Shares rout shows we are still in the dark about health of banks

It used to be the case that reports on the health of European banks merited front-page headlines. Former regulators such as Matthew Elderfield and Patrick Honohan were household names.

Shares rout shows we are still in the dark about health of banks

We have now reached the point where the European Banking Authority (EBA) published a report on the outcome of the 2015 EU-wide transparency exercise and it barely received a mention outside the business sections.

And yet the report provides detailed bank-by-bank data on risk exposures, capital positions, and asset quality on 105 banks, including AIB, Bank of Ireland, and Permanent TSB.

The objective, as described by Daniele Nouy, the new head of the European banking watchdog, the Single Supervisory Mechanism, was to increase the level of transparency and to restore confidence in the continent’s banks.

Ms Nouy hoped the EBA study would help reassure investors by providing detailed knowledge about the banks’ balance sheets.

Initially the study was well received. Analysts appeared encouraged by soothing comments that EU banks continued to strengthen their capital buffers.

Based on these reassuring noises an investor may have been tempted to place some money in European banks.

The week after the publication of the report, the EuroStoxx Bank index stood at a six-month high.

Then roll forward to January and the disappointing results from Deutsche Bank. Its shares fell off a cliff and the banking index slumped 35%.

It was a very bad month to be a bank investor.

John Cryan, Deutsche Bank chief executive, was wheeled out to reassure everyone that the bank was “rock solid”. Attention was focused on so-called Coco bonds.

Ironically, instruments that were introduced in Europe following the crisis which were meant to make banks safer turned out to be destabilising and self destructive.

Investors feared that banks would not be able to sell any more Coco bonds later in the year, creating uncertainty about the sustainability of some banks’ capital.

The shock waves hit Ireland too.

Despite its 30% jump in underlying profits, Bank of Ireland shares have fallen from a high of around 35 cents a year ago to around 26 cents, and losing a quarter of their value at a time when, paradoxically, the Irish economy is posting growth figures at the top of the European league.

What seems obvious is that the continued over reliance by European regulators on technocratic measurements of banking health is not working.

The market seems to feel that the balance sheets of Europe’s banks are still too opaque.

Uncertainty about derivatives and exposures to under-performing sectors still persists. There are unresolved concerns about the adequacy of provisions for non-performing loans.

The message is loud and clear: ‘It doesn’t do what it says on the tin.’

The banking system needs more confidence building measures, not just stress tests.

European regulators prioritise financial engineering and capital adequacy but ignore the fundamental problems that got banks into trouble in the first place —the absence of old-fashioned banking integrity.

If financial institutions went beyond the current regulatory framework and made more comprehensive disclosures about their policies they may benefit from a positive public endorsement.

What we can say is that the recent reaction to losses in the banking sector indicates that the European banking regulators have not yet restored sufficient confidence to the market.

Eight years after the crisis some might say a lot has been done. Others might say there is still a lot more left to do.

Eugene McErlean is a leading expert on banking and corporate governance

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