July 11, 2019

IMF published its staff report in context of the 2019 Article IV consultation on euro area policies with member countries. The IMF Directors welcomed the further increase in capital buffers of the banking sector and the reduction of nonperforming loans (NPLs), but were concerned about the structurally low profitability in the sector. They welcomed progress in implementing the Financial Sector Assessment Program (FSAP) recommendations, but noted that the overhaul of bank supervision and the review of the bank resolution framework have been delayed. Directors welcomed the agreement on a backstop for the Single Resolution Fund (SRF) from the European Stability Mechanism and encouraged EU leaders to agree on a common deposit insurance scheme.

The staff report highlights that tier 1 ratios continued to increase in most countries and substantial progress has been achieved in reducing NPLs, which have fallen to just under 4% of gross loans in the third quarter of 2018, although the NPL ratio remains in double digits in four countries. EBA stress tests from November 2018 showed that even with a sharp slowdown, no large bank would fail in the adverse scenario. However, continued supervisory pressure is needed for banks where NPL levels are still high. While overall liquidity risks appear low, supervisors should carefully monitor short-term U.S. dollar funding mismatches in some banks. The assessment points out that macro-prudential policies should be used more actively to manage financial vulnerabilities in both housing and corporate sectors. France, for example, has tightened large exposure limits for big French banks lending to highly indebted corporates and some countries have increased their countercyclical capital buffers (CCyB). However, bank-based tools cannot address risks arising from non-bank loans.

Overall, Annex 1 to the report summarizes the 2018 Article IV policy advice and the actions taken to implement these recommendations, while Annex II summarizes progress against the recommendations of FSAP. The report also contains the risk assessment matrix for euro area and a table on the structural reform plans in selected euro area countries, including France, Germany, Greece, Italy, Portugal, and Spain. The authorities broadly agreed with the FSAP recommendations and have started to implement them. As recommended in the 2018 FSAP, borrower-based tools could be legislated, where they are currently unavailable, and used more proactively against risky firms and households. Urgently addressing of data gaps in the area of commercial real estate and non-bank financial institutions is also needed to allow a fuller assessment of financial stability risks. The report mentions that financial sector preparations for a possible no-deal Brexit are well advanced, but there are residual risks. Most U.K.-based banks and investment firms have secured licenses to operate in the EU-27. EC has provided conditional recognition to U.K.-based central counterparties to clear derivatives until March 2020 in case of a no-deal Brexit. For uncleared derivatives, ESMA has temporarily reduced the regulatory costs of moving these contracts to EU-27 counterparts. Banks can continue to issue new minimum requirements for own funds and eligible liabilities (MREL) under English law provided a contractual clause is inserted recognizing the resolution powers of SRB in case of a bank failure. A remaining, albeit unlikely risk, is that a British court might fail to recognize the resolution powers of SRB on the existing MREL.

Furthermore, the report notes that ECB Banking Supervision demonstrated its early intervention powers recently by replacing bank management with its own administrator in an Italian bank last year. ECB Banking Supervision is striving to reduce legal fragmentation of bank supervision by drawing up an action plan to feed into the next review of the Capital Requirements Regulation/Directive (CRR/CRD); however, this review will not be completed before 2022. Progress on completing the Banking Union has stalled amid a lack of consensus on risk-reduction and common deposit insurance. EU leaders have agreed that the European Stability Mechanism would serve as a backstop to the Single Resolution Fund (SRF), which could come into force before 2024 if there is sufficient progress on risk reduction by 2020. The Eurogroup has stated that this will require progress toward a 5% gross NPL target and the MREL targets for all SRB banks, but the details are unclear.

A high-level working group set up to discuss EDIS has focused on the appropriate design of a common deposit insurance scheme in the steady state, while abstracting from transition issues. However, these discussions have not yielded an agreement so far. A technical working group has also been set up to examine proposals for liquidity post resolution—that is, to ensure that a newly resolved bank has adequate access to market and/or Eurosystem liquidity, even in the absence of sufficient high-quality collateral on its own balance sheet. Nonetheless, a broader review of the European bank resolution framework, which was initially scheduled for 2018, has been postponed to the next Commission. 

 

Related Link: Staff Report

 

Keywords: Europe, EU, Banking, Securities, FSAP, Article IV, NPLs, Stress Testing, Macro-Prudential Policy, Brexit, CRR/CRD, Resolution Framework, EDIS, Banking Union, IMF

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