«BLUEPRINT SERIES 25 EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS Dirk Schoenmaker and Nicolas Véron, editors Thomas Gehrig, Marcello Messori, ...»
According to FMA’s 2015 notification to the ESRB (ESRB, 2015), the Austrian banking sector can be characterised as large in relation to the Austrian economy, and as highly exposed to emerging markets (mostly EU member states in central and eastern Europe, and Russia, Turkey and Ukraine). Austrian banks are also insufficiently prepared for the reduction/removal of the implicit government guarantee and under-capitalised in relation to their European peers. The Austrian banking sector’s very specific ownership structure (with a high share of non-joint-stock companies) renders re-capitalisation difficult in times of crisis.
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Source: Bruegel and Raiffeisen Bank International (2015). Notes: For Bank Austria the following applies to net loans: Turkey: pro-forma (41 percent stake at-equity since 2013); Slovakian unit merged into the Czech unit in 2013; Fitch assumption for Ukranian unit (booked as available-for-sale since 2013).
While generating higher returns on equity relative to lending in the euro area, the banks’ CEE exposure results in asset quality problems as indicated by a relatively high proportion of non-performing loans. The Austrian subsidiaries of Sberbank and VTB have achieved substantially lower NPL ratios and loan impairments52.
Exposure to central and eastern European (CEE) countries A specific feature of the Austrian banking market is its substantial CEE exposure mainly through the three largest banks: Bank Austria, Erste 52 See Gehrig (1998) for an explanation of domestic advantage in cross-border lending because of the presence of local information. In his model cross-border banks face an adverse selection problem highlighted by higher NPL ratios, loan impairments and provisioning.
56 | BRUEGEL BLUEPRINT Bank and Raiffeisen International (see Figure 8). Together these banks comprise the largest group of cross-border banks in the CEE area.
Erste Bank and Raiffeisen International together account for about 20 percent of total CEE lending from the 15 countries that formed the European Union before the 2004 enlargement, while Bank Austria together with Intesa Sanpaolo account for about another 17 percent.
Overall the CEE markets still appear underbanked53. For example, collateralisation in the CEE area in 2014 typically is still below 20 percent of GDP, compared to the euro-area average, which grew from 30 to 40 percent of GDP between 2002 and 2014. Some euro-area countries have collateralisation levels of up to 40-50 percent of GDP. This suggests the existence of further unexploited banking opportunities in the CEE area.
Despite improvements on the asset side, Austrian banks started to reduce their CEE exposures in 2014. Partly this was a reaction to the SSM and the resulting increasingly conservative supervisory environment in their home countries, Austria and Italy54. In particular, Erste Group CEO Andreas Treichl has repeatedly complained about unfair treatment of CEE engagement and supervisory bias in the ECB’s comprehensive assessment55, in the face of which the ECB felt compelled to justify its asset quality review and stress testing procedures56.
53 ‘Underbanked’ is understood here in terms of services provided, not as a measure of banks per customer. In the latter sense, the euro area is largely viewed as overbanked.
54 Among the SIs supervised by the ECB since 2014, only Santander and KBC increased their CEE exposure in 2014 markedly, despite growing NPL ratios.
55 See for example Bloomberg, ‘ECB stress tests biased’ 25 April 2014, or Reuters, 6, June 2014. On Austrian TV (ORF, ZiB2) Mr Treichl said on 26 October 2014: “In Brussels and Frankfurt they haven’t yet engaged intensely enough with this region, and especially they haven’t grasped how strong the Czech Republic, Slovakia and Poland have become” (author’s translation from German), implying a serious lack of expertise on, or knowledge of, regional CEE fundamentals at the ECB and the European Commission.
56 Bloomberg, ‘ECB defends stress test from Erste’s criticism of design’ 24 May 2014.
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Austrian banks continued to reduce the CEE exposures in 2015.
Comprehensive assessment and stress tests The 2014 comprehensive assessment was criticised by the Austrian banking industry and Austrian regulators. There was a widespread sense that the ECB was modifying the fair-value accounting of impaired assets according to its own excessively restrictive interpretations or preferences, and, as widely claimed, in contradiction to Austrian accounting standards, and even IFRS57. In late 2014, ECB officials had to defend themselves repeatedly in the Austrian public debate against the charge of unduly interfering in the banks’ accounting practices. The details of the definition of non-performing loans, or merely impaired loans, and their implementation was a key issue in that debate, because it significantly affected CEE exposures58. In aggregate, the large Austrian banks had to adjust their required Tier 1 capital by less than 1 percentage point because of the differential accounting treatments (0.65 percent in case of RZB).
