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2014-11-04 08:36:45
Europe s banks are in decent shape but that is not enough to repair its economy
Nov 1st 2014
FIVE years ago this month, the discovery of a black hole in Greece s public
finances marked the start of the euro-zone crisis. Policymakers have scrambled
to contain it ever since. The outcome of their latest ploy, a probe of the
continent s banks intended to demonstrate their solidity, was revealed on
October 26th. Results were mostly encouraging, at least outside Italy. But more
will be needed to prod Europe s economy back to growth.
Run over several months and involving 6,000 staff, the stress tests were
certainly more diligent than Europe s past attempts, which on several occasions
resulted in banks faltering soon after they were pronounced healthy. Much of
the work was overseen by the European Central Bank (ECB), which is taking over
regulation of the euro zone s biggest lenders next week.
Probing the books of the 130-odd banks involved unearthed minor flaws rather
than the graveyards of skeletons some had feared. The ECB found 136 billion in
troubled loans banks had not already owned up to, bringing the European total
to 879 billion ($1.1 trillion). But the correction is piddly compared to the
22 trillion of assets they hold.
Regulators used the revised numbers in a simulation of how banks would fare in
a severe recession. They concluded 25 of them would experience losses big
enough to reduce their capital below the regulatory minimum, with a collective
shortfall of 25 billion. But given the tests were run on end-2013 figures and
most weak banks have been busily raising capital since, only 9.5 billion more
is now needed, at just 13 banks a small fraction of the 200 billion raised
since mid-2013. Only seven have more than 500m to raise (see chart).
Sceptics question how tough the tests really were. Even the worst-case economic
scenario failed to gauge the impact of deflation, for example, which would
cause defaults to soar, since it would reduce firms and households income
relative to their debts. Nor did it assess most state-owned banks in Germany,
which will remain the purview of the national regulator and many of which are
believed to be full of dud assets. But in most respects they were as rigorous
as stress tests carried out in America in 2009, which proved a turning point
for the financial sector there.
The tests did highlight weakness in Italy s banks, home to four of the
institutions still in need of fresh funds. Monte dei Paschi di Siena, the
country s third-largest bank, was by far the most prominent lender to flunk;
its shares slumped this week and it is now considering strategic options .
Most other failures were in the small, struggling economies of the euro zone s
periphery.
One immediate outcome of the tests was encouraging: the interest rates banks
pay to borrow decreased slightly, as fears over their solvency abated. As banks
rely on short-term borrowing to fund around half the loans they extend, that is
equivalent to a factory getting a big price cut from a supplier. The rebate
should be passed on to borrowers in the form of lower rates. This change will
be felt most strongly in the periphery, where firms have been paying higher
interest rates on loans than their rivals in the euro zone s core.
Banks still hold a disproportionate amount of their own country s sovereign
debt, however, so any sign of a fiscal crisis could easily undo them. The
creation of a banking union underpinned by a single supervisor within the ECB
is part of a broader plan to cut the doom loop that has tethered Europe s
banks to the fortunes of their government (and vice versa) one of the biggest
flaws in the design of the single currency.
For now, the main problem for Europe s banks is the continent s anaemic
economy. They have been proved (mostly) solvent, but whether they are viable
depends on whether they can find customers both willing to borrow and able to
repay. Few firms are bullish enough to expand, even if banks are ready to back
them.
Before the stress tests, banks were seen as an obstacle to growth, giving
ammunition to policymakers reluctant to boost demand, for example through a
bond-buying scheme at the ECB or by slowing budget cuts. Those arguments have
now been weakened. A healthy financial sector is a necessary but not sufficient
condition for a revival of the euro zone.