The most important thing happening in the European economy over the next year is the ECB’s comprehensive assessment of large euro area banks. This process will involve an asset quality review, a supervisory risk assessment and a stress test followed by the requirement that banks be recapitalised to address weaknesses that are found. Yesterday, we got a preview from Ireland as to how this process might work and it wasn’t at all pretty. In fact, it was pretty shambolic.
Because Ireland’s banking sector played a major role in sending the country into an EU-IMF program, the troika decided that Ireland’s bank assessment should begin prior to the other countries. So yesterday, the three Irish banks involved in the European bank assessment announced that they had received the results of a “balance sheet assessment” of their accounts of June 2013 from the Central Bank of Ireland (the terminology in relation to the comprehensive assessment changed over the course of the year but this balance sheet assessment appears to be what the ECB now calls an “asset quality review”.)
The timing of these announcements now looks a bit awkward. Originally, the idea seemed to be to have the announcements take place just prior to the ECB’s process for other countries but the timeline on the ECB’s assessment has slipped. It will now review bank balance sheets as of December 31, 2013, so interpreted strictly the Irish banks will need another balance sheet assessment again early next year. This begs the question why the Central Bank of Ireland (and ECB, who must have been involved) bothered to release the assessment of the June 2013 books at all.
If the timing of the balance sheet assessment was bad, the handling of the announcements was far worse. As of yet, the Central Bank of Irelandhas made no statement whatsoever on the balance sheet assessments. (Here is its list of press releases.) Instead, the three banks involved all released their own statements with varying amounts of information disclosed.
Revealing the most information was Bank of Ireland. This bank released a sheet of information (“Schedule 1”) that looked like something provided to it by the Central Bank of Ireland. The sheet showed that the Central Bank believed capital was lower and risk-weighted assets higher than the bank’s own accounts showed.
Calculated according to the 2014 regulatory capital rules, the Central Bank believes Bank of Ireland had a common equity tier 1 capital ratio of 9.85% in June while the bank’s own accounting treatment showed a figure of 13.8%. This 9.8% is still above the 8% ratio that will be required by the ECB following next year’s exercise. However, it would be below the 10.5% requirement that the Central Bank of Ireland has itself set in recent years. By this year’s regulatory capital rules, the Central Bank views Bank of Ireland’s common equity tier 1 ratio as 10.6% which is just above this requirement.
Does this mean that Bank of Ireland’s capital ratio is about to be written down by four percentage points? The Central Bank is its regulator so you might imagine that this would be the case. However, Bank of Ireland’s statement contains a number of criticisms of the Central Bank’s calculations. Indeed, the bank “remains confident in its own methodologies, calculations and impairment provisions” and the statement merely says the results will “remain subject to ongoing engagement” with the Central Bank.
The Central Bank certainly has the powers to compel Bank of Ireland to raise capital on the basis of its own assessment and this may be what happens. But it is not clear to me whether Bank of Ireland will be forced to release year-end accounts calculated in line with the methodologies preferred by the Central Bank of Ireland.
All told, it’s hard to know what Bank of Ireland’s reported capital ratios will be in its next report. However, the fact that a stress test has to be done next year and that this exercise will involve further (yet to be determined) capital requirements suggests that the bank will probably need to raise more capital.
If things are a little unclear with respect to Bank of Ireland, the situation is clear as mud when it comes to the other two banks that made announcements yesterday.
Allied Irish Banks (AIB) put out a terse announcement unaccompanied by a Schedule 1 sheet. It stated
AIB has been advised of the findings of this review which it will consider in the preparation of the bank’s year end December 2013 provisions and financial statements.
Based on an initial assessment of the findings of the BSA, the Bank believes it continues to be well capitalised and in excess of minimum regulatory requirements.
You might be tempted to read that statement and conclude that AIB’s “Schedule 1” sheet showed that it was well-capitalised and did not need to raise new capital. I think that’s a bit optimistic. AsBill Clinton might say, it depends on what the meaning of “Bank” is.
Given that the “Bank” in question had to do “an initial assessment of the findings” to come up with the “belief” that it is well capitalised, then my interpretation is that the “Bank that believes” is AIB. (The capital B being an affectation the bank (all lower case) likes to use in press releases.)
So the bank (or Bank …) believes that it’s well-capitalised. Well good for them. But remember that Bank of Ireland also disagreed with the Central Bank and believe their own figures are better. So there’s a lot of subjective beliefs floating around here. Most likely, AIB’s Schedule 1 sheet shows that it requires more capital.
Then there’s the most tight-lipped of the three banks, Permanent TSB, who provided no figures and simply stated
Based on the communicated results the outcome confirms that the capital position of permanent tsb plc is above minimum regulatory requirements.
What this means depends upon whose notion of “minimum regulatory requirements” you’re thinking of. It could mean above the Central Bank of Ireland’s guidelines of 10.5% or it could mean above the current European CRD4 minimum common equity ratio of 3.5%. A cynic might suggest that if it was the former then the bank would have released the results. Perhaps modest PTSB (who describe themselves without using a single upper-case letter) are hiding a set of fantastic results. Perhaps not.
The Central Bank of Ireland and the ECB should remember that the purpose of this exercise is to bring clarity to bank balance sheets. Yesterday’s events achieved the exact opposite with people scratching their heads interpreting strangely-worded statements and wondering about the figures that were not reported.
The ECB needs to use yesterday’s events as a lesson. It would not be acceptable for this kind of shambles to be repeated whenever the first stage of the ECB’s comprehensive assessment is completed. Either all banks involved in the process reveal the details of their assessment or else the whole exercise should be conducted in secret. Allowing stronger banks to report results while we are left wondering about the weaker ones is a recipe for financial instability.