If five years is an unwisely long time for a person to skip a proper checkup, it is an eternity for a $40 trillion banking sector displaying many signs of ill health.
The results on Sunday of tests that aim to determine if Europe’s banks can survive a crisis came roughly half a decade after the United States forced its banks to undergo similarly thorough tests. Earlier European banking tests had been less comprehensive and failed to identify major problems. This examination was also seen as a test of the credibility of the European Central Bank, led by Mario Draghi. The results appeared to be rigorous enough, finding that 13 banks failed the test and that the region’s lenders needed $31 billion to bolster their financial footing. Poring over the numbers, banking specialists said that Europe’s regulators had done a relatively competent job. While no large banks failed, the tests did not appear to be a whitewash either, they said. As a result, the tests may have instilled some confidence in financial giants that dominate Europe’s economy, which could then help jump-start the lending that is needed to reduce the region’s chronically high unemployment.
“They can be helpful in bringing stability to the European system and also therefore to lending,” said Michael S. Barr, who was an assistant secretary at the United States Treasury Departmentduring the first American tests in 2009.
An upswing in lending may not be long coming in Europe, according to some analysts and investors.
“When nonperforming loans are rising and eroding capital you are unlikely to lend more,” said Atul Lele, chief investment officer at Deltec International. “And when banks are better capitalized, there is more appetite to lend.”
Stress tests are used by banking regulators around the world as a systematic and public way to force banks into shape. In doing so, they focus on capital ratios, which measure how much a bank finances its operations with its own cash flows and shareholder funds. The more capital a bank has, the less it relies on borrowed money, a flighty source of funding that can evaporate in a crisis.
In the stress tests, the authorities and the banks guess the amount of losses the banks would suffer on loans and securities in dire economic and financial situations. They then calculate how much capital the bank would have left after bearing the losses. If the capital falls below a certain threshold at a bank, it fails the test — and has to take remedial actions quickly. Monte dei Paschi di Siena of Italy, the world’s oldest bank, met that fate, for instance. It had to find about $2.7 billion of capital.
The big hope is that the healthier banks will now lend more to corporations in Europe. Since the financial crisis of 2008, bank loans to companies have fallen by $690 billion, or 11 percent, according to data from the European Central Bank. Partly offsetting that decline, European companies have increased their borrowing through bonds by $545 billion over that period, according to central bank data. Even so, over that period American banks ended up increasing lending to companies. After a decline, loans to corporations grew $203 billion, or 13 percent, all while corporate bond issuance was booming.
Still, Mr. Barr recalls that the uptick in the United States took a while to occur. “There was not an immediate surge of new lending in 2009,” he said, “It took a significant period of time, additional fiscal stimulus and additional government programs to revive lending.”
The American stress tests may have worked because they took place at a time when the government was doing so much else. At the time, the Federal Reserve’s bond buying program was injecting trillions of dollars into the banking system and the wider economy. The European Central Bank has similar stimulus programs in place, but economists mostly doubt that they will have the same impact as the Fed’s.
But the American stress tests may also have been better designed. In 2009, the United States regulators structured the stress tests in such a way that banks could not meet required capital ratios by cutting their lending or holdings of securities, actions that can damage the economy. Instead, the capital increases had to come from measures like issuing new shares to investors. “This was an additional signal of market confidence,” Mr. Barr said.
Yves Mersch, a member of the European Central Bank’s board, said last week that the region’s banks, anticipating the stress tests, had bolstered their balance sheets to the tune of $260 billion. But only 40 percent of that sum came from issuing equity and retaining earnings, the purest forms of capital that investors trust most.
The stress tests have paved the way for the European Central Bank to assume full authority over the Continent’s banks. Like the Federal Reserve in the United States, it may choose to gradually stiffen the tests to increase the chances that they appear credible. One way to do that would be to determine whether the banks could meet a clearer measure of their capital called the leverage ratio. This yardstick, which is less vulnerable to manipulation, is included in American tests.
But applying the leverage ratio may reveal a yawning hole at European banks, according to an analysis by Sascha Steffen, an associate professor at ESMT European School of Management and Technology in Berlin, and Viral V. Acharya, a professor of economics at New York University. They first assumed European banks had to write off all the nonperforming loans that are not covered by reserves. Then they calculated how much equity capital the banks would then need so that their equity capital equaled 4 percent of total assets. In that situation, the banks in the sample would have a theoretical capital shortfall of nearly $350 billion.
“If solvency is not taken care of, there might still be problems,” Mr. Steffen said.
The New York Times
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