Home » The ECB Is Getting Out Of Kilter With The Federal Reserve

The ECB Is Getting Out Of Kilter With The Federal Reserve


The ECB is under twin pressures, both of which are only likely to increase. Firstly, with interest rates stuck at minus 0.4% ECB policy is diverging from Fed policy; secondly, problems with Europe’s banking look likely to be highlighted soon by the ECB’s Supervisory Board.

A) Interest Rate Policy and ‘Tiered Interest Rates for Banks’

At a recent event in London, Patrick Harker of the Federal Reserve Bank of Philadelphia observed that the US Federal Reserve Bank must be mindful of the need to synchronise interest rates globally. Unfortunately, he appeared unaware that the ECB has no chance of matching the US central bank’s ambition to raise interest rates possibly as high as 3% in one or three stages in the next 18 months. In defence of the ECB, known problems in banking – such as Deutsche Bank’s continued overtures regarding a possible merger with Commerzbank, and Italy’s Banca Monte dei Paschi di Siena’s (BMPS) continuing problems — wear heavily on the ECB’s interest rate decisions. BMPS failed and was bailed out by Italian taxpayers in December 2016, then was refloated in July 2017 with its shares priced at euros 6.49. Today its shares trade at euros 1.28. Put differently, it is bust; the tiny but positive share price is akin to an option premium on the chances of yet another bailout that might benefit shareholders.

Lest the reader be inclined to dismiss these two stories as isolated examples, consider the recent news that the ECB is considering yet another new policy initiative designed to inject cash into struggling banks – ‘Tiered Interest Rates’, which translates as giving back to banks the estimated €7 bn of negative interest which the ECB earns on banks’ deposits. To date, the ECB’s plethora of loose money policies has always been presented, relatively successfully, as part of its legitimate macroeconomic mandate to stimulate lending and boost Europe’s economy. ECB critics counter that all that these policies have achieved is the keeping afloat of struggling Systemically Important Financial Institutions (SIFIs).

Such positive presentational spin will be difficult to apply to the putative ‘Tiered Interest Rate’ policy. This policy is blatantly motivated by the ECB’s desire to donate to banks the ECB’s legitimate earnings given its decision to keep its bank rate at minus 0.4 %. There are accepted reasons (reasons with which we disagree, by the way) for the imposition of negative interest rates; chief among them is the importance of assisting Europe’s SIFI banks’ weathering of the continuing (10 years +) GFC storm. The ECB has stated that banks should lend to real economies and be discouraged from parking funds with the ultra-safe ECB; hence the negative rate. As the global economy risks slowing further this could prove a significant headwind to Eurozone bank profitability.

Therefore, should the ECB adopt any Tiered Interest Rate policy, it will be exposed to the charge of ‘running with the hare and hunting with the hounds.’

B) The ECB’s Supervisory Board is Investigating Banking Problems

The new Chair of the ECB’s Supervisory Board (SB), Andrea Enria, published his “Introductory Remarks” on March 21st. As usual, the mainstream media focused on the comforting message he sought to convey, namely that in the five years since Banking Union incepted the SB has learned its lessons and now proposes to further minimise the chances of a GFC2 by i) developing and implementing a ‘Crisis Management Framework’ and ii) upping its game in the perpetual battle against money laundering.

Regarding this latter point, the SB along with other ECB sister institutions (such as the European Banking Authority) has clearly been rattled by the Den Danske Bank, Tallinn branch 230 billion USD scandal. The impact of this story is more serious than most commentators have realised. Firstly, the Danish authorities knew it was going on almost ten years before the story came to light; secondly the supposedly tech savvy Estonian authorities failed to notice any unusual activity but still accept no responsibility and even today continue to simply blame the Danes. Thirdly, the sums are so large, and the laundering was so easily carried out, that the criminals had no need to open up any other money laundering channel to cleanse the fruits of their nefarious activities, meaning that many smug smiles of satisfaction have quickly been wiped from the faces of regulators in other EU member states – officials who had naively previously celebrated the effectiveness of their oversight. Swedbank is also implicated in this scandal with its Estonia Branch washing Russian money, events which claimed the scalps of its CEO and Chair.

