November 28, 2014 / 9:18 AM / in 3 years

ECB's Nouy says banks must show they can make profits

LONDON (Reuters) - Euro zone banks that failed or scrapped through this year’s health checks will have to demonstrate they can make sustainable profits and may need to sell off loss-making units, the European Central Bank’s top banking supervisor said.

Daniele Nouy, chair of the Supervisory Board of the European Central Bank, speaks at a Thomson Reuters newsmaker event at Canary Wharf in London November 28, 2014. REUTERS/Neil Hall

Daniele Nouy, who heads the ECB’s banking supervisory arm, told Reuters on Friday that simply finding more capital to plug shortfalls uncovered by the stress test may not be enough.

“Partly because of the financial situation in Europe and partly because of the structure of the banking systems in Europe ... the sustainable profitability is probably the main challenge and the main risk for banks in the coming years,” Nouy said.

“They have to establish sustainable profitability.”

She added: “There are a number of banks that went through the comprehensive assessment, but might not go through next time.”

From this month, the ECB became the direct supervisor for the single currency area’s top 120 banks like Santander (SAN.MC), BNP Paribas (BNPP.PA) and Deutsche Bank (DBKGn.DE) with powers to force them to top up their capital buffers or make other changes to keep them safe and sound.

Nouy has already asked some of the banks who struggled in the stress test to resubmit their plans for reinforcing their capital buffers. The supervisor is now also taking into account a broader consideration of banks’ business models, which marks a departure from their earlier narrow focus on capital levels.

“When we review the capital plans of the banks with a shortfall now it’s totally about business model, it’s the most important dilemma,” she said.

“We are not considering that one category of business model is better than another,” she said.

“A lot of bankers are not in denial. They may not be rushing to take measures, but they know this is something they will have to address.”

Jose Vinals, director of monetary and capital markets at the IMF, last month said an IMF study showed only about 30 percent of eurozone banks had a structure able to deliver a reasonable rate of return over time to build capital and support new lending, compared to about 80 percent in the United States.

CATASTROPHE CAPITAL

Nouy, a former Bank of France senior official, warned struggling banks resorting to hybrid debt or contingent capital, which she dubbed “catastrophe capital” because it is written down or converts into equity when a bank is near collapse, to bolster their safety buffers.

“If the bank is not profitable, do we want the bank to use contingent capital with a costly coupon? We are not sure.”

One of the key markets the ECB is trying to push as part of its efforts to revive lending in Europe is the securitisation market, which collapsed during the financial crisis.

The ECB is pushing for lighter capital charges on top quality securitised debt but Nouy made clear that she would not be in favour of laxer capital rules.

“As a supervisor, I am not ready to make a regulatory gift or supervisory gift. I think it can fly very well just by simplicity on high quality. Those are not risk-free assets,” she said. “I hope there is a enough good paper to get it started.”

The ECB will launch a “supervisory campaign” next year that will scrutinise profitability of lenders, and home in on any concentration of risks or dangers from poor quality loans on their books, and risks from misconduct.

Banks will have to consider whether they should be holding on to loss-making or problematic branches and subsidiaries that are not core to the business.

“Sell your branch or sell your subsidiary if you believe you are not able to control the culture or have proper internal control or put adequate people to manage the bank,” Nouy said.

“A lot of significant losses were taken in places that were of small importance vis-a-vis the rest of the group.”

Nouy said the ECB will check the models each bank uses to tot up risk-weightings assigned to their loans, a core calculation for determining how much capital they should be holding.

These calculations vary so much some regulators have looked for simpler ways such as emphasising the leverage ratio, a broader measure of capital to assets on a non-risk weighted basis.

She said it was unclear whether the next stress test of major lenders in the wider European Union will take place in 2015 as the “post mortem” of this year’s health check was still under way.

Additional reporting by Steve Slater

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