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«BLUEPRINT SERIES 25 EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS Dirk Schoenmaker and Nicolas Véron, editors Thomas Gehrig, Marcello Messori, ...»

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Although the Bank of Portugal has placed a capital surcharge on such holdings, there is an obvious potential for further capital consumption in case they are brought to market prices, or if the funds fail to generate the additional value necessary to bring the assets’ intrinsic value close to the current balance sheet valuation130. Total amounts parked exceed €3 billion. A mark-to-market valuation of the banks’ holdings in some of these independent vehicles could enhance the size of their capital needs, especially for those that had most recourse to such schemes.

True sales of NPL portfolios have been small in number, thus making it more difficult to provide a market test of the value of problematic assets.

129 The Bank of Portugal added that BCP had already identified a set of measures to fully cover the shortfall detected, and that, in the particular case of BCP, the stress test did not fully reflect the globally positive developments resulting from the implementation of the restructuring plan negotiated with the European Commission.

130 The market sentiment is that, in most cases, these values are currently above market levels, thus implying a hidden loss.

147 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS

Another controversy arose with the resolution in December 2015 of Banif (designated an LSI by European banking supervision). As mentioned above, the bank benefited from state support in 2012, but the operation’s approval by the European Commission’s Competition Directorate-General never took place because DG COMP maintained that Banif had failed to demonstrate sustainable economic viability.

In the week prior to the resolution, leaks appeared in the Portuguese press that the bank had to be resolved. The subsequent bank run led to its application for emergency support, which was denied, and resolution mechanisms were then activated. The operation resulted in the separation of the original bank into a bad bank, a platform managing NPLs (named Oitante), and the sale of branches, deposits and performing loans to Santander Totta for €150 million. Public support from the Portuguese authorities amounted to €2.255 billion, to cover future contingencies, of which €1.77 billion came directly from the Treasury and the remaining €489 million was provided through Portugal’s resolution fund, benefitting from a government guarantee131.

The Bank of Portugal’s supervision of Banif has been called into question by many politicians and commentators. As noted previously, the Bank of Portugal has established permanent teams in the most relevant institutions and has been showing a more proactive stance than in the past. Nevertheless, the Banif case – notably the lengthy and inconclusive period of discussions involving the bank’s management, the Bank of Portugal, the Government of Portugal and DG COMP – was seen by many as further evidence of the supervisor’s lack of effectiveness, and thus reignited criticism of the Bank of Portugal’s allegedly dovish approach. This has led the public to take a more favourable attitude to the direct role of the ECB in supervising Portuguese banks, although, as noted before, more sophisticated analysts have raised doubts about the ECB’s ability to effectively supervise the system 131 When the resolution occurred, the Portuguese state was already creditor for €825 million, €700 million of which was shares of the bank and €125 million was unpaid CoCos.

148 | BRUEGEL BLUEPRINT at this juncture, since the ECB was involved in the monitoring of Portuguese banks during the 2011-14 assistance programme and was unable to pre-empt the problems in BES and in Banif. There has been great pressure, especially from politicians, for changes in the appointment of the Bank of Portugal’s top officials, especially the governor, and their accountability to elected representatives. On 2 May 2016, the government announced the creation of a working group including the governor of the Bank of Portugal, the president of the insurance regulator and the president of the securities regulator, to propose new institutional arrangements for financial markets regulation, including bank supervision. In addition, the pressure on the Bank of Portugal from politicians and public opinion might have smoothed the ECB’s entry into direct regulation of local players, by indirectly fostering a collaborative approach between the staff of the two institutions: there are absolutely no reports of any problems in the daily relationship between the supervisory staff of the ECB and Bank of Portugal.

There is, however, a growing sentiment that the Bank of Portugal is, in practice, being led by the ECB (and, in some cases, also by DG COMP) in addressing some of the most delicate situations, such as the recent resolution of Banif. In the Banif case, the Portuguese press made express reference to an email sent by Danièle Nouy to Portuguese Finance Minister Centeno132 allegedly promoting Santander as the purchaser of the ‘good bank’ and mentioning her knowledge that alternative offers from US funds were found not to be compliant with European state aid rules by the European Commission.

This episode reinforced the perception of a de-facto secondary role played by the Bank of Portugal, although the latter publicly assumed responsibility for the resolution.

