Europe's banks have been doing a collective impression of Ben Johnson. The Canadian sprinter famously won the 100 metres at the 1988 Olympic Games with the aid of anabolic steroids. For three months, almost the entire European banking sector has been on similar performance-enhancing drugs, courtesy of cheap loans from the European Central Bank. But unlike Johnson, whose deception lasted only a few days, they are in danger of being allowed to cover it up.
Later this month, banks will start reporting results for the first quarter. None are currently expected to disclose what proportion of their earnings are due to ECB President Mario Draghi's Longer-Term Refinancing Operations, which allowed them to borrow about €1-trillion ($1.3-trillion) at an annual rate of just 1 per cent for three years. That could create some bizarre distortions.
Many bigger banks have taken ECB money as insurance against a renewed euro zone crisis. Their LTRO cash is on deposit with the ECB, where it is earning interest of just 25 basis points – costing them money. If all €1-trillion of LTRO were so used, it would knock €7.5-billion off banks' net interest income for 2012.
But plenty of smaller peripheral banks are using the LTRO as a lifeline. Recent ECB data suggests they have been using the cheap funds to invest in high-yielding sovereign debt. If all €1-trillion were invested in three-year Italian government debt at an average yield of 4 per cent, the sector's net interest income would be €30-billion higher.
The omerta probably suits Mr. Draghi fine. Weaker euro zone banks will be more profitable, allowing them to bolster their capital. Stronger banks could look worse, but can always reduce their LTRO exposure. Some, like BNP Paribas and UniCredit, are pondering whether to do so.
But the confusion is less good for shareholders. With zero clarity on which banks' earnings are LTRO-enhanced, investors will continue to apply a large uncertainty discount when valuing European bank shares. Banks hoping for a higher valuation should spell out what their earnings would have been without the LTRO. Otherwise, their shares will continue to be tarred with a deserved doping discount.