As the European Banking Authority happily announced last week that its bank recapitalisation programme was not hurting the real economy, the question arose, again, over the point of the exercise. With sovereign paper rallying hard this year, leaving the grim second half of 2011 a distant memory, it’s only natural to wonder whether banks should still be holding capital against last September’s mark to market losses.
But the answer is that they should.
The EBA brought this upon itself when it said last week that it would “continue to monitor the need” for the extra capital, leading to the suggestion that it was considering dropping the 9% core capital requirement.
The ratio is calculated by putting Basel 2.5 risk weightings on banks’ September 2011 balance sheets, including market marks on sovereign paper. Banks have till the end of June to meet the requirement.
Sovereign debt prices have strengthened sharply since the exercise was designed in the darkest stretch of the fourth quarter last year, but that does not mean the formulae should be revised.
For a start, it would shatter the credibility of the EBA. And it would constitute a reckless bet that the market will not go back down as fast as it has come up.
But most importantly, it would ignore the success that the recapitalisation effort has had already.
The rally over the last six weeks owes a lot to the European Central Bank’s long term refinancing operation. But stronger banks are also boosting market confidence. UniCredit’s €7.5bn rights issue, a response to the EBA’s capital requirement, is one factor behind a rally in Italian sub debt, for example.
The recaps are not much fun for the banks involved, which have had to scramble to generate the necessary capital. But it is important not to lose sight of the purpose: if the banking system is more resilient, it is less likely lenders will dump their sovereign holdings at the next sign of trouble.
Shoulds and should-nots aside, even if the EBA were to step back now, it would likely make little difference. Banks do not have to hold the capital beyond June — but with Basel III looming, it would be a brave treasurer that would consider running down their capital ratios anytime soon.