|
 In practice, a spirit of comprehensive compromise has been just as
important.
A series 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, rigor,
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.
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.
EARTHQUAKE PROOF
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 February 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.
One attendee described the meeting as "antagonistic", with delegates
struggling to follow the logic of parts of the approach outlined in
a 300-page 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.
CONCESSIONS
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.
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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.
"It was a pragmatic view, it was quite difficult to argue with the
logic of taking the old value," one source said.
Another concession related to shipping loans. In working out their
value the ECB originally wanted to discount cash flow models that
based a ship's value at how much income it would generate for its
owner in the future, and instead value ships based on how much they
would sell for. Eventually it agreed to accept the discounted cash
flow models so long as the final valuation was reduced by about 10
percent, sources said, below what the bank initially recorded.
Almost every bank failed to follow at least part of the methodology
the ECB wanted them to use to simulate how they would perform in a
crisis, said one source familiar with the exercise. They are hopeful
that the ECB will allow them a little wriggle-room, said one banking
regulation expert familiar with the process, having seen it become
more adaptable as the process went on.
"The ECB backed down to some extent. You could also say they became
more realistic, because they realized (the) huge resistance among
banks," the expert said.
DEADLINES AND TRAFFIC LIGHTS
With so much riding on the stress tests, political interest was
inevitable.
Officials were limited in what they could tell politicians about how
the test results were shaping up, so briefings focused on the amount
of capital banks had already raised, a sum that totaled 100 billion
euros between mid 2013 and September 2014 according to the ECB's
estimates
The actual scenarios - theoretical economic shocks that banks had to
prove they could weather – were not publicly disclosed until April.
The detail of the scenarios was devised by the European Systemic
Risk Board, a group chaired by ECB president Mario Draghi that was
set up to improve financial supervision, in consultation with
officials from national euro zone regulators and the EU's banking
regulator the European Banking Authority. Those details were hard
fought, sources say - in particular the size of the fall in economic
growth, property prices and employment that banks should have to
prove they could withstand in different countries.
Many thought the ECB's final deadline would have to move, given the
almost weekly demand for more data.
But it kept the banks in line with a daily traffic lights system
showing which banks had fallen behind - a mechanism some bankers
told Reuters looked like a kindergarten exercise.
But, said one source familiar with the design: "It worked."
After a quiet August, the ECB began discussions at the end of
September to forewarn banks of major issues that had appeared in the
test results - without giving them so much information they would be
forced to immediately disclose it to investors.
As the exercise draws to a close, most believe that this time
around, the results will deliver a convincing verdict on the health
of Europe's banks.
"This is the fourth exercise and - I hope - the last," said one
official.
(Additional reporting by Eva Taylor and Andreas Kroener in Frankfurt
and by Paul Taylor in Paris; Editing by Simon Robinson and Sophie
Walker)
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