Banking — union or disunion

March 11, 2014

EU finance ministers face the mammoth task of finalizing everything on banking union that was set out in principle by their leaders at a December summit, since when not much has happened. Last night, the Eurogroup of euro zone finance ministers made little progress bar agreeing that they needed to agree quickly.

Intractable issues such as who decides when a bank is failing, how a decision is taken to wind down a failing bank, what is the precise role of the European Central Bank, European Commission and European Parliament and how long it will take to build up a fund from bank levies to pay for failing lenders all have to be sorted out.

Plan A was for the fund to be built up over 10 years and then be pooled but critics say that leaves the bloc’s governments exposed for too long.

European governments disagree not only amongst themselves on the details but also with the European Parliament, which must give its blessing before the project can become law.

Negotiations are set to stretch into Wednesday. If agreement is not reached this week the parliament will run out of time before May elections and then the project will face months of further delay.

The banking union is supposed to break the vicious circle of indebted states and the banks that buy their debt. Euro zone banks now hold about 1.75 trillion euros of government debt, equivalent to 5.7 percent of their assets and the highest relative exposure since 2006, according to the European Central Bank. In Italy and Spain, roughly one in every 10 euros in the banking system is now on loan to governments.

Separately, the ECB will divulge more details of the methodology behind its health checks of Europe’s banks which will give the 128 banks being tested their most explicit insight to date on how their books will be examined by inspectors looking at whether they need billions of euros of extra capital to strengthen balance sheets. Estimates of the capital shortfall range from 280 billion euros to as much as 770 billion.

Informed sources told us yesterday to watch out for the point at which ECB views loans as becoming impaired, and the way ‘hard to value assets’ are treated. This is crucial in dictating how much damage to the financial system the ECB health checks will show – if a loan’s status is changed from performing to non-performing, it would have a higher probability of default and force a bank to set aside more capital to provide for higher likely losses.

We know that the simple rule of thumb would be that any loan more than 90 days overdue is non-performing, but there will be other triggers that also suggest full repayment is unlikely, It is those that banks may not have fully factored in.
Only when this process is complete late this year is much-needed bank lending to the real economy likely to pick up.

Bank of England Governor Mark Carney and colleagues appear before a parliamentary committee. They are there to talk first about the economic outlook, then Scotland and lastly Carney will be pressed about oversight and an internal review into whether Bank staff turned a blind eye to possible manipulation of key rates by foreign exchange traders.

A pro-Russian force opened fire in seizing a Ukrainian military base in Crimea on Monday and NATO announced reconnaissance flights along its eastern frontiers.

Today, the Ukrainian parliament is sitting and ousted president Viktor Yanukovich will make a statement in Russia which may offer legitimacy to Crimea’s leaders. Barring an inadvertent sparking of hostilities, there is not much percentage in Russia putting its forces in Crimea onto a more aggressive footing ahead of Sunday’s Crimean referendum so we may be in something of a holding pattern.

The U.S. has already imposed some sanctions on Russia and the EU is threatening to follow suit unless Moscow comes to the negotiating table. French Foreign Minister Laurent Fabius has just said that sanctions could be imposed this week.
Washington said the U.S. and Russian foreign ministers could meet this week but only if Moscow was prepared to engage seriously on a diplomatic solution.

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