October 24, 2013

Will the ECB correctly review the disaster in the banks’ balances and assets that Mario Draghi helped to cause?

Sir you write that “a great deal hangs on the drily named ‘asset quality review’ that the European Central Bank is undertaking of the banks it will soon supervise.” “ECB review must have sharp teeth” October 24. We already know what they will find:

First, very dangerous excessive exposures to what banks are allowed to hold against very little capital, because the assets are perceived as absolutely safe, “The Infallible”;

Second, dangerous remnants of exposures to what was ex ante were perceived as very safe and could therefore be held against very little capital, but that ex post turned out to be very risky, among others because of an excessive access to bank credit, “The Ex-Infallible”

And third, they will find an almost total absence of assets of those which require banks to hold more capital, like loans to “The Risky”, medium and small businesses, entrepreneurs and start-ups, something which is extremely dangerous to the real economy.

But will the review state so? You write: “The ECB needs to be conservative. Mario Draghi, a central banker renowned for his political nous, will be all too aware that this exercise is a test not just of bank balance sheets, but also of his own institution’s credentials.”

But Mario Draghi was also for many years the chair of the Financial Stability Board, and is therefore much to blame for the very wrong incentives given to the banks, namely that these could earn much much higher risk-adjusted returns on equity when lending to The Infallible than when lending to The Risky. 

So do you really think the review will state the truth? Which would of course imply that the ECB’s boss credentials are not that good? Or will the ECB try to leave us in our blissful ignorance.

PS. By the way, in your opinion, is a European bank that has 50% of its assets in US Treasury and 50% in German public debt, a good bank?