EU Tax-Asset Moves Boost Banks While Keeping Sovereign Link

Sep 04, 2014 7:51 am ET

(Adds EBA stress-test details in sixth paragraph. Read a summary of Basel and EU rules on deferred tax assets here.)

Sept. 4 (Bloomberg) -- Governments across struggling southern Europe are allowing banks to shore up their capital with tax credits, even though this runs counter to the European Union’s drive to disentangle the finances of lenders and states.

Portugal last month joined Italy and Spain in permitting the conversion of some deferred tax assets into credits that banks can count toward the capital they’re required to have on hand. When a company overpays taxes in one period, it can book a deferred tax asset that reduces its liability in the future. Greece is considering a similar move. All but Italy received bailouts during the debt crisis that included aid for banks.

The rule changes are a boon to banks as they try to satisfy tougher post-crisis capital requirements and pass this year’s health check conducted by the European Central Bank and the European Banking Authority. At the same time, the credits give banks a claim on the public purse, strengthening the vicious circle that fueled the euro-area crisis.

“For some countries, providing their banks with some help to meet their regulatory requirements takes precedence over a fuller separation of the fortunes of their banks from the public finances,” said Richard Reid, a research fellow for finance and regulation at the University of Dundee in Scotland. “The treatment of DTAs probably falls into this camp.”

ECB Oversight

Euro-area governments in 2012 embarked on a concerted bid to break the link between banks and sovereigns by centralizing supervision and crisis management of lenders. This push enters a new phase on Nov. 4, when the ECB assumes oversight of euro-zone banks after releasing the results of its balance-sheet exam in late October.

Deferred tax assets “may be recognized” as core capital for the purposes of the EU stress tests insofar as they haven’t yet been phased out under the bloc’s rules, the EBA said in April.

Under those rules, banks must steadily deduct some deferred tax assets from capital over a transition period that runs to 2018. The EU exams will test lenders against a three-year period of financial stress.

Deferred tax assets arise when a bank books losses or credits that it expects to be able to use to reduce its future tax obligations. This can happen for reasons including a carry- forward of unused tax losses and temporary differences in how profits are recorded for tax and accounting purposes.

Core Capital

These assets accounted for about 10 percent, or 105 billion euros ($138 billion), of the core Tier 1 capital of banks assessed in a July 2011 stress tests, though some lenders’ levels are far higher, according to EBA data.

The deferred tax assets in regulators’ crosshairs are those that banks can only make use of when they are profitable. Since profitability is never guaranteed, regulators stipulated that they aren’t reliable enough to count toward more than 10 percent of a bank’s core capital requirements. These rules laid down by the Basel Committee on Banking Supervision and the EU come gradually into force in the next five years.

In Portugal, the government permitted companies to convert deferred tax assets into tax credits when they report losses. To qualify for this option, companies must issue conversion rights that will give the state the right to become a shareholder or sell those rights in the market, Finance Minister Maria Luis Albuquerque said in June.

Spain passed rules last year that allowed the country’s banks to keep counting 30 billion euros of deferred tax assets as capital under the latest international rules, known as Basel III. The large amount held by Spain’s banks mostly stems from losses booked in 2012 as the government forced them to clean up their real estate assets.

Spanish Banks

“Under Basel II, these DTAs were capital of the highest quality, but under Basel III that’s not the case,” Economy Minister Luis de Guindos said at the time. “If we hadn’t made this change to company tax, Spanish banks would have been at a disadvantage to their competitors.”

Discussions in Greece on making the rule change are gaining momentum, Harris Kokologiannis, chief financial officer at Greece’s Eurobank Ergasias SA, said on Aug. 29.

“We hope that this will materialize at the end,” he said. “And if it happens, we will have a dual positive impact for the stress test as well as for the fully loaded Basel III.”

Patricia Jackson, head of prudential advisory at accounting firm EY in London, said that while this practice is “in line with EU and global capital standards, the problem is it potentially increases government expenditure and certainly government exposure.”

‘Direct Claim’

“In order for the tax credits to still qualify as core capital, nations are giving banks a clearer, direct claim on the government,” she said.

This claim doesn’t necessarily violate EU regulations on state support for companies, which are intended to promote fair competition, according to the European Commission.

“DTA reforms do not necessarily involve state aid,” said Antoine Colombani, a spokesman for Joaquin Almunia, the EU’s competition policy chief.

“There might be state aid involved only when the reforms provide selective advantages to certain undertakings or sectors of the economy which cannot be justified by the intrinsic logic of the tax system and which cannot be declared compatible under the EU state aid rules,” he said.

--With assistance from Rebecca Christie and Gaspard Sebag in Brussels, Paul Tugwell in Athens, Anabela Reis in Lisbon, Charles Penty in Madrid and Ben Moshinsky in London.