Our front page story in tomorrow’s dead tree version of the FT includes lines from confidential analyses distributed to European Union finance ministers at their gathering in Copenhagen. As usual, we thought we’d offer a bit more from the documents here at the Brussels Blog.

Among the most interesting elements in the documents are discussions about Europe’s banks, which have seen a surge in confidence thanks to the European Central Bank’s €1tn in cheap loans, known as LTRO for long-term refinancing operations.

One of the analyses in particular – the three-page “Assessment of key risks and policy issues” prepared by the EU’s economic and policy committee – warns that there are new signs of instability in the European banking sector. Details after the jump…

The paper warns of several potential danger spots in Europe’s banks, noting that even with the LTRO, many will still need to find cash to run day-to-day operations and warning banks are turning to unstable sources for financing to fill those gaps. In addition, because banks put up so much collateral to get the LTRO loans, they may no longer have the kind of high-quality collateral normally needed to get low-interest loans to fund regular operations:

[N]ew sources of instability may be emerging. Despite the ECB’s LTROs, funding gaps still remain in EU banks’ balance sheets and seem to be closing more slowly than in other regions. Moreover, evidence shows that banks have turned to more volatile sources of funding such as structured products. They also rely more on covered bond funding, which may hamper the recovery of unsecured markets. Moreover, considering the amounts of collateral used by banks in the LTRO operations, there are increasing concerns in the market about the availability and quality of bank’s remaining collateral. Finally, the funding gaps and the need to raise capital beyond the EBA recapitalisation exercise may contribute to deleveraging pressures and a further tightening of lending standards.

That last line is a reference to new requirements from the European Banking Authority that the region’s banks raise billions of euros in new funds to raise capital buffers, a measure adopted last year in an attempt to reassure markets that Europe’s banks were reliable. Bankers have long warned the measure would force them to sell off assets and horde cash, preventing them from lending to businesses in the real economy.

The second analysis, a European Commission document titled “Economic Outlook, Financial Stability in the EU: Policy Challenges and Way Forward”, also raises concerns about whether Europe’s banks are using the current calm to clean up their balance sheets. It also raises questions about the kind of funding banks are usuing, but adds another question: whether banks have fully written down the large numbers of bad mortgages and other loans they’re still holding:

There is also a risk that the current low interest rate environment, weak business cycle, bank fragility, and depressed collateral values increase the propensity for banks to forbear on loans (and in all other investments). Instead of recognising losses, banks may choose to delay risk recognition. Delayed risk recognition and forbearance could constrain lending to more creditworthy customers and thus weaken recovery. Postponing losses recognition may have detrimental effects when interest rates rise or macroeconomic conditions deteriorate.

It may not be more than other analysts have been saying for months, but coming in an official document – and distributed to finance ministers at one of their most high-profile meetings – it makes clear that many in Brussels want to sound an alarm that the worst of the eurozone debt crisis may not yet be over.

Get alerts on World when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.
Reuse this content (opens in new window)

Follow the topics in this article