A Shifting Landscape

In October 2014, the European Central Bank concluded a year-long assessment of the balance sheets for Europe’s 130 largest banks, known formally as the ‘Comprehensive Assessment’. It revealed a cumulative capital shortfall of €24.6 billion euros among 25 of the euro areas’ largest lenders under ‘adverse’ circumstances. Three out of four of Greece’s largest banks failed to meet the capital requirements imposed by the ECB. While this did not come as a surprise considering the country’s financial troubles, the outcome was in fact less alarming than it would at first seem. Taking capital accretion and projected future earnings into account, only one of the three failed Greek banks were actually expected to fall short in such a scenario – and even then only by a small margin.

However, neither the banks nor the ECB could have anticipated the drastic shift in the political climate signalled by the rise to power of the anti-austerity Syriza party. Its uncompromising stance on the bailout programme coupled with the promise to halve Greece’s debt has frightened many investors. Over 20 billion euros (12 percent of Greek GDP) has already left the country since December. In mid-January, Eurobank and Alpha Bank, Greece’s third and fourth largest banks, sought access to emergency funds from the national central bank. This type of funding, known as emergency liquidity assistance (ELA), is made available to borrowers at a much higher interest rate: 1.55 percent compared to 0.05 percent for ordinary lending. As such, this type of financing is only meant to act as a short-term liquidity bridge, rather than address persistent structural problems such as those facing the Greek banking system.

After the Governing Council’s decision on 4 February to no longer accept Greek bonds as collateral for normal loans, ELA is the last remaining avenue for banks that are in need of liquidity. This squeeze comes at a time when the Single Supervisory Mechanism, the ECB’s banking watchdog, has begun requesting that banks maintain much higher capital buffers than other regulatory agencies have in the past. In some cases, these new requirements are nearly four times the level they were before the 2008 crisis. Furthermore, the Supervisory Review and Evaluation Process guidelines, recently released by the European Banking Authority, will require that supervisors (both national supervisors and the SSM) regard a lenders’ business plan as an integral part of their overall assessment. Although the guidelines will only apply from 2016, this development is still unfortunate from the perspective of Greek banks. It will force them to account for poor market conditions in their planning, which will impact the course their business takes and almost certainly rule out certain money-making opportunities.

It remains unclear how exactly the SSM will react if banks are unable to maintain the mandated capital buffers, or otherwise comply with the prudential requirements it imposes. This has stoked investors’ fears and makes Greece’s banking system appear all the more vulnerable.

The Implications of Banking Union

The Comprehensive Assessment was originally conducted to help the ECB prepare for the task of banking supervision. On November 4 2014, the ECB assumed responsibility for overseeing all euro area banks under the so-called Single Supervisory Mechanism (SSM). The SSM is part of an EU-led effort to increase and enhance financial sector cooperation amongst European countries. Known as the Banking Union, this initiative consists of two pillars: the SSM and the Single Resolution Mechanism (SRM). The purpose of the SSM is to provide a unified and consistent regulatory framework across the euro area, while the SRM will ‘wind-down’ (i.e. help to fail in orderly manner) any bank that is supervised by the ECB.

The mainstay of Syriza’s campaign platform was that it would renegotiate the terms of the country’s bailout agreement with international lenders in order to lessen the painful austerity measures, which have devastated the way of life of so many. However, even if Greece’s new leaders decide to reject any further financing by the troika, there will still remain a measure of international oversight as long as the euro remains the national currency. Furthermore, because conditions under which ELA is provided are also largely determined by the ECB, a degree of international control will remain in this regard as well.

Although the SSM does not have the kind of leverage required to make demands as wide-reaching as those of the troika, its influence over the banking sector is far from negligible. There are estimates that more than 100 new regulatory requirements and guidelines will be implemented in the coming years as a direct result of the SSM. It goes on:

“[These new regulations] will induce changes in all aspects of banking, from the underlying business model, strategy and profit-and-loss statement to the balance sheet and governance structure.”

We have already seen these changes to a certain extent. Last December, the ECB sent out letters to many of the banks it supervises, requesting that they bolster their capital reserves. In January, further letters were published regarding matters such as dividend distribution policies and the SSM’s approach vis-à-vis existing supervisory practices.

However, it’s important to realize that there are grounds for questioning the legitimacy of the SSM. One of the most cited concerns is the continued involvement of national staff in the supervision process. Most of the people who work at the SSM are in fact ex-employees of national supervisors who left their jobs in order to pursue a career at the European level. Furthermore, the supervision of the Euro area’s largest banks is conducted by so-called Joint Supervisory Teams (JSTs), which combine officials from both the SSM and the ECB. On the one hand, it’s not surprising that many SSM staff were recruited from Europe’s existing supervisory bodies. But on the other hand, the people who are now tasked with oversight of the entire euro area banking system are largely the same ones who presided over it before, and during, the financial crisis. These are questions which Syriza might well raise if faced with unreasonable demands from the ECB in the context of bank supervision.

As pan-European supervision is still quite a novelty, it remains difficult to predict how it will affect the market. Investors might see the Banking Union both as either a last line of defence or as yet another regulatory hurdle which merely adds to the cost of doing business. And while it’s reassuring to know that there will always be some measure of European oversight as long Greece keeps the Euro, the very same institution which protects also has the power to levy heavy fines and can significantly impact the business viability Greek banks in other ways too. One scenario worth contemplating is what might happen if the SSM bares its teeth and comes down hard banks which cannot play by its rules. Syriza promised that it would strive to remove Greece from beneath the troika’s heel. If the ECB decides to play tough on supervision, might this be enough for Greece’s new leaders to seriously consider the possibility of leaving the Euro?