The ECB Should Be Firmer With Troubled Banks

The failure of three banks in less than a month has led the European Central Bank to wonder whether it needs fresh powers to deal with struggling lenders. Some new tools might prove useful, but they aren’t the main thing. What the ECB needs most is the will to resist political pressure and act promptly when necessary.

The recent crisis at Banco Popular, a Spanish lender, showed that the euro zone’s bank regulators can act swiftly when they choose to. Yet the liquidation of Veneto Banca and Banca Popolare di Vicenza, two Italian lenders, happened only after a prolonged and costly delay. In the end, the Italian government had to commit up to 17 billion euros to persuade Intesa Sanpaolo, a rival lender, to acquire the good assets of the two banks.

Evidently, the regulatory system still needs work. European supervisors want to be able to force banks to increase their provisions and raise more capital when the regulators deem it necessary. The so-called Single Supervisory Mechanism can already ask for this, but lenders can often deflect the demand. Stronger powers could indeed help in such cases — though they won’t make much difference with the most urgent problems, where banks are on track to fail regardless.

There, the ECB has to strike a balance. It should act as early as possible to prevent a crisis from dragging on, which would only add to the eventual costs; but it also needs to be sure that a bank is “failing or likely to fail,” or else it will face legal challenges from investors who’ll lose money when the bank is wound up. In practice, political pressure is brought to bear as well, weighing in on the side of undue delay.

The ECB needs to lean against that. And it should keep something else in mind. Banking is an increasingly competitive business, disrupted by new entrants and technologies. The market is less forgiving than it used to be, so turning around a troubled bank is more difficult than before. Supervisors ought to be suitably skeptical when reviewing the business plan of a bank on the brink of failure, and should always insist that a troubled bank raises all the capital it’s likely to need, rather than settling for less.

Getting those judgments right will require clarity and determination more than new powers.

Source: Bloomberg.com