The Single Supervisory Mechanism (SSM) - Mind the (capital) gap | Whitepaper
In just under five months the Single Supervisory Mechanism (SSM) will start and the European Central Bank (ECB) will take charge of prudential banking supervision in the Eurozone.
The ECB is busy establishing the operational apparatus needed for the new supervisor. Banks designated as ‘significant’ by the ECB – assessed on the basis of balance sheet size or importance to their domestic banking system or economy – are completing the ECB’s comprehensive assessment exercise, designed to test the financial resilience of banks before the ECB takes on responsibility for their supervision.
Through the comprehensive assessment the ECB wants to draw a line under doubts about the quality of assets on all significant banks’ balance sheets. At the end of the exercise, the ECB will decide whether any bank needs to improve its capital position.
Estimates of the size of the capital gap vary. It seems likely that some banks will face shortfalls. Mario Draghi, President of the ECB, has spoken about the need for the comprehensive assessment to be credible through being tougher and more conservative in its assumptions than previous European exercises. The Chair of the SSM, Danièle Nouy, has said that it has to be accepted that some banks have no future.1
Now is the time to start planning for the results of the exercise, in particular for the possibility that banks have to remedy capital shortfalls. Some banks have already taken action, but others have not. The ECB has indicated that banks will have between six and nine months to address any shortfall after the results are made public in October. For those banks that find themselves with a shortfall, their options will be greater the earlier planning and execution start. Moreover, there is the opportunity to tackle broader, long-standing problems, rather than just apply a quick fix.
In this paper we consider the options available to banks and the practicalities of implementing them in this particular context. None of the options available are simple; all of them may be challenging against the backdrop of a Eurozone-wide exercise, where several banks may be taking similar action and given that by the nature of the exercise, banks will have been found to have material balance sheet weaknesses.
Banks do not only need to anticipate the reaction of the market. Regulators and governments may also stake a claim to influencing the outcome. For example, Mario Draghi has said that “what [the ECB wants] to achieve is a ‘good’ form of bank deleveraging, where equity is built up, either through retained earnings or through outright issuance, where deposits rise and where balance sheet reduction takes the form of an asset carve-out, rather than of credit attrition.”2
Just as this is an opportunity for the ECB to start with a clean sheet, so too could it be for banks. The ECB may encourage some well-capitalised banks to make some hard decisions on legacy assets, in the process helping them wipe the slate clean. In some cases this may be received positively by investors.
1. Interview of Danièle Nouy with the Financial Times, published on 10 February 2014
2. Speech by Mario Draghi at the presentation ceremony of the Schumpeter Award, Oesterreichische Nationalbank (OeNB) 13 March 2014
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