The European Central Bank reported on Monday that 51 huge euro zone banks are adapting to sudden changes in interest rates and may need to aside more capital against that risk. The ECB also stated that they are still concerned with the bad loans stacking up on balance sheets in the euro zone.
Last week, the European Central Bank supplied new proposals for boosting its monetary stimulus after low interest rates and large bond purchases, which will force banks from 2018 to set aside more funds to cover newly classified poor debts. It may also show additional measures to go through the sector’s huge stock of shoddy debt.
Euro Zone Banks on Poor Loans
Italy’s banks hold approximately 30 percent of the euro zone’s 915 billion euros of soured loans, and the country has reacted negatively to the new measures as they ask the European Central Bank to ease them following a public consultation that will happen until December 8.
When asked about Italy’s concerns regarding the new policies, an ECB executive board member stated, “Since we have found already a solution for non-performing loans going forward, we are still concerned we have to deal with the existing stock. If we have rules in Europe, we cannot always put forward cultural exceptions, especially if these cultural exceptions are... home-made.”
Long recovery procedures have been a disadvantage for Italian banks since the new rules require banks to set aside cash at regular intervals against loan losses.
The ECB member also said, “Bankruptcy laws are still a national competence and judiciary reform is a national competence. So in order to speed up the European banking union... you need to bring your own house in order in every country. Our intention is not to reduce the ability to lend but to have a healthy banking system.”
The European Central Bank still requires processing the most recent data and incorporating them into its policy decision. Markets are expecting the ECB to slash asset purchases by a third on a slated meeting on the 26th of October, while at the same time lengthening quantitative easing by 6 or 9 months and indicating eased monetary policy for a long time to come.
ECB on Interest Rates
After multiple simulating scenarios ranging from a sudden monetary tightening, which was also followed the Lehman Brother’s subsided, the European Central Bank found that most of the 111 euro zone banks are prepared for drastic interest rate changes. The increase in interest rates could mean the banks suddenly necessitate growing capital.
However, the bank said that it needed thorough discussions with 51 of them after finding they may be making themselves vulnerable on massive bets on derivative instruments and overly aggressive models for calculating risk.
Banks in richer countries such as Germany have long complained regarding the ECB’s extremely low interest rates, which have squeezed the margins they make on loans.
The ECB also reported that if interest rates stay at their end-2016 level and no credit growth occurs, the aggregate net interest income would reduce by 7.5 percent. The ECB also warned that banks may be taking much of their client deposits for granted which have failed to account for increase of online banks and higher rates.