A hearing at the European Parliament in mid-December caused much end of year excitement in bank capital circles. Chair of the Single Supervisory Mechanism, Andrea Enria, said that greater use of subordinated debt could serve to offset the impact on some banks of common floors on risk weights under the Basel framework.
According to Enria, the EU’s fifth capital requirements directive will give eurozone banks on average 90bps in capital relief in the early 2020s – equating to about €74 billion according to Bank of America research. That’s because CRD5 – part of the implementation framework for the Basel reforms – also newly allows banks to count sub-debt towards some of their individual capital requirements, so-called Pillar 2.
Andrea Enria, ECB
This suggestion that the ECB will not – as previously expected – find ways to universally maintain the equity component of Pillar 2 could, in effect, reduce banks’ additional capital demands over the coming years by about half.
However, as markets did not properly price in a €135 billion Basel hit modelled by the European Banking Authority in July, investors would be wrong to rush back into the sector now that the actual impact may be much lower.
Bear in mind that Enria has his own new weapon against banks with unjustifiably low risk weights in the form of the ECB’s targeted review of internal models. That will cut short celebrations by struggling banks, especially ones with big capital markets operations, like Deutsche Bank and Societe Generale.
Meanwhile, if Enria and his colleagues are now slightly easier on banks, that probably speaks more to the severity of their challenges, rather than presaging an end to the post-2008 regulatory consensus. The same could be said of any slight new regulatory forbearance in the UK, as banks there also need more time to restructure as mortgage margins fall further and Brexit hits.
Banks’ share valuations, of course, are not supposed to be the remit of regulators. But the ECB knows how much its actions are hurting eurozone banks, risking financial stability. Bankers cite a similar reason for what they say is a change in the supervisor’s approach to share buy backs (UniCredit announced one in December).
As analysts at UBS note, keeping hopes for dividends alive is all the more important now that the sector is so fragile. As negative rates serve to cut profits further, lighter regulation is a rare way of making weak banks more appealing to investors. Indeed, capital relief under CRD5 would have the biggest impact on the banks with the lowest valuations, notably the German and Italian lenders.
Still, the regulators’ bigger concern will be that banks can afford more investment in technology, and more redundancies – the latter being especially problematic in Germany, due to the strength of labour laws and trade unions, as at Commerzbank. Allowing bigger dividend pay outs will be merely the reward.