ECB too lax in supervising Europe’s largest banks, watchdog warns

The European Central Bank is too lax in supervising the eurozone’s largest lenders, the EU’s external auditor has said, as it called for greater assurances that “credit risk is properly managed and covered”.

The auditor hit out at the ECB for being insufficiently aggressive in pushing eurozone banks to reduce high levels of non-performing loans.

Friday’s detailed critique by the European Court of Auditors also accused the ECB of being too slow to decide capital requirements and lacking sufficient staff.

Banks on both sides of the Atlantic have come under increased scrutiny in recent weeks after the failure of several US lenders and the forced rescue of Credit Suisse.

The European auditor, which focused on the supervision of 10 lenders with high levels of bad debt, said ECB officials were too hesitant to use their full powers and applied them unevenly.

“Those with a higher share of non-performing loans were given more time than the others, and banks could choose a coverage approach that was most advantageous to them,” the report stated.

An ECB official said the auditors “didn’t understand that the disposal of NPLs consumes capital, as the banks have to accept a price below book value.

“Hence if we raised too much the capital requirements they would have made less disposals not to breach the requirements, and NPL volumes would have been slower to drop. The calibration at the bottom of the range was based and conditional on the banks’ plans to reduce NPLs.”

It maintained that it had ultimately achieved its objective, as toxic debts had fallen steadily from more than €1tn eight years ago to below €350bn last year, equal to less than 2 per cent of total loans.

In response to the auditor’s criticisms, the ECB said it would set banks’ capital requirements more speedily — a process the watchdog found took 13 months from the end of the relevant reporting period.

It also committed to address staffing shortfalls that left it unable to carry out a quarter of its prioritised investigations of banks’ internal risk models and 10 per cent of on-site inspections.

However, the central bank rejected some of the recommendations and said others had already been addressed since a team of external auditors examined the central bank’s supervision of lenders in 2021.

Its methodology for setting bank capital requirements “ensures that all material risks to which an institution is exposed are appropriately covered”, it said.

The ECB was given responsibility for overseeing the most important eurozone lenders after a banking meltdown and sovereign debt crisis that ripped through the region more than a decade ago. This led to the creation of its Single Supervisory Mechanism in 2014 as a separate unit from the central bank’s monetary policy operations.

“Our overall conclusion is that the ECB [has] stepped up its efforts in supervising banks’ credit risk, and in particular non-performing loans,” the European Court of Auditors said in its 121-page report. “However, more needs to be done for the ECB to gain increased assurance that credit risk is properly managed and covered.”

The auditors issued three main recommendations for the ECB: to streamline its supervisory process, strengthen its risk assessment of banks and use more effective measures to make banks manage risks better.

The central bank accepted the first recommendation, saying it was “considering ways to reduce” the time it takes to set bank capital requirements. But it only partly accepted the other two recommendations, rejecting a call for it to lift a hiring freeze imposed across all the ECB’s existing activities this year.

The ECB said some staff had been added in place of external consultants.

It would review next year if “more formal escalation processes” were needed to push national central banks to provide more staff to joint teams. It said there was still a 4 per cent staff shortfall at the supervisor, which employs about 1,600 staff.

Some concerns had already been addressed, after a review last year of its methodology for assessing credit risk and the addition of an “independent supervisory risk function” that acts as a second line of defence on setting banks’ capital requirements.