ECB: Comprehensive Review: Successful start, end unknown

The focus of interest in the stress tests is on the number of failed banks and the capital shortfall established. Some critics will therefore doubtless find the results disappointing: In fact, taking into account fresh capital that has already been raised since end-2013, 13 banks failed the test, but mainly only minnows, and the shortfall in the European banking system is only EUR 9.5bn. However, this point of view misses two things: Since Lehman eurozone banks have already shored up their capital reserves by more than EUR 700bn; and bank balance sheets have shrunk by almost EUR 4,000bn in the last two years alone. Given current business volumes, European banks are on average not short of capital (and certainly not of liquidity). The IMF reaffirmed this in the latest Global Financial Stability Report: In sum, capital ratios in the eurozone are (at least) as high as on the other side of the pond. The problem lies elsewhere: many eurozone banks struggle to cover their capital costs.

The real significance of the ECB’s bank review therefore lies in the preceding scrutiny of bank balance sheets (Asset Quality Review – AQR). For the first time comparable figures are now available for the eurozone, there is more transparency and clarity regarding the evaluation of asset positions. The AQR is a kind of sweeping due diligence examination for the most important banks in the eurozone – the results of which are now available to all. They therefore provide the perfect occasion for banks and investors to plug holes or adjust business models as necessary.

So the long-term impact of today’s figures should by no means be underestimated. The exercise serves to create the conditions to build a more integrated European banking system and overcome the refragmentation of markets, reflected above all in a sharp decline in cross-border bank loans. The reactivation of European interbank markets – instead of the broad refinancing via the ECB with corresponding Target II balances - would be an important milestone in restoring the health of the banking system.

For the economy, by contrast, the results are relatively insignificant. Why should a bank which has successfully passed the test step up its lending now? Presumably it was aware of its adequate capital base beforehand. So hopes that the stress tests alone will boost lending are likely to be disappointed. And in the USA, the “inventor” of the stress tests, corporate lending fell for a further six quarters following the first successful test in May 2009. To get the economy back on its feet quickly, action needs to be taken elsewhere.

Dr. Michael Heise

Allianz SE
Phone +49.89.3800-16143

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