The new “Crisis Management Framework”, appears to reflect the fears of Mr. Enria and his Board that many large banks are in terrible shape. Two acronyms, new to us, go some way towards clarifying this point:

  1. 1. SREP (Supervisory Review and Evaluation Process). In fairness to the SB, understanding the condition of all of Europe’s SIFI banks has been no easy task, even 5 years after supervisory powers were vested in it. The SB’s problem is that the primary supervision is still the domain of national authorities heavily influenced by governments wishing to suppress bad news. SREP is the SB’s way of addressing this by assessing how multiple regulatory rules are enforced by national authorities.
  1. 2. TRIM (Targeted Review of Internal Models). It is common knowledge that the Basel rules since 2008 have allowed banks to self-assess the riskiness and hence regulatory capital weighting of their own assets. It is widely known that banks game their internal models to the hilt. Supervision of these models is of course the responsibility of national central bank regulators, but of course they are ‘influenced’ as explained under the SREP point above. To Mr. Enria’s credit, the SB seems to be on top of this problem:
“TRIM has helped to form a common understanding across the SSM of regulatory requirements related to internal models. Furthermore, it has allowed us to identify the most common shortcomings of internal models used by significant institutions”

In tandem with the above two programmes, Mr. Enria specified the SB’s increasing focus on the problem of Non-Performing Loans which in our view continue to zombify many banks. Detailed NPL measurement, reduction targeting, and bank-by-bank strategy assessment guidelines have been issued by the SB to national regulators. Concerns about solvency are revealed both by Mr. Enria’s emphasis on detailed accounting guidelines, and his openly expressed concerns that bank assets are not being valued on a consistent basis across EU jurisdictions:

“Finally, supervisory activities planned for 2019 include work relating to trading risk and asset valuations as well as ongoing preparations for Brexit”

Despite these eminently sensible areas of focus, we genuinely wonder if Mr. Enria fully understands the probable impact of this possible crackdown, if the programmes are indeed pursued with integrity and vigour. It is entirely possible that the incoming Chair has fallen into the trap of believing in the established measures of bank health. Under the subheading “Building on a Solid Foundation”, the reader is reassured that NPL volumes have been substantially reduced, from euros 1 trillion (2015Q1) to euros 628 billion (2018Q3). However, as we have explained, the bulk of this has been achieved by legal and accounting sleight of hand; by for example securitisation structures that indenture taxpayers and do not remove the NPLs from the bank’s balance sheet in any real sense, in that banks will still be obliged to cover expected portfolio losses.

In similar vein, Mr. Enria argued that Europe’s banks have been getting stronger by citing the Common Equity Tier 1 (CET1) industry wide regulatory capital ratios. The pan Europe ratio has strengthened from 11.3% (2014Q4) to 14.1% (2018Q3). But CET1 is a discredited measure of solvency or robustness.


It is entirely possible that senior executives of the ECB and their tributary limbs, and of national central banks have become so wedded to the banking recovery story that they have contracted a variant of “Stockholm Syndrome”, the term used to explain hostages’ love affairs with their captors. This fear of addiction to the false recovery story is further reinforced by a recent pronouncement by Francois Villeroy de Galhau, Governor of France’s central bank and an ECB board member. He acknowledged that Europe’s banking system is clogged up and is not working across national boundaries, but attributed responsibility for this malfunctioning to excessively onerous capital requirements imposed on banks who have subsidiaries in other EU countries.

Combined with the tacit admission of interest rate setting impotence as demonstrated by reports of possible ‘tiered’ interest rates, the noble efforts of the Supervisory Board led by its new Chair might inadvertently result in a more overt exposure of the truly parlous condition of European banking.

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