Portugal’s Banking Disaster / The New York Times

The Opinion Pages | EDITORIAL

Portugal’s Banking Disaster

By THE EDITORIAL BOARDAUG. 6, 2014 / The New York Times / http://www.nytimes.com/2014/08/07/opinion/portugals-banking-disaster.html?hpw&action=click&pgtype=Homepage&version=HpHedThumbWell&module=well-region&region=bottom-well&WT.nav=bottom-well&_r=0

A government rescue of one of Portugal’s largest lenders is an object lesson in regulatory failure and the haphazard manner in which European officials have gone about fixing their troubled banking system.

The Portuguese government said on Monday that it would split the bank, Banco Espírito Santo, into two. The bank’s branches, customer deposits and healthy assets are being spun off into a new entity called Novo Banco that will receive a capital infusion of 4.9 billion euros, or about $6.6 billion, from bailout funds the government and central bank control. The remaining part of Banco Espírito Santo will hold the bank’s loan portfolio and will be wound down over time. Shareholders and some creditors of the banks are expected to lose most of their money as part of the plan.

Banco Espírito Santo’s financial problems can be traced to dubious loans the bank made to prop up other businesses that were controlled by the bank’s parent company. Last week, the bank reported losses of €3.58 billion in the first six months of the year largely because of those loans. This was not merely a failure of the Portuguese officials who had the primary responsibility for supervising the bank. The European Commission, the European Central Bank and the International Monetary Fund share some of the blame because they have been intimately involved in Portugal’s economy and financial system for the last three years after lending the country €78 billion to help it get through a financial crisis. In May, the three organizations said “bank capitalization has been significantly strengthened” in Portugal, which suggests that they were overly optimistic about the progress that had been made.

Later this year, the European Central Bank will take over supervision of the largest banks in countries that use the euro from national regulators that oversee banks. An important test of the E.C.B.’s credibility will come when it publishes the results of a “stress test” of 128 European lenders in October. The central bank has to make sure this exercise is not a pro forma checkup that makes it easy for banks to look good and hide their problems as Banco Espírito Santo appears to have done. Europe’s economy will not recover until its banking system is truly healthy.