Are European supervisors gearing up for a phase of more intense bank intervention as a natural by-product of their stance, policies and guidance around Covid-19? The European Banking Authority’s (EBA’s) discussion paper and consultation process on early intervention measures (EIMs), published on June 26, certainly landed at a fascinating time.
Let’s face it: EU policymakers and monetary authorities seem to be purposely and purposefully (albeit no doubt in all good faith) endangering the solvency of the eurozone banking system as collateral damage for an all-out effort to salvage the regional economy from the ravages of the pandemic. In the circumstances, it is perhaps only logical that they should be dusting off under-used EIMs available to them under the Bank Recovery and Resolution Directive (BRRD) as a way of heading off resolution and insolvency – which they want to avoid at all costs.
Of course, the deep irony is that while early intervention is designed to give supervisors the tools to identify and deal with poor practices or activities at the individual bank level, poor practices and activities are in fact being created and enhanced by the very actions supervisors are forcing banks to take. At the outer edges, these actions could be tantamount to an official form of reckless endangerment. So, what exactly are supervisors doing that is so detrimental?
· They are pressuring banks to lend into the sharpest recession in decades, which will force a reversal of the long-run trend of declining non-performing loans.
· They are telling banks to run down capital buffers, underestimate probability of default and reverse current policy and under-provision against bad loans.
· Loan losses will undermine already weak profitability.
· Supervisors had already brought forward a weakening of capital adequacy by allowing certain elements of bank capital to be met with AT1 and Tier 2 instruments rather than core equity.
EIMs have been part of the supervisory toolkit since 2015 and stand as one of the three pillars of the BRRD, sitting between recovery/resolution planning, and resolution. Yet, the EBA states, EIMs have been limited in their application, noting that almost half of the EU’s supervisors utilized measures contained in the overlapping own funds requirement of the Capital Requirements Directive instead.
The EBA thinks this might indicate that EIMs introduced by the BRRD have not increased, to the extent envisaged by the legislator, the capability of competent authorities to prevent a crisis. We do seem to be heading towards some sort of banking calamity (how systemic or idiosyncratic remains to be seen), but certainly one where the solvency of current outliers and potentially other banks may be jeopardised over the medium term as non-performing loans shoot up and business conditions remain weak. Taking resolution politically off the table leaves early intervention as the default option.
Stress testing is the most public aspect of early intervention (EI) in order to offer supervisors an early-warning map. More interventionist aspects lie in influencing banks’ governance and risk management practices, business models, and risk cultures (either through ‘guidance’ or edicts). EBA guidelines currently identify three types of EI triggers: an overall stress test score of four (= high risk) as well as low segment scores; material changes or anomalies in key risk indicators (financial and non-financial); and specific significant events or circumstances that indicate that EI conditions might have been met.
Once EIM triggers are breaches, the tools available to supervisors are pretty wide-ranging. They can force bank management to update recovery plans and quickly draw up plans to overcome problems; they can force shareholders’ meetings so necessary decisions can be made; they can remove or replace members of management bodies or senior management if they’re deemed unfit. They can also require management to draw up debt restructuring or debt renegotiation plans, change banks’ legal or operational structures, force business strategy changes, and have assets and liabilities valued. If that doesn’t work, they can remove entire senior management and management bodies and replace them with temporary administrators.
The EBA conducted a survey last year on the application of EIMs among supervisory authorities and says it sees “significant merit in raising issues stemming from the implementation of the early intervention framework in the BRRD, as well as in the context of other existing supervisory powers, in order to highlight high‐priority issues”. At the current time, there is no higher priority issue than dealing with the effects of Covid-19.
Of the 28 supervisory agencies that responded to the questionnaire, incidentally, only 17 provided a detailed number of EI trigger breaches and detailed breakdowns. Six said that they’d identified some or numerous breaches of EI triggers, but remarkably said they hadn’t kept track of how many. The remaining five reported no breaches (although that was partly down to the fact that they hadn’t implemented the EBA’s guidelines). Not an overly comforting picture.
In summary, official interventionism is the name of the game in the Covid-19 environment. Governments have taken control of huge swathes of their economies, endangering and then demolishing them through uncompromising lockdowns and other measures administered by law enforcement. They have done this while seeking to balance the damage by adding massively to indebtedness that will be a huge burden on populations for years to come.
Banking policy over the coming one to two years will be critical. The deadline for responses to the EBA’s consultation is September 25.