Letter from Berlin After the bank stress tests, ECB backroom tension lingers.

The Magazine of international economic policy 220 I Street, N.E., Suite 200 By Klaus C. Engelen Washington, D.C. 20002 Phone: 202-861-0791 • Fax: 202-861-0790 www.international-economy.com [email protected]

he surprisingly positive out- portfolios such as HSH Nordbank to sub- out to be the biggest loser. With nine of come of the ECB’s health stantially increase their capital. BaFin the twenty-five failing banks and four of check for German banks and the Bundesbank point to the fact that the fourteen banks still short of capital, may be something of a re- German banks had strengthened their Italy’s central bank supervisors are not prieve for the strained rela- balance sheets by €14 billion in prepara- looking good. This may explain why Ttions between Germany and the ever- tion for the asset quality review and stress Draghi didn’t show up on October 26 to more-powerful European Central Bank test exercises. present the ECB’s health check results under its controversial Italian president, As it turned out, only one of himself, but left the job to his vice presi- Mario Draghi. But for the ECB, the real Germany’s twenty-five banks failed dent, Vítor Constâncio. stress and tests are yet to come for the the test of capital strength under the As to the deteriorating relation- supervisor tasked with making hard deci- ship between Germany and the ECB—a sions with far-reaching consequences for theme we covered at length in the Winter member states, their governments, and Italy’s banking system—for 2014 issue—a Reuters report on the visit their financial sectors. years supervised by Banca of ECB board member for international Berlin’s political leaders had not ex- relations, Benoît Cœuré, to the Berlin pected that Germany’s banks would come d’Italia chief Draghi—turned chancellery a few days before the health out at the top of the health check ahead of out to be the biggest loser. This check results were announced shows that the launch of unified banking supervision things are getting worse. Draghi had sent in the euro area. On the one side was the may explain why Draghi didn’t Cœuré to Berlin with a plea that the con- common view that with the ECB empow- show up to present the ECB’s stant bashing of the ECB president stop. ered as top eurozone bank supervisor, a But Cœuré failed to receive assurances. comprehensive health check of bank bal- health check results himself. “Benoît Cœuré received a fairly cold ance sheets and a tough stress test in coop- response when he visited Merkel’s office eration with the London-based European ECB’s “adverse scenario,” and none recently, having been told that the chan- Banking Authority would be needed. fell short after 2014 capital boosts were cellor has no control over the debate, even On the other side was apprehension taken into account. Only Münchener though she would not join in the Draghi- that the ECB could bungle this major Hypothekenbank missed the require- bashing in Germany,” said the report. The challenge on the way to much deeper ments for the region’s systemically im- article cited sources saying that “Merkel financial integration.A nd—with a short portant 130 banks at the December 2013 felt betrayed by Draghi’s speech at a list of German potential problem banks cut-off date. By raising €408 million this central banking conference in Jackson circulating—there was apprehension that year, the special lender is off the hook. Hole,” as it questioned the agreed fiscal the highly fragmented German banking Some German Draghi watchers ex- policy stance. The Reuters report also system could come out as loser. Such press a bit of schadenfreude that Italy’s worries led German supervisors to force banking system—for years supervised Klaus Engelen is a contributing editor Landesbanks with major shipping loan by Banca d’Italia chief Draghi—turned for both Handelsblatt and TIE.