A common feature of SSM supervision became evident in those early days. In attempts to implement equal standards and to be fair in this respect to all euro-area countries, standards would converge to the 57 For example, Raiffeisen CEO Walther Rothensteiner insisted of the legality of the accounting procedures chosen by his bank, versus the ECB’s insistence on reclassifying loans for asset quality review purposes (Salzburger Nachrichten, October 2014). In their discussion on the innate tensions in the treatment of NPLs and impaired assets in different accounting regimes, Bholat et al (2016) and Roaf (2014) also highlight the particularly conservative ECB approach. They also imply that the standards agreed in the ‘Vienna Initiative’ with respect to problematic exposures in CEE and south-eastern Europe were significantly laxer than the recent ECB policies.
58 While it appears to be closer to the Austrian perspective that renegotiating loans is a characteristic feature of doing business within the CEE area and not necessarily an indication of bad performance, the ECB – in their attempt to implement equal treatment throughout the euro area – as a matter of principle prefers to treat any such renegotiations as indicators of non-performance (relative to the initially agreed contractual terms). Accordingly, the discretionary choices were treated more conservatively by the ECB during the asset quality review.
58 | BRUEGEL BLUEPRINT toughest, most conservative levels. Already within these first months of negotiations, Austrian members felt they were being deprived of opportunities to attract good business for the sake of fending off risky business. These views have been reiterated regularly in more recent disagreements between Austrian stakeholders and the ECB.
The stress test results themselves did not come as a surprise, and Austria banks performed according to expectations. Only ÖVAG (Österreichische Volksbank AG, by then the central entity of the Volksbank system) failed the stress test. But this problem was already being taken care of at the time, and in June 2015 the Volksbank system was reorganised into eight regional groups with Volksbank Wien taking the lead function. The bad assets were transferred into a part-government owned bad bank, Immigon Portfolioabbaugesellschaft AG.
Significant institutions (SIs) In June 2015, the Financial Market Stability Board (FMSB), a newly established institution at the FMA to implement macroprudential regulation, decided that banks with significant CEE exposures (namely Erste Group, Raiffeisen and Bank Austria) would be subject to an extra 3 percent systemic risk capital buffer. This requirement will be phased-in by mid-2017. It is worth noting that these systemic risk buffers were added despite the fact that the systemic risk exposures of the Austrian SIs were declining, according to various measurements of systemic risk such as SRISK (see Gehrig and Iannino, 2016). While the CEE lending business has been largely profitable (especially in the Czech Republic, Russia and Turkey), and significant risk premia had been earned, considerable losses, non-performing loans and tail risks also remain on the books (Romania, Ukraine).
Because of their extensive cross-border activities, two Russian
subsidiaries were determined to be significant by the ECB in 2015:
Sberbank Europe AG and VTB Bank (Austria) AG. These two, and seven other banks in other euro-area countries, were subjected in 2015 to a comprehensive assessment that complemented the one carried
59 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSout in 2014. While both banks passed the asset quality review, they failed to meet the 5.5 percent CET1 ratio under the adverse stress test scenario (reaching levels of 4.1 and 4.2 percent respectively). Both banks were able to make up the shortfall through capital injection by their respective parents before the conclusion of the stress tests.
Less significant institutions (LSIs) The FMA maintains responsibility for supervising about 550 less significant institutions in Austria. The FMA argues that this arrangement provides sufficient flexibility to account for local and regional specificities.
The largest group of less significant banks comprises most local Raiffeisen banks, which are organised in the form of cooperatives.
These institutions are formally independent. As cooperatives, however, they guarantee each other’s obligations, and therefore share each other’s risks. Despite their less significant status, these banks are very concerned about the possible current intention of the ECB to merge them into larger, possibly systemically important players. There is considerable mistrust in the industry about the FMA’s ability to effectively protect them against such schemes. The FMA is seen as executing Frankfurt’s orders and implementing the instructions of the ECB.
Perception and debate In the first 18 months of European banking supervision, the public debate about banking in Austria has been dominated by the resolution of the Carinthian bank Hypo Alpe Adria (and the related bad bank HETA) and that of ÖVAG (see below). The restructuring of Bank Austria, with the transfer of its CEE exposure to the Italian head office of Unicredit Group in Milan, announced in October 2015, also attracted much publicity.
