The EBA's stress tests reveal their own lack of credibility

Pulling Hair

Stress tests for Europe’s banks are Orwellian doublespeak.

They are not designed to show the real state of lenders across the continent, nor do they provide any real insight into how the 51 banks examined in the latest exercise would withstand another crisis. Instead, the stress tests are designed to impart confidence, to explain that things aren’t quite as bad as they appear to be.

Even by this measure they have proved to be a failure. This much was evident from the caning taken by bank shares across Europe on Monday, when investors had the opportunity to pass judgment on the findings of the European Banking Authority, which were published after markets closed for business on Friday night.

The EBA thinks conditions have improved since the last time it conducted stress tests, in 2014, and that it can now do what it calls “steady-state monitoring”. The 8% drop in the share price of UniCredit, Italy’s biggest bank, and the 3% fall in bank shares across Europe shows that investors see things differently. What’s more, the investors are right.

There were three things glaringly wrong with the latest examination. The tests did not include banks from two of the most troubled eurozone countries: Greece and Portugal. They did not test for the most likely problem: a prolonged period of negative interest rates following Brexit that would further impair the profitability of European banks. And they did not say whether individual banks had passed or failed.

In order to give the exercise a tinge of credibility, the EBA singled out Italy’s Monte dei Paschi as a bank that would see all its capital wiped out under certain conditions: recession and a sharp increase in interest rates. Monte dei Paschi duly announced on Friday that it was raising €5bn (£4.2bn) in capital from private sources.

This is good as far as it goes, but the truth is that Monte dei Paschi is the tip of a barely concealed iceberg. The best solution to the problem would be for Europe to copy what the United States did long ago: provide ample quantities of federal capital, write off bad debts and allow some banks to fail. However, this would require the creation of a European banking union, a development that has stalled due to lack of enthusiasm in Germany.

The second-best solution would be for Matteo Renzi’s government to be give the all-clear for a national bailout of Italy’s banks, even if this means playing fast and loose with Europe’s state-aid rules. Otherwise, Europe’s banks will, at best, continue to exist in a nether world where they continue in business but are unable to fulfil their prime function, which is to provide loans to the private sector.

At worst, they will collapse when the war games end and they are put under real duress. At this point, the stress tests will be exposed for what they are: a sticking plaster over a gaping wound.

Powered by Guardian.co.ukThis article was written by Larry Elliott, for theguardian.com on Monday 1st August 2016 17.46 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010

 

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