Whilst diplomatically presented as a merger, the union of Spain’s third and fourth largest banks, announced mid-September, is in fact the acquisition of Bankia by Caixa. Shares in multiple European banks rose on the news – Société Générale and Paribas of France were up 5%, Commerzbank’s shares rose 8%, while two other Spanish banks mooted to be considering merging, Sabadell and Bankinter, climbed by 11 and 6% respectively. Many commentators welcomed the news, believing the merger is a force for good. Bigger banks are stronger. However, there are several aspects to this transaction that should be of concern to bank stakeholders, taxpayers and regulators.
Financial and Banking Newsletter
Whichever candidate wins the forthcoming US election, America’s big banks expect continuing concessions in the two key areas of monetary policy and bank regulation. Monetary policy looks unlikely to change much, with the Federal Reserve (Fed) under Jerome Powell committed to keeping interest rates lower for longer, trying to create some price inflation and growth. In terms of regulation, banks expect to be allowed to increase the sizes of their balance sheets. With little investor appetite for fresh equity, this implies a relaxation of the rules restricting leverage. Do banks prefer one candidate over the other?
The usual reaction to major accounting-based corporate collapses is that they are ‘one-offs’. When the truth comes out, it is relatively easy to understand the methods and motives of the bad guys, and yet it always seems surprising that auditors and regulatory watchdogs did not spot the malpractice and stop it earlier. Let us take a brief look back at the major accounting shocks of the past 20 years, the measures taken to prevent these scandals recurring, and then assess the effectiveness of these measures in the light of what we know about Wirecard.
Ever since concerns were first voiced in Germany about the Bundesbank’s exposure to the Eurosystem’s payment and settlement system known as TARGET2, the Bundesbank itself has sought to assuage such concerns. In its March 2011 Monthly Report , the Bundesbank accepted that TARGET exposures constitute risks, but sought to play them down as “risks associated with the Eurosystem’s liquidity supply”. The Report reassured the reader that even if a Eurozone central bank were to default, an actual loss would only arise if the collateral such bank had posted failed to cover the exposure, and even if there was such a shortfall, the “cost of such loss would be shared among the national [central] banks”. The Bundesbank’s view on this subject obviously carries weight. With a net claim of 919 billion euros as at end April 2020, it is the largest creditor of TARGET2.
ECB calls for European Integration via a Common Fiscal Policy Response
ECB President Lagarde announced a keenly awaited new policy statement on April 30th. There was to be no increase to the Euros 750 billion Pandemic Emergency Purchase Programme (PEPP), but the economic deterioration of member states would be closely watched and, if necessary, the size of the programme would be adjusted in the future. She further endorsed the proposed new euros 1 trillion Recovery Fund which is supposed to take the pressure off the ECB in supporting member states’ efforts to rebuild virus hit economies. Media reported that the ECB was ‘keeping its powder dry’.
COVID-19 Responses Attempt to Pull Political Leaders Across Debt Mutualisation Red Lines
In the past month, two new large liquidity injections have been announced. Firstly, a euros 750 billion Pandemic Emergency Purchase Programme (PEPP) was launched to “expand the range of eligible assets under the corporate sector purchase programme (CSPP) and to ease the collateral standards.” And secondly, on 9 April the euros 530 billion SURE funding package (Supporting Unemployment Risks in Emergency) was agreed.
A substantial and growing amount of press attention has been devoted to the subject of Central Bank Digital Currencies (CBDCs) since last year’s announcement of Libra which spooked regulators at central banks who are petrified of losing control of the mint. Central banks have a mixed track record in understanding and predicting trends in alternative payment technologies, and prior to Libra were relaxed that bitcoin was unlikely to attain mass adoption. Jerome Powell, head of the Federal Reserve gave congressional testimony shortly after the Libra announcement denigrating it on several counts. Nonetheless, Libra doubtless turbocharged central banks’ research.
The European Stability Mechanism is Critical to the Future Functioning of the Euro
In the ten years since the first iteration of the European Stability Mechanism (ESM) emerged, its status has changed markedly. Initially, it was just a clever example of financial engineering deployed by the ECB to enable certain EU member states to be bailed out without imposing the costs directly on the better off countries of Europe.
The Brydon Report on Audit. Will Banks’ Financial Statements Become More Reliable?
Sir Donald Brydon, former Chairman of the London Stock Exchange, published just before Christmas his wide-ranging review of the UK audit industry. This is likely to have significant ramifications for bank financial reporting throughout Europe because (with only a few national opt outs) accounting and auditing rules set in London form the basis of the relevant European Union (EU) directives.
In November, Germany’s Finance Minister Olaf Scholz wrote an article in the Financial Times claiming that he had devised a common European Deposit Insurance Scheme (EDIS)[[EDIS has since 2015 been envisaged as a Eurozone-wide scheme which would cover the costs of repaying deposits of up to euro 100,000 lost in future bank failures.]] that could be acceptable to both sides of the hitherto gridlocked debate. Mr Scholz also circulated a document which he believed provided a clever solution to the stand-off between the heavily indebted European member states (‘debtor countries’) and the rest of the Eurozone. In particular, since the 2010 outbreak of the first Greek sovereign-debt default crisis, a number of countries led by Germany resisted debt mutualisation and the sharing of the costs of other countries’ bank failures. In fact, the financially stronger countries demanded new banking rules, which would ensure that any common bank insurance scheme would apply only to banks demonstrably solvent at the scheme’s inception. The stand-off has endured for over two years because the weaker countries, and Italy in particular, continue strongly to resist any reform of the rules which would overtly expose any of their major banks as insolvent.