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 After reckless lending brought several banks and some governments to
their knees during the global crisis, which is still playing itself
out in a number of euro zone countries, next year's Asset Quality
Review (AQR) by the European Central Bank will judge whether the
banks have done enough to recognize and provide for losses on their
loan books as of December 31.
The results feed into EU-wide stress tests that assess whether banks
need to raise more capital to insulate themselves against future
economic and financial shocks.
A Reuters analysis of the third-quarter results of Europe's 30
largest banks found that almost two thirds of the 27 that report
detailed quarterly figures said their balance sheets were less risky
at the end of September than at the end of June.
Cutting risk means they need less capital.
Assets such as unsecured personal loans, distressed commercial loans
and certain derivatives carry a higher risk weighting, while
government bonds are unweighted.
Swiss bank UBS cut 9 billion Swiss francs ($10 billion) of
risk-weighted assets (RWA) in the quarter by exiting derivatives
positions, while Spain's Bankia traded risky real estate assets with
national "bad bank" Sareb for 19.5 billion euros ($26.6 billion) of
government-guaranteed bonds.
But almost two thirds of the banks took lower charges for loan
losses in the third quarter than a year earlier, and the 'coverage
ratio' — what they set aside for losses relative to their stock of
impaired loans — rose only marginally.
John Paul Crutchley, co-head of European banking at UBS, thought
they would have increased provisions, drawing a parallel with the
way U.S. banks position themselves and their balance sheets before
the Federal Reserve's annual review, so the review won't unearth
nasty surprises.
"It's probably because at the Q3 stage there was a complete unknown
about how the ECB was going to conduct these asset quality reviews
(in euro zone countries) and stress tests," London-based Crutchley
added.
He and Berenberg's London-based banks analyst James Chappell expect
to see more action in the fourth quarter, as banks learn more about
the standards the ECB will apply in the euro zone and national
regulators will apply elsewhere.
At a recent industry event in Brussels, the head of the ECB's AQR
working group, Dutch regulator Anthony Kruizinga, was asked how
banks should prepare their year-end statements if details of the AQR
remain unclear. Banks should be more prudent, he replied. The DNB
and ECB both declined to elaborate.
COVERING ALL BASES
As things stand, coverage ratios vary widely across the EU, ranging
from 94 percent at Commerzbank to below 50 percent at others. The
ratios are difficult to compare across banks since they all use
slightly different metrics, but are expected to be closely examined
in the ECB's tests.
Banks were expected to improve the ratios in the run-up to the tests
by taking more provisions, but coverage ratios rose on average just
3 percent in the year to September 30 among the 22 that report the
data. Nine had lower ratios.
The bank with the biggest drop — Swedbank, down 18.5 percent — did
not respond to requests for comment.
Hot on their heels, Spanish banks BBVA and Bankia cited factors
including the transfer of real estate assets to Sareb, and changes
mandated by their local regulator.
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Stephen Smith, London-based head of transaction services at KPMG,
said banks could also increase provisions in the fourth quarter if
they believe another part of the ECB review — the Supervisory Risk
Assessment (SRA) — might force them to give up on some types of
assets, as portfolios in wind-down attract higher provisions.
Smith noted that banks' low margins and the 600 billion euro funding
gap being filled by the ECB's long-term refinancing operation (LTRO),
which provides cheap loans to banks, might suggest some banks don't
have a viable mix of assets.
"If you're doing a Supervisory Risk Assessment asking yourself
whether or not you've got a sustainable business model here, you can
imagine the ECB would conclude that there's quite a lot of work to
do," he said.
RWA MINEFIELD
While banks are generally encouraged to take a prudent approach to
assessing asset risk, global supervisors from the Basel Committee to
the Bank of England have remarked upon the vagaries of RWAs and the
scope for banks to manipulate them.
The ECB's head of financial stability Ignazio Angeloni told
reporters the AQR could change a bank's overall RWA density — the
relationship between total assets and RWAs — by moving loans from
one risk category to another within a bank's own model.
In the third quarter, 16 of 27 European banks that give detailed
quarterly reports had lower RWA density than a year earlier.
"Given the impact of riskier assets on RWA calculations, there is an
incentive for banks to de-risk ahead of the AQR and stress test,"
said Jonathan McMahon, a partner at Mazars and a senior financial
regulator in Ireland until 2012.
The banks with the biggest falls in RWA density cited changes in the
make-up of their portfolios and denied that they were vulnerable to
having their risk weightings forced up by regulators.
RWA's role in the stress tests, which are being run by the European
Banking Authority (EBA) across all 28 EU countries, is unclear.
There have been talks about 'benchmarking' for RWA treatments to
show how banks compare, putting pressure on those furthest from the
norm. The EBA declined to comment.
"No-one's going to do anything until they've seen the actual details
of what's going to happen in that review," said Berenberg's
Chappell.
The bluntest tool banks have to avoid capital shortfalls based on
their year-end position is to raise more capital before then, but
Chappell doesn't expect that.
"If you're going to do it you're going to announce it as part of
your results, because then you've got the full 2013 results for
investors to look at," he said.
($1 = 0.8982 Swiss francs)
($1 = 0.7323 euros)
(Additional reporting by Himanshu Ojha;
editing by Will Waterman)
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