IMF Says EU Banks Face Further Losses

March 15, 2013, 12:18 p.m. ET

IMF Says EU Banks Face Further Losses

By PAUL HANNON

With anemic economic growth likely to lead to more losses on loans, risks to the financial stability of the European Union remain “elevated,” and urgent action is needed to adequately capitalize the bloc’s banks and establish a shared system for closing down or restructuring failing institutions, the International Monetary Fund said Friday.

In its first-ever review of the health of the financial system across all 27 EU members, the IMF said the bloc has made some progress in addressing the weaknesses that have exacerbated its fiscal crisis and stalled its economic recovery.

But it said much work remains to be done, with banks likely to face higher losses on loans to households and businesses to add to the losses they have suffered on their holdings of government bonds. The Fund added that low economic growth and low interest rates may also weaken insurance companies and pension funds.

“Risks remain elevated, especially in a context of low growth and fiscal retrenchment,” the IMF’s board of directors said. “Regulatory and policy uncertainty, and gaps in policy frameworks also continue to pose vulnerabilities. Further ambitious steps are thus necessary to rebuild confidence and achieve long-lasting financial stability in the region.”

The Fund recommended that bank regulators quickly review the quality of banks’ assets, “based on harmonized definitions of forbearance and non performing loans.” Since the onset of the euro zone’s fiscal crisis, investors have been skeptical of the self-declared soundness of the bloc’s banks, and that has made them unwilling to provide funding to banks.

“The overstatement of asset quality has been one major cause of the banking crisis experienced by some EU countries,” the Fund said.

The Fund welcomed the decision in December by EU leaders to create a single supervisor for the bloc’s banks, but said that must quickly be accompanied by other elements needed for a full banking union.

In particular, it said the bloc should quickly establish a common mechanism for “resolving” troubled banks. At present, the cost of closing down or restructuring a bank is borne by taxpayers in the country in which that bank is based, even if it operates widely across the EU, and even if its failure would have negative consequences for other banks.

“Directors underscored the importance of creating without undue delay a Single Resolution Mechanism,” the IMF said, adding that a common deposit insurance program is also required.

The Fund said many of its directors saw the need for “a time-bound road map” toward establishing both those elements of a banking union.

However, creating such a mechanism is fraught with political difficulty, since it will require taxpayers from across the bloc to pool their resources.

“A few directors considered that progress on this front depends on greater fiscal integration in the EU,” the IMF said.

The euro zone’s fiscal crisis has exposed the difficulties of coordinating policy across 17 different members, and the banking problems that followed have exposed similar flaws in the EU as a whole.

The IMF said those problems are still evident in the way that the proposed single supervisor will operate. Because of restrictions detailed in EU treaties, the European Central Bank’s governing council will have to take decisions on banks, acting on recommendations from a Supervisory Board that draws some of its members from outside the currency area.

“This may open the door to conflicts and accountability problems,” the IMF said.

The Fund also noted that within the Supervisory Board and the governing council, “decision makers may not be fully independent from national interests.” In order to reduce that risk, the Fund said the Supervisory Board should include “a more significant representation of permanent, full-time officials or independent experts” without ties to national governments.

Ultimately, it said EU treaties should be changed to allow representation on the ECB’s governing council for nations that aren’t members of the euro zone when supervisory, but not monetary policy, issues are being decided.

The task of repairing banking systems in some countries is too great for national governments to bear without putting their own financial soundness at risk. The euro zone’s bailout fund—the European Stability Mechanism—is likely to have a role in funding the repair of troubled banks, but to what degree and under what circumstances is unclear.

“Guidelines for the ESM to directly recapitalize banks need to be clarified as soon as possible, so that it becomes operational as soon as the SSM is effective,” the IMF said.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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