Nouy in Credibility Drive Says ECB Will Let Banks Fail

The European Central Bank’s willingness to let lenders fail will depend on the funds available to wind them down, analysts said, after the new head of banking supervision said some should go out of business.

Daniele Nouy, chair of the supervisory board of the ECB’s regulatory arm, told the Financial Times it’s necessary to accept that some banks “have no future,” and that authorities must “let some disappear in an orderly fashion and not necessarily try to merge them with other institutions.”

Her comments come as the ECB carries out a three-stage assessment of bank balance sheets, culminating in a stress test, before taking over as supervisor in November. It has a “single opportunity” to establish its reputation and credibility, Nouy said in the interview, published today. The central bank may have to balance the desire to take a tough approach with the potential disruption that could occur from letting banks fail without a sufficient financial backstop in place.

“The market is concerned the limit to the toughness will be the amount of financial resources available to put into the sector and that will necessarily curb the potential outcomes,” Jon Peace, a London-based analyst with Nomura Holdings Inc. who has a neutral recommendation on European bank shares, said by phone today. “The jury’s still out as to how severe the test will be.”

The Euro Stoxx Banks Index of 28 euro-area lenders fell 0.8 percent by 5:20 p.m. Central European Time today, trimming the gain this year to 5.3 percent.

An ECB spokesman declined to comment. The central bank published a transcript of the Nouy interview on its website.

‘Last Instance’

The euro area’s political leaders are handing supervision of their biggest banks to the Frankfurt-based ECB to ease the sovereign debt crisis and win back the trust of investors. Global regulators are trying to work out how to allow banks to go bankrupt without causing widespread economic turmoil or requesting aid from taxpayers.

“If there’s an interested party for buying these banks, or if there’s outside capital, that’s fine,” Neil Smith, a banking analyst at Bankhaus Lampe in Dusseldorf, said today by phone. “If there aren’t either of those, then the bank may well fail. It’s in the last instance that the bank fails.”

Backstops are in place for the ECB’s tests, allowing for a “very rigorous” review, ECB Vice President Vitor Constancio told reporters in Frankfurt last week. Banks found to have capital shortfalls can turn first to investors and then to public money, “which is available,” Constancio said.

Some banks will probably fail the ECB’s tests this year, according to Luigi Odorici, chief executive officer of Italian cooperative bank Banca Popolare dell’Emilia Romagna SC.

‘Teutonic Approach’

“Many banks will probably be unable to pass if the tests are excessively strict, while if they’re manageable, some will lose their independence, but that won’t be a disaster,” the CEO said in a phone interview from Modena, Italy today. “I hope that the bar imposed by the ECB will not be too high just to show a ‘Teutonic approach.’”

The stress test will require banks to hold capital equivalent to 5.5 percent of their risk-weighted assets under a scenario simulating economic turmoil, the ECB said last week. While some investors may have considered that level to be lenient, it will allow the ECB to make other conditions of the test more onerous, said Peace.

Nouy told the FT that there is a “firm commitment to do whatever has to be done” to make sure the banks supervised by the ECB are “seen as sound and safe and transparent.” Her remarks come after ECB President Mario Draghi has said the central bank won’t hesitate to fail banks in the stress tests.

“They’re not necessarily saying banks are going to disappear from existence,” said Smith. “They’re simply making a heavy hint that there won’t be state help for these banks.”

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