The EC is reportedly considering an investigation of the use in some jurisdictions’ banks of deferred tax assets as core capital. DTAs are losses that banks can use to offset taxes, but only work when the bank is turning a profit. Otherwise, they are simply amassing tax benefits while continuing to lose money.
Royal Bank of Scotland said in October last year that one of the main barriers to increased lending in the eurozone was the relative lack of both volume and quality of capital. But another problem is the sheer size of the system relative to gross domestic product. In Europe, the banking sector represents 3.1 times gross domestic product — the largest banking system in the world by that measure, RBS analysts said.
DTAs are thus a part of the overall problem. If struggling and unprofitable banks can prop themselves up by effectively counting losses as a buffer against future losses on the premise that they will make profits in the future, the result is a bloated and unproductive system. That is exactly what post-crisis regulation has sought to avoid.
The question the EC is considering is whether allowing banks to count DTAs as core capital should be considered state aid, which is banned under the new regulatory regime. If it is decided that such accounting should be deemed state aid, the ECB would likely be authorised to force banks to recalculate their capital ratios, something which could be extremely unsettling for banks like Spain’s Bankia, for which RBS says DTAs comprise around 75% of core capital.
Most jurisdictions don’t allow for DTAs to be used as core capital, but banks in the periphery, as well as in Germany, are largely excused by their national regulators for doing so. It is no coincidence that the banking sectors in some of those jurisdictions tend to be overpopulated, especially in Italy and Germany. Forcing stricter capital requirements to be applied across the eurozone might be the way to motivate the consolidation so badly needed, and otherwise so very politically unlikely, in those countries. Doing so would force inefficient or unprofitable institutions to get on and raise capital or face being taken over by healthier or better capitalised rivals, national or otherwise.
If Europe wants a lean and efficient banking sector, DTAs have to go.