Compromises could ‘dent’ ECB stress test credibility

Results due on Oct 26

LONDON, Oct 19, (RTRS): When Europe announced its latest health check of top banks early last year it promised a “comprehensive assessment” of how well prepared they were to withstand another financial crisis.

In practice, a spirit of comprehensive compromise has been just as important.

Aseries of Reuters interviews with officials, bankers and others involved in the European Central Bank’s financial inspection of the euro zone’s biggest banks shows that in the seven months since it began, the ECB has had to shoot down countless pleas from banks and national supervisors for special treatment.

At the same time, according to sources who spoke on condition of anonymity, supervisors have revised the way they value assets and banks have failed to provide all the data demanded — multiple compromises that could cumulatively threaten the tests’ reputation as tough and consistent.

The ECB, which takes over as supervisor for the region’s top banks on Nov 4, declined to comment in detail on the issues raised but insisted the exercise was robust and thorough.

It will announce on Oct 26 which of Europe’s 130 biggest banks have valued their assets properly and which have not, as well as whether banks need more capital to withstand another economic crash. Anticipation of the results is already affecting bank shares, with Italy’s Monte dei Paschi falling to an all time low last week amid fears it would be forced to raise more cash.

“This health check ... is unprecedented in terms of scale, rigour, severity and transparency,” a spokeswoman said.

“It provides in-depth information on the condition of the largest banks in 19 countries and aims to strengthen banks’ balance sheets by identifying problems, build confidence and enhance investors’ trust.”

That said, one of the first compromises of the process came just two months into it, when the ECB privately acknowledged, according to sources with knowledge of the discussions, that there were “real dangers” of negative consequences if the banks were kept in the dark about how they were faring right up until the results were announced.

Reviewing

The auditors were then allowed, for the first time, to begin sharing information with the banks they were reviewing.

“We would take a file with the largest (loan loss) provision movement (and) ... told them why we were uncomfortable with provisioning that area,” said one source familiar with the meetings.

The banks could then work out the maximum adjustment to provisions they were likely to face, the source said — a key clue to the ECB’s final assessment of whether they would have to raise more capital or rein in dividends.

“You knew what the major drivers were,” confirmed one senior banker who attended meetings for his company. “I don’t expect any surprises.”

Around the same time, Daniele Nouy, the head of the ECB’s supervisory arm which is leading the exercise, spoke publicly of the importance of banks being given a ‘right of reply’ to the ECB’s findings.

The original process started with just ten ECB employees. More staff and consultants joined the team — which later moved to Frankfurt’s only earthquake-proof building — to spend hundreds of hours crunching the numbers.

A project manager was hired in September 2013 in the form of Oliver Wyman, a management consultancy headquartered in the United States.

A month later, when ECB president Mario Draghi met the chief executives of the banks that would be tested to try to convince them of the exercise’s worth, information was still sparse.

A draft methodology was finally circulated in January 2014 between some national regulators and auditors, as well as ECB officials and the Oliver Wyman team. Details of what was christened the Asset Quality Review (AQR) were kept secret by personal non-disclosure agreements which included a fine of 100,000 euros for any breach.

On Feb 17, the ECB held its first meeting with the experts who would participate in the AQR. Executives from Oliver Wyman faced a crowd composed of national regulators and consultants in the same room in which the ECB gives its monthly press conference on interest rates.

Approach

One attendee described the meeting as “antagonistic”, with delegates struggling to follow the logic of parts of the approach outlined in a 300page draft manual.

At a second meeting, a few weeks later, patience was in even shorter supply: Two sources present said an Oliver Wyman representative responded to one question with the words: “It is not beyond the wit of man to follow the manual.”

For the institutions about to be reviewed, it appeared very much to be “the Oliver Wyman show”, said one banker who was a central figure in his bank’s engagements with the ECB. “The ECB was relying far too much on its consultant,” the banker said.

Oliver Wyman declined to comment on any aspect of this article, citing client confidentiality.

There were not many more meetings before the test manual was published in mid-March.

“The time pressures the ECB was forced to operate under meant there was not really a lot of scope or time for consultation with banks,” said Robert Priester, deputy chief executive of the European Banking Federation.

While banks were getting to grips with the level of scrutiny to which they would have to submit, the manual also showed investors why this round of bank tests would be more transparent than previous ones in 2009, 2010 and 2011, sources said.

Work got underway. National supervisors settled into their new roles as buffers between their banks and the ECB. The ECB battled for consistency. National authorities pushed for concessions. But the latter had limited power.

“The whole process was very prescriptive... (What the national supervisors did) was common sense decision making,” one national supervisory source said. Patriotism sometimes intruded. “That is obvious, that you try to protect your own banks,” a second national supervisor said. “You would not like to see banks in your country fail.”

April and May saw the granting of a major concession, three sources said. Working out the value of banks’ collateral, auditors were initially only allowed to consider developments up to December 2013. This was moved to the end of March 2014 for some countries, including Portugal and Belgium — allowing banks to incorporate more recent values of their assets as those values started to rise.