Will an Asset Quality Review Proceed for European Banks?

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A problem has emerged with the European Central Bank’s plan to assume its role as a supervisor of bank’s in the region, Reuters reports. The ECB is set to begin its so-called asset quality review of European banks over the course of the next few months with the formal announcement of the project set to be made sometime next month. The review is expected to cover primarily four areas of banks’ balance sheet — real estate, small and medium enterprise lending, and legacy assets from before the financial crises — areas that, for some banks, cover up to 75 percent of their assets.

Where the problem lies is what to do after the review is completed. While a handful of optimists expect the review to proceed largely without any hitches, many believe that the review will expose holes in the balance sheets of many European banks. In order to fix those holes, funds are needed, and the European Central Bank isn’t quite ready to be on the hook for the entire sum just yet, especially considering that the amount of money cannot be determined until the review is complete.

Germany takes a similar stance, claiming that they only wish to be responsible for the results of the review concerning the eurozone’s larger banks. If the review is completed without the capacity to fix the problems that it uncovers, many fear that any remaining confidence in the region’s banks would be completely diminished.

Analysts anticipate finding the most problems in small and medium sized banks, many of which have flown under the radar of banking reform while still carrying large numbers of so-called “underperforming” loans. The problem is especially prevalent in countries such as Spain and Italy, where the housing market has continued to remain stagnant. In these countries, a high unemployment rate also contributes to the lack of repayment of loans.

There is also considerable debate over how stringent the asset quality review will be. Proponents of a stricter review point to past efforts that gave Ireland’s banks a seal of approval only to see them require massive bailouts within a year to illustrate the dangers of a faulty scan. However, some have argued that forcing banks to undergo too strict a review would lead to a massive need of funds to plug holes in banks’ balance sheets that are not really problematic, adding that such an action could punish more aggressive banks by forcing them to restructure their asset portfolios.

The news comes as many have reiterated calls for the eurozone to establish a banking union, a measure that cannot be attained without oversight, which in turn cannot happen until the asset quality review has been completed. Any holdup to the review, or to the financing of the gaps that it uncovers, could significantly delay the implementation of such a union. Regardless, the ECB has announced that it is currently accepting applications for staff to fill its supervisory board to watch over European banks.

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