Financial Times: Stakes high for Europe’s bank stress tests

22 October 2014

Good news on key issue of assisting capital-raising, writes Huw van Steenis.

As Europe is spooked by the spectre of deflation, never has it been more important to unclog Europe’s lending channels. Eurozone bank lending to companies remains weak and fragmented. So the stakes are high for the European Central Bank’s comprehensive assessment and related stress tests. They have the potential to accelerate the process of cleansing banks’ balance sheets to support economic recovery. But to achieve the catharsis the eurozone needs, the stress tests need to be a catalyst for a shift in the broader policy debate.

Investors naturally come with a degree of scepticism given the ill-fated prior stress tests. So how should we judge the current tests’ success?

First, are they rigorous enough to give confidence and help lower the banks’ cost of funding? For instance, Italian banks pay on average 1.1 per cent more for deposits than German banks, which inevitably gets passed on through higher costs to companies and consumers. The tests ideally should help give assurance so that funding costs for Italian banks can fall in much the same way they did for Spanish banks post their stress tests. While most of the inputs do look tough, it is a shame deflationary scenarios are not in this year’s exercise. Banks appear to have been treated as consistently as possible, even if local rules mean there are a large number of inconsistencies.

Second, will there be transparency in the results? The odds look reasonable as we will get over 10,000 data points on the scenarios. But the market will also want to know what the implications for capital plans and dividends will be for banks with only marginal passes, and the ECB and European Banking Authority are likely to be silent on this.

Third, do they facilitate capital-raising and restructuring? This is the acid test, as this is what will form the basis for future lending. The good news is the larger banks have used their time well. Some €48bn equity has been raised into the stress tests while banks have also sold many underperforming assets that were weighing on their balance sheets. While some will want to see a few large institutions fail the tests to show their toughness, we wonder if the true signal of success will be how big a clean-up is driven both through the aggregate size of writedowns on the day and assets sold over the following year, than simply how many banks fail the tests.
 
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