Europe’s stress-testing of its banks has, deservedly, generated a considerable amount of cynicism. Whether the regulators and their banks were too clever will become clearer overnight but it appears probable that the results of the testing will generally serve their purpose.
As discussed previously (Europe’s Goldilocks moment) it was almost inevitable that the tests would produce a relatively benign view of the state of Europe’s banks, with just enough banks failing the tests to provide some credibility. That was, in fact, the outcome, with only seven banks failing the tests, although another dozen only narrowly passed.
While one could (and many have) conclude that the testing was “managed” to produce that outcome, it is worth contemplating the chaos that would have resulted in Europe had a far larger number of banks been deemed to have insufficient capital to survive the adverse economic and financial scenarios on which the testing was based. An outcome where too few banks failed to defuse scepticism is infinitely preferable to one where so many failed that it ignited another bout of fear and loathing.
A better guide to the credibility of the process will emerge overnight but the initial reaction would tend to suggest it has largely served its purpose.
By identifying those banks that definitely have to raise more capital or be bailed out as well as those on the borderline, which will also need to take some remedial actions, there is at least a dividing line between the weak and the strong banks in Europe. There is also probably enough data from the testing now available to enable the banks themselves, as well as other interested parties, to broadly come to their own conclusions about the health or otherwise of their peers.
It is worth noting that some of the countries with system regarded as the most vulnerable, such as Spain, made the most detailed disclosures, a very sensible strategy that will also help allay some of the worst fears.
There will ultimately be two criteria against which the success or otherwise of the testing will be measured.
The first is whether it leads to at least some increased level of trust between at least some of the healthier banks and the second is whether it provides enough confidence in most of the European and UK banking systems to give them access to capital markets on reasonable terms.
The data from the testing that has been made available may help thaw the distrust that has nearly frozen inter-bank lending in Europe ever since the crisis in Greece provoked a more general concern about sovereign debt, which then spilled into concerns about counterparties.
That has been reflected in a massive expansion of the European Central Bank’s role, with those banks with excess liquidity parking it with the ECB rather than making it available to their peers while those banks in need of liquidity have been borrowing from the ECB.
The testing may help to free up the perceived better end of the interbank market, now that the system has a clearer view of which banks occupy it.
The markets’ response isn’t directly relevant to that issue, although it would clearly influence the atmospherics around European banking. Where it is going to be important is the extent to which the general reaction to the tests encourages or discourages investors to support the banks’ funding requirements.
The eurozone banks have, according to the IMF, to raise about $A2.4 trillion of debt over the next 18 months to refinance maturing borrowings. The UK banks face a refinancing task of about half that size.
If the tests don’t engender sufficient confidence in the banks, large-scale government assistance will again be required and the gradual stabilisation and normalisation of the European banking systems, which was somewhat interrupted by the sovereign debt concerns, will be undermined.
Similar stress-testing of the US banks attracted, as noted previously, similar cynicism but proved a turning point in confidence in the US financial system.
The European exercise was more extensive and, to be fair — because it was conducted at a greater distance from the peak of the financial crisis — came after a lot of repair work had already been undertaken. That improves its prospect of being accepted as broadly reassuring, even with some reservations, by the banks and the markets.
This article first appeared on Business Spectator.
Crikey is committed to hosting lively discussions. Help us keep the conversation useful, interesting and welcoming. We aim to publish comments quickly in the interest of promoting robust conversation, but we’re a small team and we deploy filters to protect against legal risk. Occasionally your comment may be held up while we review, but we’re working as fast as we can to keep the conversation rolling.
The Crikey comment section is members-only content. Please subscribe to leave a comment.
The Crikey comment section is members-only content. Please login to leave a comment.