The ECB’s Hope Test

25 Banks Failed, Sort of …

We noted on the eve of the publication of the ECB’s “comprehensive assessment” of European banks (here is the ECB’s complete report, pdf) that the central bank’s review would likely be more stringent than the EBA’s stress tests during the euro area crisis, because the central bank will become their supervisor.

However, it would also not be too harsh in its assessments, as it probably wants to avoid unnerving the markets. Apparently, this is precisely what happened. For instance, the WSJ informs us that “ECB Says Most Banks Are Healthy”. 25 banks failed the test technically, but only 13 of them actually need to come up with additional capital. A similar feelgood article appeared at Reuters, entitled “ECB fails 25 banks in health check but problems largely solved”. The WSJ writes:

“Hoping to quell years of anxiety about Europe’s financial health, regulators said Sunday that all but 13 of the continent’s leading banks have enough capital to ride out another economic storm.

The European Central Bank and the European Banking Authority announced the results of a nearly yearlong effort to assess the finances of 150 banks, identifying 13 that still need to come up with a total of €9.5 billion ($12 billion) in extra capital. Overall, 25 banks technically failed the so-called stress tests, facing a cumulative shortfall of €24.6 billion. But most have already taken steps to solve their problems since the end of 2013, the cutoff date for the exercise.

To pass the tests, banks had to show that they had ample capital to survive a crisis that would cause Europe’s economy to fall 7% below current forecasts and the unemployment rate to rise to 13%.

The exams are part of an effort to reassure investors and the public that, following years of destabilizing banking meltdowns and long after the U.S. defused its financial crisis, Europe’s lenders are back on solid footing. Restoring that confidence is a top priority, because the continent’s sluggish economy needs healthy banks to provide loans to households and businesses.

For the ECB, Sunday’s results are the final milestone before it takes over supervision of major eurozone banks on Nov. 4. Turning the ECB into the currency union’s bank watchdog is a key step to setting up a so-called eurozone banking union. The hope is that moving control over important banks out of national hands will prevent the kind of banking crises that rocked Ireland, Spain and Cyprus in recent years.

Investors and analysts mostly applauded the tests, saying they appeared to be much more rigorous than previous years’ versions. But some expressed disappointment that European Union supervisors didn’t take the opportunity to get more banks to thicken their capital cushions.

Philippe Bodereau, global head of financial research at Pimco, said the regulators’ strictures were a step in the right direction. But “I would have preferred they be a bit tougher and force more [banks] to raise capital,” he said.

So other observers have come to the same conclusion that we have come to before the publication already: the test was better than its predecessors, but still not really good enough. In our opinion the term “hope” is employed far too often in this context. Hope is not a financial strategy.