European Banks massively short of meeting Basel III
The European Banking Authority published its second report of the Basel III monitoring exercise. The report provides the aggregate results on capital, risk-weighted assets (RWAs), leverage and liquidity ratios in EU member states as of December 31st, 2011. Here is the key passage:
“Assuming full implementation of the Basel III framework as of 31 December 2011 (ie without taking into account transitional arrangements), the CET1 capital ratios of Group 1 banks would have declined from an average CET1 ratio of 10.3% to an average CET1 ratio of 6.9%. 88% of Group 1 banks would be at or above the 4.5% minimum while 49% would be at or above the 7.0% target level (ie including the capital conservation buffer). The CET1 capital shortfall for Group 1 banks is €8 bn at a minimum requirement of 4.5% and €199 bn at a target level of 7.0%. The latter shortfall also includes the additional regulatory surcharge for global systemically important banks (G-SIB), where applicable. As a point of reference, the sum of profits after tax prior to distributions across the Group 1 sample in the first and second half of 2011 was €82.8 bn.”
“Compared to the previous exercise (reporting date as of June 2011), monitoring results show an increase in Group 1 banks’ CET1 ratio of 0.4 percentage points; the corresponding shortfall with respect to the 7% target level decreased by €32.3 bn or 14.0%. This change for Group 1 banks may partly reflect additional efforts to fulfill the requirements of the EU recapitalization exercise.”
“Group 1 banks’ average Tier 1 and total capital ratio decline from 12.0% to 7.1% and from 14.2% to 8.0%, respectively. Capital shortfalls corresponding to the minimum ratios (excl. the capital conservation buffer) amount to €25 bn (Tier 1 capital) and €85 bn (total capital). Taking into account the capital conservation buffer and the surcharge for global systemically important banks, the Group 1 banks’ capital shortfall rises to €312 bn (Tier 1 capital) and €434 bn (total capital).”
“For Group 2 banks, the average CET1 ratio declines from 10.6% to 7.2% under Basel III, where 92% of the banks would be at or above the 4.5% minimum and 76% would be at or above the 7.0% target level. The respective CET1 shortfall is approx. €10 bn at a minimum requirement of 4.5% and €26 bn at a target level of 7.0%. Compared to the previous period, the average CET1 ratio of Group 2 banks is nearly unchanged at 7.2%. The average Tier 1 and total capital ratios of Group 2 banks decline from 11.4% to 7.7% and from 14.1% to 9.6%, respectively”.
The results are a “cry-for-help” to have a banking union and a federal banking regulator. Also, the findings indicate that European banks will continue to need to either raise capital via equity issuance or sell assets to reduce their capital needs. Lastly and most importantly, the take-away is that European banks won’t be lending aggressively soon and this will continue to weigh on not only Europe, but also any entity that is dependent on European banks for things like trade finance (think EM FE).
There is a solution to this situation and former SNB head Philipp Hildebrand described it in the FT on Monday:
“But a genuine solution to the crisis also requires shoring up Europe’s banking system to restore the flow of credit to businesses and households…Europe must ultimately grow its way out of its crisis. Economies cannot grow unless banks have sufficient capital to lend and businesses have the confidence to borrow to expand their operations. As was the case in the US in 2008 and 2009, central bank intervention cannot succeed on its own. Then, actions by the US Federal Reserve were bold, creative and necessary to help put a floor beneath a crumbling credit system. However, the Fed was limited in what it could achieve on its own. In the US, the end of the banking crisis required private capital investment, encouraged by incentives and financial commitments from the government. The same must happen in Europe.”
To stabilize their banking system and encourage lending, Europe must find a way to inject into their banks to bolster their Tier One capital. A great example of how not to do it, Spain is not using the full E100 billion they have available for their banks. The results of their banking audit/review are due on Friday, but they have leaked they believe only E60 billion will be needed. This is not the “bazooka” needed to provide calm and certainty for the Spanish banking system.
While the initial discussions over a European banking union with the ECB as top regulator were a game changer, the current disagreements over how to proceed are causing markets to reassess their enthusiasm. Today’s EBA report hammers home the reason why the union is needed.
