Contrasting the ECB and the ESRB

With the IMF Global Financial Stability Report released yesterday, the debate over the recapitalisation of European banks has kicked off again. Previously, it had just been the IMF trading blows with eurozone leaders (including the ECB), with the former pushing for a substantial recapitalisation of the European banking sector and the latter resisting and insisting that banks are perfectly healthy, citing the stress test results in their defence. However, yesterday the European Systemic Risk Board entered the fray – a more interesting development than it may seem.

The ESRB press release argued:

“Supervisors should coordinate efforts to strengthen bank capital, including having recourse to backstop facilities, taking also into account the need for transparent and consistent valuation of sovereign exposures. If necessary, this could benefit from the possibility for the European Financial Stability Facility to lend to governments in order to recapitalise banks, including in non-programme countries.”

Essentially, the ESRM is calling for a recapitalisation of European banks, after banks had marked their holdings of sovereign debt to market prices.

Many may ask why exactly the thoughts of this new and still obscure institution may change such a heavyweight debt. Well, the reason is that the ESRB is headed by the President of the ECB Jean-Claude Trichet and incudes all the heads of European National Central Banks. It does include plenty of other members from various EU bodies (see here for a full list) but the members of the ECB board do control 18 out of 36 votes. Add to this the member from the European Commission and the likelihood that heads of other European bodies should follow the line laid down by eurozone leaders and it would be expected that the ESRB would side with eurozone leaders rather than the IMF in this debate.

Jean-Claude Trichet has previously said that, “There is no liquidity or collateral shortage for the European banking system," and has reiterated that there is no funding crisis in the European banking sector as well as that banks do not need new capital injections. It’s also interesting since Eurozone leaders have continued to reject the need for banks to mark-to-market on sovereign debt and defended their accounting procedures against an attached from the International Accounting Standards Board recently.

All in all it seems surprising to us that a board filled with influential European leaders and officials would break so clearly with the official line that has been touted by eurozone leaders in recent months. It is clearly a welcome return to reality in some sense, but also raises questions about the growing disputes bubbling underneath the surface of European institutions on how the solve the eurozone crisis.