Following the 2017 financial crisis, the European Central Bank took drastic action to ensure that the major banks, as well as systemically important smaller banks in the eurozone, improved their governance. Weak management was perceived to have been the primary cause of the failures of some banks. Many are now asking whether the tightening of bank regulation is going too far and stifling the banks’ ability and willingness to lend.
Early in October 2017, the ECB issued new guidelines for public consultation on how banks should provide for non-performing loans.
The proposed changes in provisioning policy would apply to all unsecured loans declared non-performing after January 2018 and would require lenders to post provisions against the entire unsecured part of the lending within two years. In the case of secured lending, full provisions could be spread over seven years.
The background to this drastic change in provisioning regulation is the stark reality that some banks in the eurozone, especially in Italy, Greece, Spain and Cyprus, are sitting on substantial amounts of non-performing loans.
This fact immediately raises the question whether the ECB is right in treating all banks in the eurozone in the same manner, because of the Single Rule Book principle that in practice justifies the one-size-fits-all regulatory regime.
Former Italian Prime Minister Mateo Renzi recently insisted: “If these rules pass, credit to small businesses will be impossible. We are making the same mistakes as 2013.” While some Italian banks are suffering most from non-performing loans on their balance sheet because of past lax lending practices often tainted with political interference, Renzi’s argument is valid.
Banks will have to tighten their lending policies further as these new regulations will have an impact on their capital requirements. Some banks may decide to cherry pick in the loans market by making credit available only to the least risky business.
Investors must be warned in unequivocal terms that particular bond issues are not suitable for those with a low tolerance for risk
This practice will not be good for the economic recovery that the EU is hoping for especially as such improvement must mainly come from small enterprises.
The Italian business newspaper Il Sole 24 Ore reported that the president of the European Parliament Antonio Tajani has sought legal advice to determine whether the ECB was acting beyond its powers when issuing such guidelines. The initial legal opinion received by Tajani was that the ECB does not have such broad powers to impose binding obligations on all banks. Daniele Nouy, the president of the banking Supervisory Board of the ECB, is aware of this expert advice.
While Mr Tajani has been careful to insist that his request for legal advice was based on the importance of following proper procedures rather than to challenge the substance of the proposed ECB guideline, a clash between the ECB and the European Parliament is looking more likely. The ECB president Mario Draghi has tried to calm the waters by stating that he was open to more discussions on this subject even if he insisted that the reduction of non-performing loans ‘is the most important issue’.
Ultimately most political and banking leaders will hope that the proposed regulations will be watered down to keep the financial plumbing in the Eurozone functioning efficiently. If credit to SMEs is blocked, another economic downturn becomes more likely. Neither the ECB nor the European Commission would want this perverse result from stricter regulation.
In the case of Malta, the regulators have to be careful that stricter ECB inspired regulation on lending will not encourage more disintermediation as an increasing number of businesses resort to the bond market to refinance their bank debts or even seek new finance.
The local bond market has tens of thousands of small investors who may not be fully aware of the risks of buying certain domestic ungraded bonds that offer attractive returns but are not considered safe for investors with a low tolerance of risk.
Local regulators, as well as the Malta Stock Exchange, have a duty to smaller investors to ensure that the flight to the bond market by businesses that were formerly financed by banks is not motivated by perceived lighter regulation that seems to prevail in the bond market. This duty is not fulfilled merely by making sure that the risks inherent in specific bond issues are spelt out clearly in the legal documentation. Investors must be warned in unequivocal terms that particular bond issues are not suitable for those with a low tolerance for risk.
Now may be the right time to introduce a credit rating system for all quoted bonds.
johncassarwhite@yahoo.com