The European Commission is considering an investigation into the way some southern European countries treat deferred tax assets (DTAs), which could end up hitting the capital ratios of banks from those jurisdictions.
The possible probe stems from concerns that some peripheral governments are creating an uneven playing field by guaranteeing DTAs because they allow domestic banks to include those assets in their core capital ratios.
The Commission confirmed earlier on Tuesday that it is requesting information from Greece, Italy, Portugal and Spain on how they treat DTAs.
“We have been contacted by some stakeholders with enquiries, including members of the parliament, so we have sent out letters requesting information to those countries,” a Commission spokesperson said at a briefing in Brussels.
Another spokesperson at the Commission added that it would take some time to form a view on whether DTA schemes constitute state aid or not. She added that it was not a formal legal investigation at this stage.
“Should we take a decision, we’ll have to weigh a number of factors including existing rules and financial stability, so there are very complicated elements to take into consideration.”
One of the key issues with DTAs is that they are accounted as capital today, but only work in practice if banks are profitable in future, RBS analysts wrote in a note.
“The trouble is that the most struggling banks are the ones which have accumulated the most DTA capital over the years,” they added.
A DCM banker at another bank thought that the Greek banks could be among those worst affected: “DTAs represent 4.3%-5.1% of their core capital. If you were to exclude this, the capital position of those banks would be far, far worse.”
In Spain for instance, a change of rules in 2013 allowing deferred tax assets to be treated like tax credits backed by the state was expected to boost domestic banks’ capital by about EUR30bn.
But ING analysts thought that a probe would ultimately have a positive impact: “Although credit negative in the short term, a probe could push the banks into collecting better quality capital that would be credit positive in the longer term.”
It would also form part of the drive to harmonise the definition of capital across the EU.
Market reaction so far appears to be muted, which bankers attribute to the need for further clarification.
“From a technical point of view, this is very complex,” the DCM banker said. “Every jurisdiction has its own rules and has had different rules in the past.”
He was unsurprised by news of the potential probe, but anticipated that the debate would run for a long time: “There were already disclosures about DTAs. But we now need to work out exactly which credits we’re talking about.”
Banks were allowed to count DTAs towards their core capital ratio for centralised stress tests last year. But international guidelines set out under the Basel III capital framework will progressively cut those assets from banks’ regulatory core tier 1 equity reserves.
A syndicate banker thought that the fallout from a potential investigation would be limited given the progress made by peripheral banks in shoring up their capital.
“If you look at the way they have been going through stress tests and improving their capitalisation levels, I don’t think it will have a big impact,” he said.
Source: IFR (Reporting by Alice Gledhill and Anna Brunetti; Editing by Anil Mayre and Julian Baker)