Despite solid data, something makes ECB twice as prudent in supervising banks

Autor: Article based upon analysis from Reuters Breakingviews | Link: ECB’s bank loan-loss worries look overdone
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ECB’s top representatives are saying that lenders are overly optimistic while a future recession could pose serious threats to the banking system.

Andrea Enria, Chair of the Supervisory Board at the European Central Bank, sent strong signals recently, worried that too much relaxation could send banks into default.

I sense that an increasingly optimistic attitude is spreading, which generates a certain reluctance on the part of banks to seriously engage in supervisory discussions on the downside risks underlying the macroeconomic and financial outlook”, said Enria in a speech held in Vienna on October 4th.

Since then, ECB’s chief bank supervisor only strengthened his message.

But euro area banks performed well in the first half of the year, reflecting a sector that is resilient and relatively profitable and which benefited from the post-pandemic economic rebound and normalization of market interest rates.

Second-quarter banking statistics from the ECB show data that confirm resilient capital and liquidity levels very close to the highs seen in the first quarter of the year.

The average Common Equity Tier 1 (CET1) ratio stood around 15% and the average liquidity coverage ratio was well above 160%.

The aggregate NPL (non-performing loans) ratio, which stood at 2% in the first quarter of this year, has continued falling, while the aggregate return on equity, which stood at 6% in the first quarter, has reached over 7%.

Net interest income continued its upward trend in the second quarter of 2022.

The results of supervised banks show that this rise was driven by higher lending in the economy and by increasing interest margins, which continued to recover after narrowing during the pandemic.

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The 10 biggest eurozone lenders will collectively generate 121 billion euros of profit before taxes and loan-loss provisions in 2023, using mean Refinitiv estimates cited by Reuters.

So what is Eurozone’s chief bank supervisor worried about?

Enria’s concerns include loans to energy-intensive companies, derivatives exposure to potentially undercollateralized commodity traders, and leveraged-buyout debt.

A more pervasive and widespread financial market volatility may spill over to other non-bank financial entities.

That will expose banks active in capital market financing to heightened market, liquidity, and counterparty credit risk exposures.

A more general worry of the ECB is that banks’ risk models are based on a benign recent history, meaning they might be setting aside too little money to cover losses in a recession.

Indeed, some major banks are now sitting on a lower stock of bad-debt provisions than in 2019, so it’s possible that they’ll be in for a shock.

Nevertheless, lenders’ first line of defense could prove that Enria’s worries are nothing less than an overdone precaution. And that is their earnings, which are soaring.

ECB has a scenario that implies lenders’ weighted average bad-debt charge next year to be 0.8% of loans.

Assuming this comes true, banks’ capital is more than enough for covering loan-loss charges. In fact, they could cover three times as much.

It seems that polycrisis fits well in ECB’s arguments, where troubles on so many fronts – from the war in Ukraine and the energy crisis to high inflation and increased volatility in financial markets make the bank supervisors twice as prudent.