MNI INTERVIEW: ECB Risks Financial Instability-Italian Banker

Further monetary tightening by the European Central Bank runs the risk of prompting financial instability, a senior Italian banker who was appointed by the Bank of Italy to sell off good banks created during Europe’s first bail-in resolution told MNI, adding that authorities should also consider raising deposit guarantees.

The ECB should pause to monitor the lagged effect of its policy moves since it began raising rates last July before pushing ahead with further tightening, Roberto Nicastro, who was entrusted by the resolution authority to chair the healthy remains of four banks liquidated in 2015 and is now president of Banca AideXa, said in an interview.

Interest rate decisions over the next quarter will be particularly crucial, he said, pointing to a slide in credit revealed in the ECB’s recent quarterly lending survey.

“A credit crunch effect is happening and it's quite clear,” Nicastro said.

“If the tightening process continues to be very strong in Europe for a few quarters, then other risks might emerge.”

DEPOSIT GUARANTEE

Still, banks are in better shape than before the global financial crisis, he noted.

“Having said this, it will really very much depend a bit on how central banks act going forward. In principle, we are okay,” Nicastro said, though he added that the implementation of the final parts of Basel III regulation could be used to open the way to double Europe’s limit for guaranteed deposits to EUR200,000.

Such a move “could have some merit”, he said, noting that it would take European norms closer to the U.S. guarantee level of USD250,000. Currently the average European bank has half of its deposits within guaranteed limits, a proportion many times higher than was the case at the recently collapsed Silicon Valley Bank in the U.S.

It would be wise for the European Union to take action now to further strengthen its banking system architecture rather than to wait for a crisis, particularly given that its decision-making process tends to be slower than in the U.S., Nicastro said.

“Maybe this is the reason why in the last five years European law makers, European regulators and European supervisors have been significantly tougher than their American equivalents,” he added.

One necessary move will be to unblock funding for a backstop to the Single Resolution Fund, which requires final ratification of a reform of the European Stability Mechanism treaty – currently held up by Italy. But Nicastro noted that Europe’s resolution framework would still work without it. (See MNI: EU Loses Patience As Italy Blocks Bank Backstop-Officials)

In practice, he said, resolutions are not always in line with pre-arranged plans, pointing to how governments had to become involved to find solutions as SVB and Credit Suisse neared collapse.

TLTROS

The ECB must also be careful to monitor “very, very thoroughly” how banks cope with the maturity of about EUR500 billion in cheap TLTRO loans in June, though it is not clear whether bridging finance will be required. (See MNI SOURCES: ECB Set For TLTRO Discussions Ahead June Maturity)

“I can see why this is being discussed,” he said, “We have a clearly tighter liquidity situation nowadays, both in the banking system and especially in the economy as a whole.”

In Italy, banks’ profits are likely to be sustained for the next quarter or so, before interest margins begin to suffer and they face both the impact of high inflation on operating costs and a slightly increased cost of risk, he said. Steep reductions in nonperforming loans over recent years mean that any increase should leave them still at easily manageable levels.