Within the financial community, there are strong rumours about the ECB’s possible intention to restructure the Raiffeisen banks and Volksbanken, and their possible inclusion in the common European 60 | BRUEGEL BLUEPRINT deposit insurance scheme. Banks feel their traditional lending activities are being held back by excessively intrusive regulation, and also by an excessively accommodating monetary policy59. The financial sector is disappointed with the FMA, which does not seem to defend national interests against Frankfurt’s dominance, and is seen as giving in prematurely to questionable requests from the ECB.
There is also a widespread feeling among the the Raiffeisen banks and Volksbanken that both the ECB’s monetary policy and its supervision unnecessarily constrain profitable traditional and hitherto resilient business models. This comes on top of an Austrian bank levy introduced in 2011 in order to recoup some of the cost to taxpayers of the banking sector bailouts of previous years. This bank levy was introduced as a permanent rather than a temporary measure. The ECB’s additional efforts at harmonisation of options and national discretions (ONDs) and its ‘strengthening’ of supervision standards and attempts to create a level-playing field, might reduce (traditional) lending while effectively making it less risky. Accordingly, many observers, especially within the LSIs, sense a strong connection between what they argue is excessively conservative supervision, and low growth and lacklustre economic activity. According to this view, all these developments seriously undermine the competitiveness of the Austrian banking sector, both internationally and at home.
Deposit insurance The 2015 Austrian law transposing the EU Deposit Guarantee Scheme Directive of 201460 leaves the basic depositor protection unchanged at the level of €100,000, and in special cases even at €500,000.
Contributions according to the new law will have to be fully funded by the banking sector. In the previous regime, contributions were shared 59 Laura Noonan (2014) ‘Interview – Erste chief sees bank regulation as biggest constraint on lending’ Reuters, 6 June.
, 60 Bundesgesetzblatt 159/2015: Einlagensicherungs- und Anlegerentschädigungsgesetz.
61 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSequally between the banking sector and the government at a guarantee level of €50,000 each. Accordingly, explicit partial former funding of deposit insurance by the taxpayer has been transferred to the banking sector in the wake of the creation of the banking union61.
Cooperation between the FMA and the ECB The relationship between the FMA and the ECB is portrayed as cooperative in both institutions’ public communications. ECB Supervisory Board chair Danièle Nouy and vice chair Sabine Lautenschläger have been repeatedly invited to present their views at FMA annual conferences, which receive widespread attention from the financial community. The annual conferences meetings in 2014 and 2015 focussed on demonstrating complete supervisory harmony. Even so, Nouy did not shy away from emphasising that the ECB would have the final say in case of a stalemate.
Hans-Jörg Schelling, Austria’s finance minister since September 2014, has strongly supported the SSM in public speeches. In his address to the 2014 FMA annual conference (Schelling, 2014), he clearly invited the cooperation of the financial sector. At the same time he emphasised the need to evaluate the SSM in due course, in particular its roles to improve financing for small and innovative firms and to increase the resilience of the banking sector.
Among regulators, however, the sense of harmony with Frankfurt has increasingly been replaced by an attitude of fatalistic cooperation.
Conflicts with the ECB ‘higher-ups’ are carefully avoided. The feeling is that, whenever Frankfurt-based JST members turn a deaf ear to issues voiced by FMA members, the latter will not insist on making their points. ECB supervisory staff members are viewed by more and more of their FMA counterparts as dominant and insisting on their self-attributed expertise, including on local Austrian matters.
61 Article 25 (3) of the new law allows for additional discretionary government guarantees on a case-by-case basis.
62 | BRUEGEL BLUEPRINT The cooperative banking sector (Raiffeisen banks and Volksbanken) largely regards the FMA attitude as one of appeasement that too easily surrenders the interests of the cooperative banks and of LSIs more generally. In particular, attempts by the ECB to transform cooperative banks into systemically important institutions via forced mergers are a major source of concern. The argument is that the ECB has effective control. The FMA is viewed as having been degraded to a local subsidiary of the ECB, effectively forced to cooperate in implementing the orders from Frankfurt.
Resolution of systemic banks: HETA and ÖVAG While the Austrian banking market is heavily over-banked, structural reform is slow. Because of its connections to political parties, the exit of the failed Hypo Alpe Adria (HAA), however, has attracted public attention.
HAA’s banking license was withdrawn in October 2014 and the remaining assets were managed by HETA under FMA supervision. An independent commission headed by former high-court judge Irmgard Griss, in a report (Griss, 2014) that was widely considered as unusually frank and detailed, attributed HAA’s problems to its close political relationships and supervisory failure, including by the OeNB and the FMA.