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Spat between BoI and regulator a warning sign for ECB ahead of review

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Over 85pc of credit applications received from SMEs in the year to end June were approved

Over 85pc of credit applications received from SMEs in the year to end June were approved

Over 85pc of credit applications received from SMEs in the year to end June were approved

Ireland is the scene of a skirmish between lenders and regulators that offers a warning to the European Central Bank as it conducts its own probe into the region's balance sheets.

The skirmish centres around Bank of Ireland which has disputed what it claims is the Irish Central Bank's estimate that it should set aside an extra €1.1bn to cope with souring loans.

The Central Bank hasn't confirmed the figure and the resolution of the quarrel, which started in December, won't be clear until Bank of Ireland publishes full-year results on March 3.

The spat shows the risk of potentially destabilising squabbles in the financial system when audits of bank balance sheets are kept under wraps, as the ECB plans to do in a much- larger exercise this year. The Frankfurt-based institution has built in a three-month hiatus between auditors leaving banks' premises at the end of its Asset Quality Review (AQR) and publication of the results in October.

"If the ECB can pull off a slow process this year of evaluating banks without triggering serious financial instability, it'll be doing very, very well," said UCD economics professor Karl Whelan. "The public stand-off between Bank of Ireland and the regulator was a mess and presages what's going to be a difficult and complicated process across Europe."

The ECB is carrying out a three-stage review before it becomes the euro-area bank supervisor in November. A risk assessment has been completed and the AQR is under way. The third element, a stress test, will be conducted in coordination with the European Banking Authority in the three months after the AQR ends.

Banks won't be informed of the results of the AQR unless material shortcomings are found that need to be corrected immediately, an ECB spokeswoman said. A "distilled outcome" of the AQR and stress tests will be released in October, said ECB official Ignazio Angeloni.

While the ECB has published many of the details of its methodology for the AQR, including a capital threshold of 8pc, the delay in announcing results while the stress test is carried out could unsettle markets as rumours emerge.

"There are so many people involved, it is difficult to imagine that there aren't going to be leaks," said Dirk Jaeger, managing director for banking supervision and accounting at the Association of German Banks. "The ECB are saying clearly that the calculation will be done at the end, that the whole thing will be published as one number. Whether that can really be kept to, I can't say."

The situation here gives one indication of how the process might pan out. When the Central Bank assessed the bailed-out banks' balance sheets last year to prove they had enough capital before we exited the €67.5bn bailout, it didn't release the results publicly. Instead, the banks were informed and allowed to decide how to handle the information.

All three of the lenders reviewed – Bank of Ireland, Allied Irish and Permanent TSB – said they remained adequately capitalised after the exercise.

Bank of Ireland gave more details. It had to provide investors with the information as it was preparing to sell shares within days to repay part of its €4.8bn taxpayer bailout.

The bank said the regulator's estimate that it may have to increase provisions for residential mortgages by as much as €400m was based on industry wide trends, whereas its own arrears levels were lower. It also said it "remains confident in its methodologies, calculations and impairment provisions" for real estate, construction and corporate loans, where the Central Bank estimated it needs to set aside €486m of provisions.

The regulator said Bank of Ireland may need to book a €274m additional loan-loss charge as a result of a new regulatory treatment of defaulted assets that takes full effect this year. The bank said it has already "substantially" accounted for the development. The Central Bank also estimated the lender needs to raise its risk-weighted assets, a determinant of how much capital a bank needs to hold, by about 13pc.

As a precursor to the EU-wide bank stress tests, the balance sheet assessment raised more questions than answers," said Conall Mac Coille, chief economist at Davy Stockbrokers.

Bank of Ireland will probably set aside about €470m of additional provisions to appease the regulator, according to analysts at Bloomberg News. The one-time charge is expected in the March results and may drive the lender's full-year loan impairment loss to €1.8bn, according to Emmet Gaffney, an analyst with Investec.

Anne Mathews, a Bank of Ireland spokeswoman, declined to comment. The Central Bank also declined to comment.

The ECB has said the credibility of its own review is crucial to putting its supervision of euro-area banks on a sound footing. The review "will dispel any lingering doubts" about banks' balance sheets, ECB Vice President Vitor Constancio said last year. The Central Bank is due to release details about its stress-test scenarios in April, which in the 'adverse' case could model a general economic downturn coupled with reductions in values for specific asset-classes.

It's in the interests of European and national regulators to ensure the process runs smoothly, according to Stephen Smith, head of KPMG's AQR task force, which is advising a number of national central banks on the assessments.

"I'm sure both the ECB and the national regulators will recognise the stakes that are being played for and how deeply damaging leaks emanating from the process will be," Mr Smith said. "It would run counter to the point of the exercise to promote stability. It would defeat the major objective, which is to establish the credibility of the ECB as it starts its new role." (Bloomberg)

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