Over the weekend there was a lot of coverage on the results from the European Central Bank’s stress testing – looking at how banks would respond if for example, house prices were to fall, or exchange rates move significantly. Actually, of the 130 banks tested, 25 failed, but many were smaller players in southern Europe, and are already in the process of plugging the gaps. Stress tests by their nature are imprecise, and market reaction was as expected.
The much more interesting aspect though was the parallel testing under the Asset Quality Review. According to the Economist, this was only applied to 123 big banks in the euro zone’s 18 countries, which from next month will be regulated by the ECB instead of national watchdogs.
The ECB found €136 billion in troubled loans banks had not fessed up to, bringing the European total to €879 billion ($1.1 trillion). Italy will have to implement the biggest reclassification of loans (€12 billion), with Greek (€8 billion) and German banks (€7 billion) also challenged.
Many banks that thought they might fail the tests have raised over €45 billion in equity, strengthening them considerably. That explains why only 12 banks will have to unveil plans to raise capital when 25 have apparently failed, including Eurobank in Greece, Monte dei Paschi di Siena in Italy and Portugal’s BCP, the only three with more than €1 billion to raise. They now have to come up with plans to strengthen their balance sheets.
These tests are as much a stress test of the European Central bank which is taking on an ever more important role, as the individual banks themselves.
