European View

EU parliament’s request for derivatives stress test is a signal that must be heeded

by Marco Onado

24 Exclusive content for IT24

It's more than a rock in the pond. The EU Parliament on Wednesday opened machine-gun fire against the European procrastination on the banking issue, with arguments very close to the ideas recently proposed by this Il Sole 24 Ore-ItalyEurope24.

The first issue concerns the problem of banks' non-performing loans, which have exceeded €1 trillion. The European Commission continues to see them as a problem that single countries need to resolve domestically, backing Germany's idea that everybody must put their own house in order before benefiting from the advantages of the monetary union.

But the problem has now become European, as the slowdown of single economies impacts the entire region, blocking the transmission of monetary policy, and becoming a source of possible systemic risks. The Commission has adopted a “chicken hawk” stance that is proving entirely inadequate.

Europe must instead provide a unitary and coherent response to the problem. The message has come from the International Monetary Fund a few months ago, and the OECD reiterated it recently. European supervision authorities have said the same: the European Banking Authority, the Bank of Italy and the European Central Bank have spoken recently.

The EU Parliament backs a proposal largely shared by the three institutions: a sort of common scheme to be harmonized between the different systems of a bad bank that allows lenders to dispose of the exceeding part of doubtful loans, a transaction to be funded with tranches of securities with different levels of risk through a securitization process in order to “buy the time” necessary to collect the guarantees.

The ECB has noted that bad loans, amid provisions and estimated market prices, are 80% covered. The discounted prices offered by specialized operators are the result of different market inefficiencies but also of the privileged position of possible buyers: a classic situation where public intervention becomes necessary.

The European Parliament has endorsed this position and launched the ball in the field of the Commission, which cannot continue to ignore so many authoritative warnings and this important political signal.

The resolution raises another important issue (largely discussed by Il Sole 24 Ore-ItalyEurope24): what to do about the most complex securities which don't have official prices (the so-called level 3 assets) but which represent a sizeable share of assets, especially for the big French and German investment banks.

Like it or not, the Basel regulation, by allowing banks to use internal models to value risks, has created a true bias in favor of financial assets instead of funding productive activities and opened the door to true “manipulation” of risk-weighted assets used to calculate capital requirements.

The European Parliament spoke today about supervision bias, with the impression that the austerity adopted by the ECB when it looks into loan portfolios does not apply when it comes to security portfolios.

The European Parliament has launched a clear and strong political message that the ECB cannot ignore.

Supervision authorities don't have tools other than capital requirements to determine the volume of banking assets. European banks are indeed too big (according to a report by the European Systemic Risk Board) and too focused on financial than productive activity. But to correct these structural imbalances, European policy, led by parliament, should ask what sort of banks we want and what is the necessary legislative framework.

Instead, we continue to be weighed down by problems created by a short-sighted search for “national champions” which today forces French and German global banks to a return on assets (ROA) which represents one fifth of US competitors (for France) and is dramatically at a zero level for Germany. The radical solution of the NPL problem in peripheral countries and the search for legislative and supervision measures to avoid that lending is penalized compared to speculative activity are two sides to the same coin: bringing the European Banking System back to its role of productivity and growth driver.