Shoddy Supervision

In Bailout of Portuguese Bank Espirito Santo, Europe's Faulty Financial Oversight On Display Again

Vitor Bento, CEO of Portuguese bank Espirito Santo. Source Espresso
Shareholders of troubled Portuguese bank Banco Espirito Santo in July named Vitor Bento, a respected economist, as the bank's new chief executive.
  • Why it matters

    Why it matters

    Public and investor confidence in Europe’s banks and governments is likely to drop further unless regulatory oversight improves.

  • Facts

    Facts

    • Banco Espirito Santo is being kept alive by a €5-billion loan from the European Union, the European Central Bank and the International Monetary Fund.
    • The financial bailout, six years after the collapse of Lehmann Brothers, underlines the still fragile state of European banking sector.
    • The problem of banks being “too big to fail” remains unsolved in Europe.
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    Audio

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It’s happened again. A major European bank has to be bailed out with taxpayer money.

The Banco Espírito Santo of Portugal is being kept artificially alive thanks to about €5 billion ($6.7 billion) in state funds. Although stockholders and bondholders also have to contribute, the lion’s share of the cash is once again being taken from taxpayers. The financial lifeline is coming from an aid package that Portugal received during the financial crisis from the European Union, International Monetary Fund and European Central Bank.

Almost six years after U.S. investment bank Lehman Brothers went bust, not much seems to have changed in governments’ vulnerability to extortion by major banks. The problem of being “too big to fail” — that certain banks cannot be allowed to fail because such a collapse poses a systemic risk — remains unsolved.

Governments, like the one in Lisbon, are still helplessly looking on as major banks get into financial difficulty. Once again, hectic telephone calls and marathon crisis meetings are necessary to fend off greater danger to European financial markets.

Governments, like the one in Lisbon, are still forced to look on helplessly as major banks get into financial difficulty. Once again, hectic telephone calls and marathon crisis meetings are necessary to fend off greater danger to European financial markets. It is true that now, in contrast to earlier cases, stockholders and creditors will participate in paying for and saving these banks. But instead of an orderly liquidation, the bankrupt institution simply lives on with billions of euros in government bailouts.

Only the names of the banks seem to change.

In Portugal, after spinning off its risky portfolios into a “bad bank,” Banco Espírito Santo resumed operations under the name Novo Banco. The Portuguese Ministry of Finance stressed that “all deposits, all bank services, all jobs and business relations of the bank” are protected. This “business as usual” is good news only at first glance.

 

A branch of troubled Portuguese bank Banco Espirito Santo in Lisbon in July 2014. Source Bloomberg
A branch of troubled Portuguese bank Banco Espirito Santo in Lisbon in July 2014. Source Bloomberg

 

The declines seen on European markets over the past few days shows how nervous investors react to any bad news from the banking sector. When a relatively small, and in Europe unimportant, bank such as Espírito Santo can have such an impact on markets, confidence in overall European bank stability declines.

Yet not only is the nervousness of the markets astonishing.

It is particularly disconcerting that regulators didn’t recognize the problems of the Portuguese bank in time. A look into its financial reports by banking watchdogs would have been warning enough, since in contrast to other European financial institutions, Banco Espírito Santo had not systematically reduced its balance sheet totals to strengthen its equity base and to comply adequately with regulators’ new demands. On the contrary, with €80 billion, the balance was almost at the same level as in 2011.

At the same time, the bank’s equity sank last year, which additionally weakened the Portuguese institution’s stability. With a half-year loss of almost €3.6 billion, the equity ratio eventually slipped down to 5 percent, which is below the 7 percent demanded by regulators. As a contrast, Deutsche Bank and BNP Paribas reduced their balance sheets last year by several hundred billion euros and considerably strengthened their equity ratios.

The bailout of the private Portuguese bank is a setback for the country’s efforts to win back investor confidence. After all, highly indebted Portugal left the E.U. aid program only in May. Apparently without a stringent health check of the Portuguese financial sector.

The emergency rescue also shows how important it is to have a functioning supervision of banking in Europe. The failure of Portuguese financial oversight is just too apparent and blatant. It can only be hoped that balance audits and stress tests by the European Central Bank will mercilessly lay bare the European banking system’s weak points, prompting proper steps to be taken.

In cases of doubt, troubled banks should be liquidated quickly. In contrast to the United States, Europe doesn’t have too few banks, it has far too many. Public trust in banks and governments will decline further unless oversight improves.

Sven Afhüppe is deputy editor-in-chief. He can be reached at: afhueppe@handelsblatt.com

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