European banks: one box ticked

The ECB stress tests show a banking system that is pretty healthy overall. All that's required now is for eurozone businesses to believe that.

It’s not all that surprising that the asset quality review and stress tests of Europe’s banks showed that most of them passed. The purpose of a stress test is to reduce, not raise, stress.

No banks will have to close, although there may be a bit of consolidation in Italy, and on the whole everything is hunky dory. Move along, nothing to see here.

The news headlines report that 13 banks “failed” the test but, actually, six of those were in Italy and Greece and all the big ones passed easily.

The real story out of the review is that a few European banks have to raise less than €10 billion, which is about a third of the €30bn or so that had been expected.

And €3bn of this is down to the Greek banks, which already have a restructuring plan in plan in place – so that leaves just €7bn to be raised, which is not much considering that €198bn have already been raised.

The only danger with this review was that it would be seen as a whitewash and not credible. So far, at least, that hasn’t happened.

As the vice president of the ECB, Vítor Constâncio, said at a news conference yesterday: “The massive nature of the exercise deserves to be acknowledged. The results are credible.”

More than 5,000 securities and 170,000 collateral items were revalued by thousands of staff. The stress tests looked at how the banks would perform out to the end of 2016 if GDP fell short by a total of 6.6 per cent over the period or if there was a 375 basis point increase in sovereign bond yields.

Under the adverse stress tests, the median common equity tier one (CET1) fell by 4 percentage points from 12.4 to 8.3 per cent, with the banks’ aggregate capital projected to fall by €215.5bn. The required CET1 ratio is 5.5 per cent.

The aim of the exercise was to restore confidence in the banking system – to improve demand for European bank shares and make it easier for them to raise the money needed and to get cross-border and interbank lending moving again.

The signs are that it will do that. Six years after the crisis, it seems Europe’s period of bank deleveraging is over and since most of them now have plenty of capital, they can start lending again and growing their balance sheets.

The next step is to get Europe’s businesses to borrow again. To do that the ECB will need to persuade them that Europe is not heading for a deflationary spiral and bust, and it’s certainly not there yet.

That’s as much about fiscal policy as the monetary policy that the ECB controls.

With the completion of the bank stress tests, the pressure will now come on for an expansion in government spending.

The incoming European Commission President Jean-Claude Juncker has advocated a €300bn investment programme and pressure is coming on the EC – specifically Germany - to allow France and Italy to ease off austerity in return for structural reforms.

The bank tests mean that a box has been ticked for Europe, but there are still a few to go.

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