Bank stress tests highlight lending fears

Posted on July 28, 2016

Eurozone policymakers are awaiting the imminent publication of stress tests on the region’s 37 biggest banks with some anxiety. Their fear is that a poor set of results could damp the recent lending revival in a region already at risk from slowing growth and the post-Brexit fallout.

    The London-based European Banking Authority will publish the test results of the largest eurozone banks at 9pm local time on Friday, after the US markets close.

    The European Central Bank, which worked with the EBA on the exercise, has also subjected the balance sheets of another 56 smaller eurozone lenders to stress tests, although these results will not be published.

    The most important figures from the tests will be those that show how well banks’ capital buffers could stand up in the event of worsening economic conditions and tougher regulation. While there is no pass or fail mark, the risk is that markets will put pressure on lenders that perform poorly to raise capital in an environment where — with share prices low and wide concern over banks’ growth prospects — this is difficult to do.

    The eurozone economy is much more reliant on banks than the US, where companies have access to other sources of capital in addition to bank loans, such as much deeper debt markets. And the ECB needs healthy banks, if they are to pass on the central bank’s cheap funding to customers so growth can strengthen.

    “In bank-centric economies that are in desperate need of a productivity miracle, it is essential that the banks are not just solvent but in a fit state to finance the growth of the productive new enterprises of tomorrow rather than just warehousing legacy loans to . . . mature companies,” said Richard Barwell, economist at BNP Paribas Investment Partners.

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    Recent bank lending surveys indicate credit markets have been thawing across the eurozone, including in member states with weaker economies such as Spain and Italy.

    In terms of the stress tests, banks in Italy, the eurozone’s third-largest economy — notably its third-biggest lender, Monte dei Paschi di Siena — are seen as most at risk. Some German banks are also seen as vulnerable.

    Faced at a press conference last week with several questions on the health of the eurozone’s lenders, Mario Draghi, ECB president, acknowledged that the sharp falls in bank stocks in the aftermath of the UK’s decision to leave the EU posed a danger to central bank efforts to steer the region towards economic recovery.

    “Bank equity prices are of some significance for policymakers, because if they drop in the way they did [and] if this is to stay, the cost of capital would increase and therefore the net return on lending would decrease,” he said. This risked “more conservative lending behaviour” by banks.

    Euro banks

    However, Mr Draghi stressed that banks in the region were in a much stronger position now than a few years ago and had raised their core capital levels from an average of 9 per cent in 2012 to around 13 per cent now. The problems of the eurozone’s banking sector were ones of profitability and not of solvency, he said.

    The signals from the ECB and EBA so far are that the tests will uncover little that will spook the markets. Economists broadly share this view.

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    “We don’t expect any meaningful impact on credit conditions from the test or the policy response,” said Dirk Schumacher, economist at Goldman Sachs. “Credit conditions have been easing until very recently, which is indicative that banks in the aggregate will not be impacted — otherwise we would probably have seen some [pre-emptive] change in lending behaviour.”

    But the tests could focus attention on existing concerns about lenders’ health — and, if the results are poor, prompt a policy response by banks and governments that leads to tougher rules on lenders. The big concern is that a big public bailout of Italian banks would undermine Europe’s attempts to create a regime to bail in private investors — and trigger a tough response from the region’s regulators.

    “The stress tests should not lead to a big drop in lending across the eurozone any time soon,” said Mr Barwell. “But there is a medium-term threat from the unintended consequences of any emergency policy response to known problems that the stress tests will highlight.

    “A bailout of a bank today could undermine the bail-in regime, prompting regulators to demand higher capital requirements across the board tomorrow. And that could weigh on lending.”

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