The ECB this week began its assessment of risk-weighted assets across 128 eurozone banks, at the start of Phase 2 of the asset quality review (AQR) designed to establish a clear picture of European banks' riskier portfolios.
The review will include examination of domestic mortgage lending by banks in member states across the eurozone. However, German banks will escape scrutiny of their residential mortgage portfolio after arguing that the exercise would be costly and unnecessary given the relative lack of activity and inflexibility in the German market, relative to many other EU countries, according to a Financial Times report.
The AQR is part of the comprehensive assessment which the ECB is undertaking prior to taking over its supervisory tasks in November. The assessment is designed to "enhance the transparency of the balance sheets of significant banks, trigger balance sheet repair where necessary, and repair investor confidence", the ECB said.
The ECB has now published its manual for the AQR which contains the methodology and guidance for national competent authority (NCA) bank teams on how to carry out reviews of risk-weighted assets.
Risk-weighted assets are assets belonging to a bank which have been given a risk weighting calculated according to the rules of Basel II, a banking accord agreed between the G10 major western economies in 2004. Banking regulators use the risk-weighted total to calculate the amount of loss-absorbing capital a bank will need to sustain it through difficult markets. The risk-weighting is designed to calculate a bank's real world exposure to potential losses. Subsequent banking rules, known as Basel III, state that banks must hold top quality capital which is equivalent to at least 7% of their risk-weighted assets.
The ECB is the central bank for the euro, Europe's single currency, and it is tasked with maintaining the euro's purchasing power and securing price stability in the euro area. Following the recent financial crisis, EU member states' finance ministers agreed to appoint the ECB the single regulator for the biggest banks in the euro zone. The comprehensive review is being undertaken by the ECB ahead of it taking over as the single regulator in November, with the AQR making up the second phase of the comprehensive review.
The ECB said this week that the AQR will examine risk-weighted assets worth €3.72 trillion, equivalent to 58% of total risk-weighted assets across the banks. The ECB estimates that the average number of credit files reviewed on average per bank will be 1,250 files.
An ECB statement issued with the publication of the manual said that the review would cover key topics that influence accounting balance sheets valuations, such as its accounting classifications and the treatment of non-performing loans. The statement went on: "The portfolios reviewed exceed 50% of risk weighted assets for all banks subject to the comprehensive assessment. Given the volume of analysis involved, it is not possible to review all exposures in the selected portfolio. Samples will therefore be taken, whereby specifics (such as loan classification and provisioning) of a particular credit (ie loans, advances, commitments or other off-balance sheet exposure) will be looked at in detail."
The reviews will be carried out by NCAs in member states, which will deliver the results to the ECB.
The results of the AQR will be revealed in October, along with the results of stress tests which will be carried out on eurozone banks in the summer. The ECB will then inform banks whether they need to raise fresh capital or implement other measures to improve their security. Banks which cause concern during the AQR could be required to take action before October, the ECB has said.
Although the AQR will require banks to review loans, including mortgage lending, which have not been independently reviewed in the past year, German banks have won an exemption from this.
According to the Financial Times, Deutsche Bank and Commerzbank, two of Germany's largest mortgage lenders, have not submitted their residential portfolios to the ECB. Senior German bankers argued that reviewing their mortgage lending would be costly. Germany has one of the lowest rates of home ownership in the EU, with 44% of people owning their own homes, compared to 83% of people in Spain. The German market differs from many other eurozone markets in that banks often ask for higher deposits and offer mortgage products which often lock in interest rates for 10 years or more.
The relative lack of activity means that German lenders often only value their loans when the mortgage is awarded, while banks in other EU countries tend to value them more often, the newspaper said.
The ECB has said that no asset class would be subject to a blanket exemption, but that it would concentrate on the riskiest area of each individual bank's portfolios. This includes commercial real estate and Commerzbank has been asked to submit its portfolio covering this area, the Financial Times said.
