ECB Policy Makers Say Stress Tests Risk Market Confusion

The European Central Bank is concerned that investors could be spooked by next year’s bank balance-sheet reviews and stress tests unless their results are carefully timed.

As the ECB prepares to take over supervision of all euro-area lenders in 2014, it will begin a three-phased analysis of the institutions coming under its umbrella. As laid out by Executive Board member Yves Mersch last month, the bank will start with a risk review before analyzing banks’ balance sheets and conducting stress tests in collaboration with the London-based European Banking Authority.

Now central bankers are wrestling with how to move through the exercise without releasing conflicting numbers at different times, particularly for banks that aren’t in good health. ECB Executive Board member Peter Praet and Governing Council member Ewald Nowotny said this week that the two organizations must avoid giving different estimates of how much extra capital banks will need to raise.

“Probably the stress test has to be integrated in the balance-sheet assessment, because you don’t want to come with one figure per bank, with the possibility of a recap, and then come later on with the stress test,” Praet said in London.

Capital Shortfall

European lenders have undergone two stress tests since 2010, with eight banks failing the last round conducted by the EBA in 2011 with a combined capital shortfall of 2.5 billion euros ($3.3 billion). ECB Executive Board member Joerg Asmussen said this month that the upcoming tests will be the final opportunity to restore confidence in the region’s financial system.

To avoid conflicts, the London-based EBA in May delayed this year’s round of stress tests until 2014, to make room for the ECB’s asset-quality reviews of banks joining the euro-area supervision regime. Investors now are looking to the assessments to uncover hidden problems so they can be properly fixed.

“Only a tough AQR, together with a credible stress test, will restore confidence in the European banking system and thereby overcome the dysfunctional interbank market and reduce the fragmentation of euro-area credit conditions,” Guntram Wolff and Andre Sapir of the Brussels-based Bruegel research group said in a paper presented to EU finance ministers last week in Vilnius, Lithuania.

‘Single Figure’

The Frankfurt-based ECB is set to start overseeing all euro-area banks as early as October 2014 after European lawmakers voted this month to approve the single supervisor. Mersch said on Aug. 29 that the ECB and the EBA will provide “one single figure of capital needs,” and policy makers continue to emphasize the importance of keeping all the reviews on the same page.

“What we have to prevent in any case is that we now have both results on capital requirements from the asset-quality review and results of a stress test,” Nowotny said in Vienna. “Instead of reassurance, that would lead to complete incomprehension. Personally I’m not quite sure whether a stress test in addition to an asset-quality review really adds great value and can contribute to an increased stabilization of the markets.”

The Single Supervisory Mechanism is a step toward a planned European banking union that is supposed to sever the link between banks and sovereign debt. ECB President Mario Draghi has said the central bank will offer details of its stress test process in mid-October, and he has repeatedly exhorted the euro area to come up with a strong process for stabilizing failing banks.

A European Union proposal for a Single Resolution Mechanism for winding up failing lenders hit a stumbling block after German Finance Minister Wolfgang Schaeuble said it’s on shaky legal ground. He was supported by countries including Sweden and Slovakia during two days of talks in Vilnius that ended Sept. 14.

Source: Bloomberg