ECB Fears Rule Diversity in Bank Assessments

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There is a lack of uniformity in bad-debt classification across the euro area, which could impair a probe by the European Central Bank. The central banking authority is attempting to evaluate the health of member banks, but the inter-country differences might impair that goal, an internal ECB document says.

There are “material differences that, if not considered, would severely affect the consistency and credibility of the exercise,” according to the document, which was obtained by Bloomberg. The writeup was reportedly drafted in November and represents current opinion at the ECB.

The bank probe was also announced in October. An ECB release explains that it was to begin in November and continue for the next 12 months. Three elements comprised the assessment: a supervisory risk assessment to review, an asset quality review, and a stress test to examine the resilience of banks’ balance sheets to different scenarios.

Together, the elements are supposed to give a picture of a bank’s liquidity and risk while enhancing transparency. “The comprehensive assessment will conclude with an aggregate disclosure of the outcomes, at country and bank level, together with any recommendations for supervisory measures,” the press release reads. The findings are scheduled to be published ahead of  November.

In practice, this has proven more difficult to manage. The countries in the eurozone felt the impact of the global recession to different extents. Applying strict bad-debt policies to areas that felt the full force of the economic downturn could negatively impact those banks. Conversely, without enough scrutiny, an accurate picture of the banks and the area’s finances will not be formed.

“A more ambitious definition would be consistent with the need to convey to external observers that the [asset quality review] is a thorough exercise,” the internal document says, per Bloomberg. The ECB said a simplified guideline could not be applied to all countries, and the document left the door open for leeway when investigators are working with a bank.

“Given the possibility to perform more granular analysis during the on-site visits, it is proposed that this analysis takes into account a more ambitious definition including the unlikeliness to repay criterion,” the news service reports the document as saying.

The European Banking Authority standardized definitions for non-preforming loans and “forbearance” in October. Forbearance occurs when a bank eases a loan’s terms based on the borrower’s ability to pay. The definitions were part of an effort to bring consistency to asset quality reporting.

Using the minimum terms of this definition would mean that non-preforming would apply to any debt that is 90 days past due. Implementing this appears to be “feasible for the majority of countries,” the document said. The ECB concluded that only half of the banks would be capable of providing data required by a stricter set of rules to be implemented later this year — that would include information about the likelihood of loan repayment.

Bloomberg reports that country-specific forbearance rules could be used during the assessment. If a country did not have any set standards, loans that granted concessions may be classified as forborne.

“It’s crucial to find common rules and a shared vision to overcome the national lobbies,” Karim Bertoni, a senior analyst on European equities at de Pury Pictet Turrettini & CIE SA in Geneva, told Bloomberg via telephone. “This is the main challenge for the ECB, which would allow a better management of banks and risk control.”

Without common regulations, the perception can persist that the banks are not being held to a high enough standard. In December, Reuters reported that the country-by-country rule changes had become a source of criticism about eurozone bank stress tests.