By now it is, or should be, well-understood that the biggest deflationary virus at the heart of the European financial system is the ~€1 trillion mountain of bad loans (of which which over €230 billion is found in Germany and France) and which casts a giant shadow both over Europe and the ECB whose president is well aware that without the central bank's bid, the liquidity and confidence vortex that is this massive monetary black hole, will promptly drag Europe's economy back into depression.
Well, as of today one can make it $1 trillion and €10 billion, because in a report published by the European Central Bank today, it announced its inspectors had found "shortcomings and miscalculations" worth more than €10 billion when going through euro zone banks’ loan books last year.
Not surprisingly - after all the stinking pile of bad debt is arguably the biggest threat facing the European financial system once QE and NIRP is over - the ECB’s annual report showed some banks were found to be deficient in the way they identify problem customers and loans, set aside provisions and choose when to grant credit according to Reuters.
In other words "some banks" lied about pretty much everything.
Tasked with avoiding a new financial crisis, the ECB has been putting pressure on banks to clean up their balance sheets from unpaid loans inherited from the last recession, a problem for most countries in the south of Europe, as well as Slovenia and Ireland. Ironically, the ECB's own monetary policy has removed all urgency to actually clean up balance sheets at a time when European junk bonds yield less than US government paper.
The bad loans, along with risky derivative instruments, will remain the focus of ECB supervisors this year, President Mario Draghi said in the report.
“In 2018 banks continue to face some key challenges,” Draghi said adding that "These include cleaning up their balance sheets, reducing legacy exposures largely originating from the financial crisis, such as certain non-marketable financial products, and from the ensuing Great Recession, such as non-performing loans."
In short, nearly a decade after the crisis, Europe still has about €1 trillion in bad loans should not be there.
The report shows the ECB’s focus has been mostly on the latter - a cause of griping among Italian banks, which meanwhile have been complaining that risks associated with derivatives held by their competitors in France and Germany have been overlooked.
Recall that as we first disclosed four years ago, Deutsche Bank has tens of trillions of gross derivative exposure on its books.
Not surprisingly, the ECB focused on the bad loan aspect instead of derivatives (knowing which usual suspects could be implicated): the ECB launched 156 inspections in 2017, around 60 of which concentrated on bank credit - in most cases including soured loans. By comparison, market risk, which includes derivatives, accounted for fewer than 10 inspections. These revealed that some banks were failing to classify their derivatives correctly according to how difficult they are to value, and therefore potentially risky.
In other words, while some banks lied about their bad loans, other banks lied about their derivatives. And with that in mind, we look forward to finding out just how the ECB thinks it can gradually or otherwise withdraw its support of the European financial system.