Audit Finds European Central Bank Not Adequately Assessing Credit Risk

Facts

• The European Court of Auditors (ECA) released a report on the European Central Bank (ECB) on Friday, concluding that its supervisors are lax towards the highest-risk lenders, applying rules inconsistently and not clearly linking risks to the capital requirements imposed.¹
• This comes as the ECB, which directly oversees 110 European banks in the eurozone and Bulgaria under the 2014 Single Supervisory Mechanism, has recently warned that the current economic environment is deteriorating the outlook for banks.²
• The European auditor focused on the supervision of ten lenders with high levels of bad debt, as banks have been under mounting scrutiny after the forced rescue of Credit Suisse and the failure of several lenders in the US.³
• The ECA issued three main recommendations for the EBC: improve its supervisory process, focus on and improve risk assessment, and bolster measures to ensure banks manage risk more effectively.³
• In response to the watchdog's 121-page report, the ECB vowed to speed up the process of setting bank capital requirements and to address staffing shortages but only partially accepted recommendations to bolster the risk assessment of banks and to adopt more effective policies to make banks better manage risks.³
• This is reportedly the first external audit review since 2019 when the ECB agreed to share bank-specific data for additional purposes, and its recommendations aren't binding.¹

Sources: ¹Reuters, ²European Court of Auditors, and ³FT.

Narratives

• Narrative A, as provided by Euronews. European regulators have been using all regulatory tools at their disposal to ensure that supervised banks address material shortcomings while also urging lenders to be more selective with clients and prudent in how they manage their exposure to financial market risks. If these moves are not enough, the ECB can make qualitative demands as a last resort.
• Narrative B, as provided by Reuters. The bad management of credit risks is a systemic problem rather than a lack of compliance by banks despite the ECB long attempting to pass the buck. Supervisors have consistently selected lower capital requirements for the highest-risk banks, often requiring higher requirements from lower-risk lenders.

Predictions