t hesitate to fail banks in this year’s stress tests and encouraged lenders that need funds to go ahead and raise them.
Austria’s Raiffeisen Bank International AG (RBI) and Italy’s Banco Popolare SC (BP) already announced share sales this year, following capital raisings by Banco Popular Espanol SA, Banco de Sabadell SA, Bank of Ireland and Erste Group Bank AG (EBS) in the second half of 2013. Popolare and Sabadell are among banks that have lifted provisions for loan losses, along with KBC Groep NV (KBC), Deutsche Bank AG and Intesa Sanpaolo (ISP) SA.
“Since the end of 2011, European banks have strengthened their capital base by 80 billion euros,” Olli Rehn, European Union economic and monetary affairs commissioner, told reporters yesterday. “This has been partly done with the view of the expected stress tests and asset-quality reviews, so in that sense banks in Europe are taking pre-emptive action.”
The banks’ efforts to get ahead of the ECB may help Draghi convince investors the ECB’s health check of institutions is thorough and credible. The Frankfurt-based central bank will take over supervision this year of about 130 euro-area lenders, from France’s BNP Paribas SA (BNP) to Bank of Valetta Plc in Malta.
Investors have rewarded banks for increasing capital. Erste shares rose 41 percent since it announced the share sale in July, twice the gain in the 44-company Bloomberg Europe Banks and Financial Services Index. Raiffeisen rose 11 percent since it flagged its deal Jan. 8, while the banking index fell 2.1 percent in the period. Sabadell advanced 30 percent since its capital increase in September. To be sure, Banco Popolare dropped 19 percent since it announced its share sale on Jan. 24.
“On the whole, cleanups have been taken reasonably well,” said Benjie Creelan-Sandford, an analyst at Macquarie Bank Ltd. in London. “There is a first-mover advantage, nobody wants to be the last one coming into the market looking for capital.”
European leaders agreed in 2012 to set up a banking union with the goal of severing the financial links between lenders and sovereigns that fueled the region’s debt crisis. The ECB, which says the union will bolster confidence and underpin economic growth, is hiring 1,000 people to start its supervisory role in November. Finance ministers agreed last month on the blueprint of a resolution mechanism for winding down failing lenders, the next stage in the union.
More to Come
Before becoming the supervisor, the ECB will conduct a three-stage review, known as the Comprehensive Assessment, to identify any capital shortfalls at the region’s biggest lenders.
Since last summer, banks increased their capital by 25 billion euros ($34 billion) by selling shares, loss-absorbing bonds, and assets they don’t consider central to their business anymore, according to Huw Van Steenis, an analyst at Morgan Stanley in London.
Raiffeisen, Austria’s third-biggest bank, last week sold 2.78 billion euros of shares to repay state aid and lift its capital ratio under the newest EU rules toward 10 percent. It followed bigger Austrian peer Erste, which sold 660 million euros of new shares in July for similar reasons.
Banco Popolare, Italy’s No. 4 lender by assets, plans to sell as much as 1.5 billion euros in shares to repay debt and boost capital amid rising bad loans. It’s the third lender in Italy to announce a share sale before facing the ECB balance sheet review, following Banca Monte dei Paschi di Siena SpA and Banca Popolare di Milano Scarl. Spain’s Banco Popular Espanol SA raised 2.5 billion euros in November, two months after Sabadell sold 1.4 billion euros of stock.
Those deals are precursors to more sales, Van Steenis said in his note this week. “Our survey suggested that investors thought 20 billion euros to 80 billion euros likely, and so more progress and disclosure will be needed to greater reassure the market,” he said.
Banks are also setting aside more money for bad loans. Raiffeisen last year took extra provisions in Slovenia, where a precursor to the ECB’s test was executed. KBC took 775 million euros of provisions for Irish non-performing loans. Sabadell and Banco Popolare took set aside more funds in their fourth quarter results, as did Frankfurt-based Deutsche Bank.
“The fact that we’re seeing banks take these pre-emptive moves increases your confidence that the asset quality review itself is going to be fairly stringent and meaningful,” Macquarie’s Creelan-Sandford said. “It’s achieving what everyone wants, which is cleaning up the historical issues and offering greater visibility.”
The ECB’s asset check sets a minimum capital requirement of 8 percent. In a following stress test which may simulate a recession, the ECB favors requiring banks to show their capital won’t fall below 6 percent, two euro-area officials with knowledge of the matter have said.
“Because of this effort of consolidation and occasionally restructuring of the banking sector, I can say that the largest European banks today have a level of robustness that’s objectively equivalent to the big American banks,” Michel Barnier, the EU financial-services chief, said yesterday.
Draghi said at the World Economic Forum in Davos last week that the most important thing is transparency.
“The operation of shedding light on banks’ balance sheets should help them raise capital,” he said.
The banks’ actions indicate they are taking the ECB’s exam seriously and that it may have a bigger effect than previous EU stress tests, in which some lenders that passed had to be bailed out by taxpayers.
“My conviction that the asset quality review and the stress tests will be more cathartic than feared has grown,” Morgan Stanley’s Van Steenis said in his note, summarizing discussions in Davos. “Whilst the tests have yet to be finalized, CEOs I met are convinced the ECB realizes the stakes and will take a hard line.”
That may help Draghi reach the goal of the EU’s banking union project and get credit flowing into the real economy in southern Europe again, said Holger Schmieding, chief economist at Berenberg Bank, in an article for the newsletter of the Official Monetary and Financial Institutions Forum, a research group.
“The ECB’s asset quality review and stress tests are likely to reveal some further capital shortfalls,” Schmieding said. “Once these are dealt with, the credit crunch will probably be over for good.”
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