One argument that is often made in Portugal is that the approach to bank problems taken by the Bank of Portugal during the 2011-14 132 See among other reports Bernado Ferrão and João Pereira, ‘Bruxelas ordenou venda do Banif ao Santander’ Expresso, 22 January 2016.





,

149 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS

assistance programme was gradual, avoiding the upfront capitalisation of banks that had been suggested by the troika. In January 2016, Governor Costa stated that he opposed the upfront approach “since that would imply resources not available in Portugal’s rescue package”.

He added that “an exercise performed at the time showed that such front loading would have a financial impact between 28 percent and 33 percent of GDP”133. There is a sense in the market that the scrutiny became gradually more demanding and rigorous and that the advent of European banking supervision in 2014 was an obvious incentive for improved procedures at the Bank of Portugal. Greater proactivity, first by the Bank of Portugal and now with direct ECB intervention, has improved the quality of the banks’ balance sheets. Gradual recognition of impairments, as seen above, has had a direct effect on the quality of bank statements but has also generated increased stress on gradually worn-out capital ratios. At the time of writing, there are great expectations about the handling of the forthcoming recapitalisation of state-owned CGD, seen by depositors as a cornerstone of Portugal’s banking sector (with more than four million private clients, most of them depositors, in a country of 10 million inhabitants), and about the positions of DG COMP and the ECB on the issue.

It is also expected that the ECB will be more demanding on the suitability of the shareholders of banks large and small. This is an area in which the ECB has clearly increased compliance requirements. In the case of BPI, the ECB forced the separation of Portuguese activities from its large Angolan exposure. This resulted in negotiations involving the bank management, the Santoro company of Angola (owner of close to 20 percent of BPI and 49 percent of Angola’s BFA, in which BPI has a 51 percent controlling stake), CaixaBank (BPI’s main shareholder with 44 percent of the capital, but voting rights that were until recently restricted to just 20 percent), an envoy from Portugal’s prime minister, and even the President of the Republic. After an agreement

133 University of Lisbon, January 2016.150 | BRUEGEL BLUEPRINT

was announcing to the market, the situation became confused and the government of Portugal eventually published a decree eliminating restrictions on voting rights in banks, including BPI. CaixaBank then launched an offer for 100 percent of BPI’s shares, and negotiations between BPI’s shareholders subsequently resumed at the end of April 2016.

All in all, the start of SSM regulation in Portugal has been well accepted, at least for daily supervisory activities, and the day-to-day joint work with the Bank of Portugal seems to be running smoothly.

But it is perceived differently by Portuguese public opinion and the business community when there are large one-off interventions, because the sequence of such interventions (BPP, then BPN, then BES and most recently Banif ) has generated public resentment towards banks and the use of public money or public guarantees to rescue them. The business community expects that improved regulation could reduce the risk of such occurrences, and understands that guaranteeing financial stability in an unstable environment comes at a cost.

In political terms, the most talked-about issue at time of writing is the ownership of banks and the apparent bias of the ECB in favour of a consolidation path that could allow major Spanish banks to take over all of the major Portuguese banks except CGD, the privatisation of which is not currently being considered. Although there is no direct evidence of an actual bias, this theme has been on the political agenda since Santander Totta’s involvement in the resolution of Banif. It has led to calls from a number of prominent individuals, including Novo Banco’s first CEO (for a brief period in the summer of 2014) and several past finance ministers, for the cancelation of the current process of selling Novo Banco, though a cancelation remains highly unlikely.

Unlike the previous government, which insisted on non-interference, the current government has openly defended direct intervention in supposed coordination with supervisors and market players, as the BPI case illustrates. The president, who constitutionally has no say

151 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS

in these matters, has admitted to being involved at least in the BPI shareholder dispute, something that would have been highly unlikely under the previous president Cavaco Silva. On 1 May 2016, a manifesto signed by several previous ministers, business leaders and top executives of the Bank of Portugal, including a former governor, called for caution in the process to avoid “dominance by one single country”, an obvious reference to the possible scenario in which Spanish banks might end up owning most of Portugal’s banking sector. The situation remains highly fluid at the time of writing, meaning the lessons for European banking supervision are not yet clear.

11 Spain David Vegara The Spanish banking system The financial crisis has profoundly changed the Spanish banking system. The housing boom prior to the crisis, accumulated macroeconomic disequilibria, the disruption in euro-area sovereign debt markets and the sharp reversal of private external financing flows beginning in the second half of 2011 all combined to put the whole system under severe stress.

