So far only UniCredit and KBC have told market participants what level of capital the European Central Bank demands from them as Pillar 2 “guidance”.
But there is a lot of insight to be gleaned from the number, and investors are likely to try and work out equivalent levels for the rest of the market.
Banks should not get caught up in such guessing games. They should simply follow UniCredit and KBC, and disclose their Pillar 2 guidance.
The European Central Bank first split its capital demands into “guidance” and “requirements” in last year’s supervisory review and evaluation process (SREP), as a means of clarifying when capital-strapped banks face legal consequences.
Breaching requirements, rather than guidance, forces regulators to act, including by restricting coupon and dividend payments, while a breach of guidance does not automatically trigger any legal action at all. Accordingly, European banks need only disclose their Pillar 2 capital requirements to the market. They are under no such obligation when it comes to guidance.
But Pillar 2 guidance is a very important number for banks, investors and regulators alike.
Danielle Nouy, chair of the ECB’s supervisory board, explained its significance clearly in a letter to Member of the European Parliament Sven Giegold last year.
“Failing to meet Pillar 2 guidance would lead to intensified supervision and institution-specific measures designed to re-establish a prudent level of capital,” she said.
Regulators might themselves argue that keeping guidance a secret gives them important breathing space to establish their demands year on year, or help turnaround struggling banks without spooking the market or losing credibility.
But investors can easily use the numbers available to them to try and work out guidance for those that have not disclosed. And if more banks publish the number, there will be more pressure on those that don’t.
A pattern is already emerging. Pillar 2 guidance for both UniCredit and KBC appears to be in line with the difference between last year’s Pillar 2 amount and this year’s Pillar 2 requirement.
Splitting Pillar 2 into requirements and guidance does not therefore seem to have raised or lowered overall capital demands — it has simply made them a little murkier.
But markets operate best with greater transparency.
There is simply no need for banks let the size of their capital buffers become a subject for speculation when they have the option to publish all of their supervisory capital demands.