Summary
The recent stress tests by the European Central Bank offered few surprises and did not cause any significant political or financial reactions in the Continent. However, these tests were only the beginning of a complex process to build a banking union in the European Union. Unlike the stress tests, the next steps in this project could create more divisions in Europe because national parliaments will be involved at a time when Euroskepticism is on the rise. More important, the stress tests will not have a particular impact on Europe’s main problem: tight credit conditions for households and businesses. Without a substantial improvement in credit conditions, there cannot be a substantial economic recovery, particularly in the eurozone periphery.
Analysis
The European Central Bank had two basic short-term goals for this year’s stress tests. On one hand, it had to come up with a test that was tough enough to be credible after tests held in 2010 and 2011 were widely seen as too soft and lacking in credibility. On the other hand, the tests could not produce results dire enough to generate panic. The European Union is going through a phase of relative calm in financial markets, and the European Central Bank was not interested in creating a new wave of uncertainty over the future of Europe’s banks.
While the tests did attract some criticism, the central bank achieved both goals. Of the 130 banks involved in the tests, 25 had capital shortfalls, a finding slightly more severe than forecasts projected. Of those 25 banks, 13 must raise fresh capital and come up with 9.5 billion euros ($12.1 billion) in the next nine months. None of the failed tests came as a surprise, however. Italy’s Monte dei Paschi, the worst performing bank in the tests, has been in trouble for a long time and had to receive assistance from the Italian government in 2012. Other failing banks are located in countries such as Slovenia and Greece, which have been severely affected by the financial crisis. And while the price of several banks’ shares dropped during the Oct. 27 trading session, no collapses occurred.
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The tests were not perfect — they used data from December 2013 and were mostly done by each participating state. The methodology and scenarios were also criticized. For example, the most extreme “adverse scenario” included in the tests considered a drop in inflation to 1 percent this year, although the rate has already fallen to around 0.3 percent. The decision to include only 130 “systemic” banks while turning a blind eye on smaller — and probably weaker — institutions also drew criticism. But overall, markets considered the tests legitimate, especially in comparison with the weak tests that have taken place since the beginning of the European crisis.
