Stress tests do little to restore faith in European banks
Investors want simpler, clearer rules and tests
Regulatory authorities have a patchy record when it comes to being in tune with the markets. But the dissonance between those involved in Friday night’s stress tests on the European banking system and investors’ view of the banks is painful.
The London-based European Banking Authority, which is overseeing the tests, has said with admirable British understatement that the recovery of the EU’s banking system from the shock of 2008 has been slower than that of the US. It concedes, too, that the EU’s regulatory authorities have been less effective at recapitalising banks.
It claims, all the same, that progress has been made. EU stress tests, it contends, should no longer be about pushing fresh capital into the system, as they were in 2011, or conducting a root-and-branch assessment of asset quality, as in 2014. Now is more about “steady-state monitoring”.
That characterisation looks dangerously sanguine. European bank share prices have nudged lows last seen in 2011, when the eurozone debt crisis gripped the region. Investors clearly think this is nothing like a steady state.
True, banks’ capital buffers are more ample than they were five years ago. But a panel of respected academics concluded last week that EU banks need €900bn of fresh capital to convince investors they are robust. That dwarfs the €260bn which the EBA says has been pumped in since 2011.
Capital ratios are also about numerators — the quality of loans and other assets — as much as they are about those fattened denominators. As has been well documented, the Italian banking system is awash with non-performing loans — €360bn of them on a gross basis.
Sure enough, Monte dei Paschi di Siena, which on Friday launched an emergency fundraising, came bottom out of 51 banks tested. Other Italian, Irish and German banks were also among the weakest.
The stress tests have provided a welcome snapshot of how exposed banks are to various scenarios, ranging from a 25 per cent fall in equity markets to a 22 per cent decline in property prices. There is also a valid reflection of conduct risk, code for the vast fines that can erode capital buffers.
But this year’s stress tests, like prior exercises, are still flawed. Carried out over recent months, the tests failed to model for some obvious risks, Brexit and the mounting threat of negative interest rates, among them. Nor is there direct reference to the so-called Basel 4 proposals to further toughen capital demands. They have also excluded markets such as Greece and Portugal where banks are weak.
Worst of all is the atmosphere of obscurity. The structure of the tests is labyrinthine — four different, and sometimes bickering, arms of the EU are involved (the ECB, its SSM bank supervisory arm, the EBA and the European Systemic Risk Board).
In addition, the exercise this time carries no threshold for passing and failing. There will be suspicions that political sensitivities have been pandered to. But it may just as much be a result of chaotic policing: bank capital levels have become increasingly bespoke but stubborn delays among national regulators in requiring banks to publish their own individual numbers means there is no transparency about capital baselines. There is also little clarity about how and when undercapitalised banks will be strong-armed into raising fresh equity.
This probably adds up to yet another failed attempt to restore investor faith in Europe’s troubled banks. Without simpler, clearer rules and tests — and clear consequences for failure — there can be little hope of this changing.