European Banks – Still Full Of Holes?

Comprehensive Assessment Paranoia

The ECB is currently busy stress-testing all “systemically relevant” banks in the euro area, the supervision of which it is going to take over as part of the banking union plan later this year. This stress test has given birth to new acronyms, such as “AQR” (asset quality review) and “CA” (comprehensive assessment). Banks that are found to be short of sufficient tier 1 capital will have to submit a credible  recapitalization plan very quickly after the CA has been concluded, and thereafter will have several months to implement it. 

As a result of the massive carry trade in government bonds of the periphery initiated by the LTROs and Draghi’s OMT promise (as we have previously mentioned, the timing and sequence of events suggests that there were sub-rosa agreements between governments, the ECB and large commercial banks, with the caveat that this is impossible to prove), a number of bank balance sheets in countries like Spain and Italy probably look significantly improved  simply due to their vast accumulation of zero risk-weighted government debt. Moreover, the ECB’s war on savers has clearly served as a redistributive device in favor of banks.

Nevertheless, the recent downfall of the Espirito Santo empire including the bank (Banco Espirito Santo) of the same name in Portugal, was a reminder that there may still be skeletons in a number of closets (an interesting backgrounder on the Espirito Santo affair can be found here by the way). A recent report in the NYT’s dealbook suggests that there is a growing consensus that the ECB’s stress test will discover many a bank balance sheet falling significantly short.  The Texas ratio has emerged as the analytical tool of choice for guessing which banks will be found wanting: