Regulators outnumber bankers at Frankfurt’s biggest finance conference this week, underlining their importance as the European Central Bank prepares to scrutinize the books of the euro area’s largest lenders.
ECB executive board member Yves Mersch is among 14 regulators, lawmakers and government officials speaking at Euro Finance Week, which started today. Their ranks eclipse the eight bankers set to speak, who include Deutsche Bank AG co-Chief Executive Officer Juergen Fitschen.
“The dice have fallen and there’s a clear hierarchy with the ECB as the new regulator,” said Markus Rudolf, a professor of banking and finance at the WHU Otto Beisheim School of Management in Vallendar, Germany. “Banks want to meet the ECB because they’re all asking themselves what the tests next year will look like and how they may fare.”
The ECB will carry out a three-step examination of about 130 of the euro region’s biggest lenders before taking over banking supervision next year. Europe’s leaders entrusted the Frankfurt-based central bank to oversee the financial system to restore confidence in the region’s banks after the credit crisis of 2008 and Europe’s sovereign-debt debacle triggered the continent’s worst recession since World War II.
Banks globally are facing a torrent of new rules to avert a repeat of the taxpayer-led bailouts that followed the collapse of Lehman Brothers Holdings Inc. That stretches from higher capital requirements under the Basel III framework, which have made some businesses unprofitable, to rules in individual states requiring companies to shed certain risky activities.
The power to drive financial stocks has shifted away from executives and toward regulators. ECB President Mario Draghi told Bloomberg Television last month the central bank won’t hesitate to fail banks in the stress tests, contributing to the biggest decline in the Bloomberg Europe Banks and Financial Services Index in almost two months.
The index, which tracks 44 firms, has jumped 50 percent since July 26 of last year, when Draghi said the central bank was ready to do “whatever it takes” to save the euro.
“There have been significant shifts in power and the dominance lies with the regulators,” said Martin Hellmich, a professor of risk management and regulation at the Frankfurt School of Finance & Management. “Bankers across Europe are looking to Frankfurt.”
Regulators are outnumbering bankers at the main event of this year’s conference in Frankfurt, continental Europe’s financial capital, for the first time in at least four years. The line-up this year compares with a ratio of 11 regulators to 13 bankers last year and nine regulators to 11 bankers in 2011. All three opening keynote speeches have been assigned to ECB and government officials.
The ECB, in conjunction with national authorities, will review the euro-area banking industry before officially taking over supervision next year. Stress tests, which subject the banks’ balance sheets to a range of adverse scenarios, will be conducted with the European Banking Authority as the final step.
The ECB has yet to reveal which loans it will scrutinize most closely on banks’ balance sheets and how it will treat sovereign debt in the stress tests. It set a benchmark capital ratio of 8 percent last month.
The ECB is “tending toward” using a three-year horizon to the end of 2016 in the stress tests late next year, Mersch told the conference today. While the central bank has yet to take a decision on how to treat government bonds, they will be “under pressure” during the test, reflecting market risk, he said.
Draghi, 66, met bank CEOs from five countries last week to discuss the assessment and has scheduled group meetings for today and Nov. 25, according to the central bank. In the closed-door briefings, Vice President Vitor Constancio is giving presentations on plans for the asset review, while Mersch is briefing bankers on preparations for the ECB’s takeover of supervision.
Mersch, 64, was one of the first to take the podium at the Frankfurt conference to discuss the ECB’s vision for Europe’s banking union. Fitschen, the 65-year-old Deutsche Bank co-CEO, is one of three bankers who spoke about “strategies for a post-crisis era.”
He said global banks with investment and retail banking under one roof are best positioned to serve their clients and that lawmakers should wait for rules already in progress to be implemented before planning further action.
Fitschen said he is “quite confident” that the ECB’s assessment along with “the steps that may be necessary in the process” can restore the confidence of investors in the euro area’s banks.
The ECB, which unveiled its three-part plan to assess the financial strength of banks last month, has begun the first stage: the selection of businesses to review early next year.
“This is about determining the riskiest assets and portfolios,” Mersch told the conference. “We’ll take a look at factors like refinancing and liquidity risks.”
The central bank will probably examine toxic assets that lenders acquired before the 2008 collapse of Lehman Brothers caused credit markets to seize, according to Hellmich.
“Shipping loans is just one area the ECB will probably look at,” Hellmich said. “Banks have a lot of assets from before the financial crisis that are weighing on their balance sheets.”
That puts Frankfurt-based Commerzbank AG, the bank rescued by the German government in an 18.2 billion-euro bailout in 2009, and Hamburg-based HSH Nordbank AG, the world’s biggest ship financier, in the spotlight.
Commerzbank became the world’s biggest financier of ships with its purchase of Dresdner Bank and still ranks among the top lenders in the industry, with 16 billion euros of maritime assets at the end of September.
Commerzbank has valued its assets correctly and remains “cautious” when assessing maritime loans, Stephan Engels, the company’s finance chief, told analysts on a conference call this month.
Eleni Papoula, a London-based analyst with Berenberg Bank, says she wants to know what bad-loan definitions and stress-test scenarios will be used so she can determine which lenders may need to raise capital. The ECB has said it will hire about 1,000 new staff to carry out oversight tasks.
“If this review restores credibility of the banks’ balance sheets, it can be a catalyst for the sector,” said Papoula. European leaders also need to create a vehicle that can absorb bad loans and express support for weaker banks as “euro-zone banks face share price underperformance until these other two pillars are in place,” she said.
Mersch said establishing the ECB as a supervisor for the euro area’s biggest banks won’t be enough to solve the industry’s problems.
“We need a European mechanism for winding down banks,” he said. “We seem to be moving millimeter by millimeter in the right direction, so the glass is more half-full.”