Europe Needs German-Style Supervision of Small Banks

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(Bloomberg View) -- The German banking system is hardly a model for the rest of Europe. During the financial crisis, Berlin spent or set aside hundreds of billions of euros to rescue its lenders. From its banking giant, Deutsche Bank, to many smaller savings banks, there is still no shortage of lenders that are struggling with low profitability.

Yet in one sense, the German banking world is offering the rest of Europe a lesson in transparency. Last week, the Bundesbank and Bafin -- Germany's central bank and the top financial supervisory authority -- published the results of a stress test on the country's less-significant institutions. This level of openness is unique among the euro zone's largest countries and should serve the rest as an example.

Beginning with the creation of the banking union in 2014, euro-zone lenders have faced two different kinds of supervision, depending on their size. Larger banks come under the direct scrutiny of the Single Supervisory Mechanism -- where the European Central Bank teams up with national authorities. They are subject to regular stress tests. Smaller institutions, however, are left to national central banks, which can take a variety of approaches in scrutinizing them, even though the SSM can decide to take direct control of the process if it thinks this is necessary. 

Last week, Andreas Dombret, a member of the Executive Board of the Bundesbank, outlined in a press conference the result of a survey on the impact of changes in interest rates on 1,555 smaller banks, representing around 41 percent of the banking sector. The key result was that 68 lenders failed the test, whose scenarios included a persistent low-rate environment as well as a sudden positive shock to the cost of borrowing. The supervisors also looked at the impact of a sudden drop in housing prices which, they concluded, did not pose a significant threat to the sector.

This exercise, which follows similar ones in 2013 and 2015, offers a level of detail that is unmatched by other major central banks. The Bank of Spain included aggregate details of a stress test it ran on less significant institutions in its 2016 Financial Stability Report but failed to specify how many banks did not pass the exam. The Bank of Italy published a more thorough document last year, offering some information on stress tests it conducted over 44 of the smaller banks it supervises -- out of a total of 462 -- but even this did not match the detail of the Bundesbank. The Bank of France is possibly the least transparent, as there is recently no publication outlining the results of stress tests on smaller banks.

Germany has more banks under the direct oversight of its national supervisors, so perhaps it is only natural it subjects them to greater scrutiny. Furthermore, this is not to say that other central banks disregard what happens in smaller lenders. In many cases, they run stress tests but prefer to keep their results private. Stress tests may not even be the best tool for understanding what is going on in smaller banks; they can be highly demanding in terms of paperwork and may impose an unnecessary burden on local institutions. Central banks may prefer a different approach, based on inspections.

And yet, at a time when markets are increasingly conscious of what goes on in the balance sheets of European banks, more transparency would be welcome. This is especially important for smaller banks, which are not subject to the scrutiny of the markets and where the quality of management can be poorer. In many cases, problems in these banks can plant the seeds of a wider crisis.

There is a case for greater harmonization of the rules governing this exercise. The European Banking Authority is working on a set of draft guidelines for all countries, to be finalized by December. It would also be good to have some minimum requirements for all central banks -- for example, the need to run a public stress test for smaller banks every three years.

Europe has gone a long way to address the weaknesses of its banks. But there are still too many differences over how supervisors handle smaller lenders. Germany is a good example for other countries to look to.

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

Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg View. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times. 

For more columns from Bloomberg View, visit http://www.bloomberg.com/view.

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