10 The International Economy Fall 2014 Letter from Berlin gives graphic details about the personal from the Central Bank of Cyprus that this out with additional loans. “It was not the relationship between Bundesbank head bank was solvent (see box). governing council’s job to keep afloat Jens Weidmann and Draghi, which has The New York Times was able to get banks that were awaiting recapitaliza- totally broken down to the extent that governing council minutes dating from tion and were not currently solvent,” as they avoid each other. May 2012 to January 2013. During this Weidmann is quoted in the ECB minutes. Analyzing the Reuters report, the time, Weidmann not only was oppos- Alerted by our sources—in particu- widely read Eurointelligence daily brief- ing ECB-backed rescues of the French- lar the team led by Achim Dübel that lis- ing concludes: “It is our view that this tens to central bank, EC community, and dispute lies at the heart of the European European leaders are planting finance ministry experts—we followed policy conflict, and its resolution will the Cyprus banking story. That was have huge implications for the future of the seeds of another crisis. months before the chaotic March 2013 the eurozone.” €10 billion Eurogroup/Troika rescue How long and how fiercely the Belgian lender Dexia and smaller banks deal. For those who have put together the Bundesbank under Weidmann has been in Ireland, Greece, and Spain, but was facts and available information from the opposing the governance erosion un- waging a major fight in the case of Cyprus actors in the Cyprus drama (See “From der the Draghi ECB, despite being pro- Popular Bank (Laiki Bank), which was Deauville to Cyprus,” in the TIE Spring gressively marginalized by a Club Med kept solvent by the misuse of emergency 2013 issue), the ECB press release is debtor majority, was brought to light on liquidity assistance loans provided by not only a big lie, but an insult and out- October 17, when the New York Times the Central Bank of Cyprus. As the New right scary in the sense of what this EU published excerpts of its so-far secret York Times reports: “In January 2013, institution is up to. As to what the now- minutes. Unlike the Federal Reserve just two months before the Cyprus res- published ECB minutes reveal, we went and the Bank of England, which release cue package, Mr. Weidmann repeated his much deeper into the mess of what hap- the minutes of rate-setting meetings in a complaint that the ECB was putting itself pened in Cyprus and in the Eurosystem matter of weeks, the ECB decrees that its at risk in propping up Cyprus Popular in terms of governance breakdown. internal deliberations must be kept secret Bank,” questioning “whether the Cyprus “[T]he way the troika of Eurogroup for thirty years. central bank … was trying to play down finance ministers, the European Central Apparently the ECB was shocked the bank’s problems in order to keep it Bank, and the International Monetary enough to release a blistering denial alive.” The ECB, warned Weidmann, Fund managed the rescue of the outsized claiming “full consensus” in the govern- was violating a core tenet, that banks on Cyprus offshore banking center will be ing council on the need to get assurances the verge of failure should not be bailed useful as a case study to document the extremely fragile state of European monetary union at that point in time. PRESS RELEASE The handling of the crisis puts big ques- tion marks around the June 2012 EU 17 October 2014 - Statement on New York Times articles summit council resolution to transfer banking supervision to the European The ECB neither provides nor approves emergency liquidity assistance. It is Central Bank—to a European institu- the national central bank, in this case the Central Bank of Cyprus, that provides tion acting as the euro area’s financier ELA to an institution that it judges to be solvent at its own risks and under its of first resort for banks that lack access own terms and conditions. The ECB can object on monetary policy grounds; in to market funding. This huge conflict of order to do so at least two thirds of the Governing Council must see the provi- interest between supervising and fund- sion of emergency liquidity as interfering with the tasks and objectives of euro ing large and small eurozone zombie area monetary policy. banks and pursuing monetary policies In this specific case there was full consensus in the Governing Council on oriented toward price stability is ig- the need to get assurances from the Central Bank of Cyprus that this bank was nored by Europe’s democratically elect- solvent. This was confirmed explicitly by the Central Bank of Cyprus, which ed leaders.” As we previously wrote, also confirmed the proper valuation of collateral after an intense dialogue be- “Draghi has ignored the most important tween it and the ECB. finding that an objective analysis of the The ECB was not the supervisor and fully relied on the assessment of the European Central Bank’s role in the Central Bank of Cyprus. Therefore to draw conclusions about the ECB’s future run-up to the Cyprus banking disaster banking supervision role on the basis of ELA to Cyprus is tendentious. would bring to light.” The key message — European Central Bank is that European leaders are planting the seeds of another crisis. u

Fall 2014 The International Economy 11