The most affected subsystem has been the savings banks (Cajas).

The crisis revealed several weaknesses in many of them. Savings banks previously had no actual shareholders; they were governed by a broad range of public and private stakeholders, and they did not distribute profits. Consequently, their ability to raise external equity was limited, contributing to inadequate capital buffers in the run-up to the crisis. Political interference by the savings banks’ public-sector stakeholders also adversely affected financial stability, while a division of supervisory responsibilities between the Bank of Spain and regional governments undermined the effectiveness of oversight of the savings banks (IMF, 2014).

An ESM-financed financial sector programme was adopted in July 2012 amid a deep recession, severe financial market turmoil, sharply rising NPLs, falling bank capital, soaring borrowing costs for banks and the sovereign, tighter credit conditions for households and firms, shrinking economic activity and rising unemployment. All

153 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS

these left a significant portion of the banking system undercapitalised, which in turn further undermined confidence and the already very difficult outlook.

The programme provided around €40 billion to support the recapitalisation process. An independent asset quality review and stress testing exercise identified those banks that were sound, those that were weak but viable (and were subsequently recapitalised), and those that were unviable (for which restructuring/resolution plans were adopted). Additional measures included the bail-in of unviable banks’ subordinated debt and preference shares, the transfer of loans and other assets to a newly incorporated asset management company (SAREB, Sociedad de Gestión de Activos procedentes de la Reestructuración Bancaria) and private capital-raising efforts.

The legal regime for savings banks was improved, and the Bank of Spain’s regulatory and supervisory powers and procedures were strengthened.

As a result of this process and of previous injections of public capital, the Spanish government (via its Fund for an Orderly Restructuring of the Banking System, or FROB) became the controlling owner of a significant part of the banking sector, holding an estimated 18 percent of all loans in the system, with plans to gradually divest. Ten institutions have been resolved and the number of savings banks reduced to eight, from 45 at the beginning of the crisis. The ESM-supported programme was completed in January 2014, and Spanish banks passed the SSM’s 2014 comprehensive assessment with only minor capital needs identified (only one Spanish bank, Liberbank, was among the 25 that failed the assessment as of end-2013, and it had no capital shortfall left as of September 2014).

Even so, the Spanish banking sector has not completed its recovery.

The sector-wide return on equity was around 5 percent in 2015, well below the cost of capital. Credit growth has been negative in Spain since the beginning of the crisis and only in early 2016 did it start to show timid signs of positive year-on-year growth, while the sector has 154 | BRUEGEL BLUEPRINT seen a decrease of over 25 percent in its labour force and number of branches since 2010 (Banco de España, 2014). The total consolidated assets of Spanish banks, including Spanish and foreign operations, reached €3.66 trillion, or 3.6 times GDP (Banco de España, 2015).

In the wake of the consolidation of savings banks, there are now 14 significant institutions. These include the two large international groups, Santander and BBVA; three domestic medium-sized private-sector groups, namely Banco Sabadell, Banco Popular and Bankinter; seven groups resulting from the consolidation of savings banks, namely Caixabank, Bankia (still owned by FROB), Unicaja, Ibercaja, Kutxabank, Liberbank and Banco Mare Nostrum (owned by FROB); Abanca, a former savings bank acquired in 2014 by Venezuela’s Banesco group; and Cajamar, a cooperative group. Less significant institutions include small rural savings banks and subsidiaries of international banking groups.

The Bank of Spain (Banco de España) is the national supervisory authority while the FROB acts as the national resolution authority.

Overall assessment The establishment of European banking supervision and its initial steps are generally seen in a positive light by the Spanish banking community. With the advent of the SSM, the European project followed the route of increased economic and financial integration in difficult times. Together with improved fiscal surveillance (the fiscal compact) and the creation of the ESM, the banking union is seen as having enabled the euro area to increase its financial and economic ties significantly, even though it was done in the middle of a severe financial crisis.

European banking supervision, which was difficult to imagine not long ago, is now a reality and has achieved significant successes in the face of the main challenges that confronted it. On the organisational front, it had to establish itself and hire hundreds of highly qualified professionals. On the institutional front, it had to develop a brand and

155 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS

a reputation quickly and in difficult times.



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