At Least the Bankers Did Well With Christine Lagarde

(Bloomberg Opinion) -- With markets in a tailspin because of fears that the world’s coronavirus-hit economies are grinding to a halt, investors are desperately searching for reasons to be confident. The European Central Bank’s decision to let lenders operate through this turbulence with much less capital and cash might achieve the very opposite.

ECB President Christine Lagarde was heavily criticized on Thursday over an emergency monetary package that was deemed insufficient (it left interest rates unchanged) and for failing to display a willingness to do “whatever it takes.” But the menu of relief she offered banks was bold in its breadth and depth. While she might not have offered much solace to Italian bondholders, she cannot be accused of wavering in her support for the finance industry.

Unfortunately, letting banks relax their standards of financial strength won’t make it easier for them to regain the trust they’re so sorely lacking. Those tighter capital rules were critical in moving on from previous crises, which exposed serious weaknesses in the financial system. It’s not clear why loosening them will make bank investors feel more secure.

European bank shares are trading at their lowest level since the 1990s — below the previous nadir of the global financial crisis. The Markit iTraxx Europe index of credit-default swaps on senior unsecured financial debt rose to its highest since 2013.

Much of the investor angst can be explained by the absence of optimism about the region’s economies, which were frail before the coronavirus hit. But it’s hard to see how the ECB’s new measures, well-intentioned as they may be, can make up for that.

In addition to increasing bond purchases, the ECB is offering more ultra-cheap funding to lenders — known as “targeted long-term repurchase operations” (or TLTROs) — for banks to plow into the economy. By lowering the cost and increasing the sum that banks will be able to borrow, the ECB is placing as much as 1.2 trillion euros ($1.3 trillion) of extra liquidity up for grabs. That’s as strong a signal as it can send.

Although lower borrowing costs will help banks roll over their clients’ debts, this may not be enough to help banks expand their loan books, unless demand picks up and the economic outlook improves. 

And the easing up on financial resilience is a dangerous path. In a coordinated response with the ECB, the Single Supervisory Mechanism (the euro zone’s bank regulator) said it would let lenders do without some capital temporarily, and allow them to use more debt instruments, instead of common equity Tier 1, to make up their requirements sooner than expected. Banks are getting a 120 billion-euro boost in capital, according to estimates by Jefferies.

Lenders have been told that they must use this freed-up capital to put money back into the economy, not to line their investor or employee pockets. And some form of regulatory forbearance was to be expected. Banks are the main suppliers of credit to the small- and medium-sized companies that are the industrial backbone of Germany and Italy. Businesses and households, coping with the virus impact, will struggle to make debt payments for months to come. Even when restrictions on movement are eased, companies may not bounce back quickly and demand will be lost.

European banks had been seeking looser rules on bad loans, in an effort to alleviate the hit from an expected wave of overdue debt. At least the ECB didn’t go this far: Easing capital requirements provides a greater degree of transparency for investors on bad loans.

The trouble with easing the rules to this degree, and without a clear framework, is that it augments investor fears of bank frailty. “Banks cannot reasonably run at such low levels, in our view, without being penalized by the market,” said JPMorgan analysts.

The ECB is also rescheduling bank inspections, giving lenders more time to address previous regulatory recommendations, and regulators have postponed bank stress tests to 2021. Investors are going to need to trust the bank supervisors even more.

For a region where national politics still determines how banks are treated when they get into trouble, and where a fragmented market makes it difficult for lenders to pursue cross-border mergers, regulatory forbearance could do more harm than good.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.

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