The introduction of a new single supervisory mechanism (SSM) by the European Central Bank (ECB) will make bank regulation more consistent across the eurozone, which may lead to improved credit positions, says Fitch Ratings in a new report.
The rating agency says that ECB supervision, which is slated to start Nov. 4, will reduce regulatory discrepancies between countries in the region. This, in turn, will improve transparency and comparability, and may prompt some banks to take actions that will improve their credit profiles, Fitch suggests.
Fitch points out that the asset quality review (AQR) component of the ECB’s recent assessment of Europe’s banks reduced the divergence in asset valuations used in the stress tests. But the review’s results still highlighted discrepancies across the region, particularly in the different speeds of implementing the new Basel III capital rules, it adds.
Also, the phase-out timetables for adjustments of securities valuations and intangibles, such as deferred tax assets and goodwill, differ among countries, it says. Fitch says the ECB calculated the impact of transitional arrangements to have been €126 billion, “with banks in Greece, Ireland and Portugal particularly reliant on phase-in rules relative to risk-weighted assets,” it says.
“We believe the [single supervisory mechanism] will help even out these discrepancies, although a transition period will be needed while the ECB establishes precise reporting requirements and banks adapt their systems accordingly,” it says.
It also expects the ECB’s oversight will eventually to bring more standardization of regulatory risk-weights; and, a more level playing field for approving internal models and calculations of risk weights under the internal models’ approach. “A single supervisor is likely to even out default and loss assumptions behind credit risk-weightings,” it says.
The second main component of the eurozone banking union framework, the single resolution mechanism, is to be adopted at the beginning of 2016, Fitch says. The regulatory banking union, in conjunction with new rules on bank recovery and resolution, will reduce the bank bail-out risk that has faced European sovereigns, Fitch says.
That said, it also notes that strong links between banks and their national sovereigns will remain. “The financial health of banks will remain interwoven with the financial health and stability of their domestic economy, which is the source of the bulk of most banks’ loans and deposits,” it says.
Fitch says that bank holdings of domestic sovereign bonds are substantial. “We expect a priority of the ECB in its new role as single supervisor to be a reduction of national sovereign bond holdings, for example by using large exposure restrictions, higher risk weights or both,” it says.
“Eurozone bank balance sheets are weighed down by huge volume of problem loans, particularly in the weakest economies. Reducing these by collateral sales or improved customer performance looks a long way off given the economic outlook in most of the countries concerned,” it concludes.