Stress-Related Disorders

All's Not Well that Ends Well

Most of Europe's banks passed the ECB stress test. But are they really healthy? Source: F1online
Most of Europe's banks passed the ECB stress test. But are they really healthy?
  • Why it matters

    Why it matters

    Even if most of Europe’s banks passed the ECB’s stress test, the long-term health of banks in Germany and the rest of the continent is still at stake.

  • Facts


    • The ECB gave 25 banks a failing grade in its stress test, but 12 have already taken steps to close the gap.
    • All but one of the 25 German banks participating passed. None still need to raise fresh funds.
    • Germany’s banks still remain less profitable than their European and international counterparts.
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In the end, the day everyone had been waiting for came and went with a whimper. The toughest-ever examination of Europe’s banking sector conducted by the European Central Bank revealed few major problems when grades were announced on Sunday. Germany’s banks were all in the clear.

Markets initially breathed a sigh of relief this morning. Banking stocks led Germany’s DAX Index higher in early morning trading. Commerzbank, Germany’s second-largest bank, saw its shares rise after the opening by more than 6 percent; Deutsche Bank, the No. 1 bank, rose almost 3 percent.

The market’s clear take-away: While 25 of continental Europe’s 130 largest banks technically failed the ECB’s test, those who flunked need to raise only about €7 billion in cash to restore their combined capital reserves to a satisfactory level — a “trivial” amount, sniffed Societe Generale in a letter to clients.

But the post-mortem mood in Germany and other parts of the European financial community to this apparent good news was anything but exuberant. The clear message: While most banks passed the ECB’s disaster scenario, they are far from healthy. Take for example Germany’s banks.

Andreas Dombret, the Bundesbank board member in charge of financial supervision, warned that Germany’s banks still have a lot of homework to do.

Germany’s average return-on-equity, a measure of how profitable a bank is, remains far below the European average, and Europe remains below Asia and the United States, according to the International Monetary Fund.

“German banks demonstrated that they are robust enough to withstand even severe stress, but have to increase their profitability in order to cross the finishing line at the front of the pack,” Mr. Dombret said on Sunday, warning that many have yet to develop a “sustainable” business model.

Elke König, the head of Germany’s banking regulator BaFin, warned that Germany’s banks should not “rest on their laurels.”

By many accounts, Europe’s banking sector remains far too big and overbanked. Some had hoped the ECB test would encourage a wave of consolidation in the industry. The ECB’s examination found that 31 banks will not make a profit in coming years under the normal ‘baseline’ scenario of its stress test.

“Many banks in the euro zone have trouble making returns on capital,” said Michael Heise, the chief economist of Germany’s Allianz, the country’s biggest insurer.

Take Commerzbank. Germany’s second-largest bank passed the ECB test even when some thought it would fail.

According to the ECB, Commerzbank had a core tier1 capital ratio – a measure of how much cash it holds in reserve – of 10.8 percent, well above the ECB’s minimum of 8 percent. In another severe economic downturn, Commerzbank’s capital ratio would be just under 8 percent – well above the 5.5 percent minimum the ECB required.

This is progress considering that Commerzbank was bailed out by German taxpayers amid the financial crisis. The government still holds a 17-per-cent stake in the bank.

German Finance Minister Wolfgang Schaeuble told Handelsblatt: “The results confirm my view that Germany’s banks are well-supported.”

“The ECB's test will not change the underlying structure. The German market remains very fragmented and all-in-all not very profitable.”

Stefan Best, Banking analyst, Standard and Poor’s rating agency

And yet, Commerzbank still has plenty of work to do. Its return-on-equity continues to languish in the single digits, when many other international banks of its size have double-digit returns. The bank only just returned to profitability this year.

“We thought they would scrape through [the test] and they have, but that doesn’t answer all the questions I have on Commerzbank,” said Neil Smith, an analyst in Düsseldorf at Germany’s Bankhaus Lampe.

The same goes for much of the rest of Germany’s banking sector. Its loan books remain bloated with unwanted assets. An over-reliance on customer deposits, which are yielding next to nothing in the current low-interest rate environment, are the “main culprit,” said Mr. Dombret.

“The ECB’s test will not change the underlying structure. The German market remains very fragmented and all-in-all not very profitable,” Stefan Best, a banking analyst with Standard and Poor’s rating agency, told Handelsblatt.

Mr. Dombret suggested that Germany’s financial sector, made up of nearly 2,000 banks, may have to shrink. But the fact that Germany’s banks passed the ECB’s test would seem to make this less likely.

“There may be some cleansing in the marketplace, but it remains unclear if there is a political will to resolve weak banks and reduce over-capacity,” Mr. Best said.

“German banks demonstrated that they are robust enough to withstand even severe stress but have to increase their profitability in order to cross the finishing line at the front of the pack.”

Andreas Dombret, Bundesbank board member

The fact that the ECB didn’t find too much wrong with Europe’s banks doesn’t have to mean the stress test was weak, though there are some questions being asked.

Daniele Nouy, who in one week will become the chief supervisor of all banks in the euro zone, noted the test was never really about how many banks failed but about bringing “transparency” into the system.

Most analysts indeed praised the ECB for a thorough test that has brought clarity to the state of Europe’s banking sector. The central bank took over the project after two previous rounds of stress tests since the 2008 financial crisis, conducted by the European Banking Authority, failed to restore confidence. It looks as though the ECB may finally have got it right.

And yet – expectations are everything. Some ECB watchers were predicting a shortfall of as much as €100 billion. Whether or not the ECB did a thorough job, the fact that Europe’s banks were given such a clean bill of health is hard to swallow, according to Mr. Smith of Bankhaus Lampe.

“I think there is a danger indeed that the stress tests are perceived to be not sufficiently severe,” Mr. Smith told the Handelsblatt Global Edition. “I actually give them 9.5 out of 10 in terms of methodology. Unfortunately, it really is about expectations.”

In particular, the ECB faced questions on Sunday about why it had not considered the possibility of deflation in the euro zone.

With consumer prices currently at an annual rate of 0.3 percent in the euro zone, the possibility they could turn negative is real. At the time the test was launched in 2013, deflation seemed unlikely and was therefore not considered. But times change.

“The ECB avoided playing through a deflation scenario in southern Europe. That is why it found only a small capital hole in many banks,” said Hans-Werner Sinn, president of the Munich-based IFO Institute.

The ECB’s test was a snapshot in time — in particular the state of European banks on Dec. 31, 2013, almost one year ago. Since then, many of the banks have taken steps voluntarily to meet the ECB’s capital reserve requirements.

All in all, 25 banks failed the ECB test – including one in Germany and nine in Italy. Twelve of these banks took measures to correct their failings since the ECB took its measurements at the end of 2013. Another two in Greece have a restructuring plan in place, and two others – Belgium’s Dexia and Austria’s ÖVAG – are being wound down.

That leaves 9 banks that still had some questions to answer over the weekend, with the biggest trouble cases in Italy, where four banks still need to raise funds, and Portugal. Only two banks, Italy’s Monte dei Paschi di Siena and Portugal’s Banco Commercial Portugues, have to raise more than €1 billion from investors.

Münchener Hypothekenbank was the only German bank that failed, though it too has since raised €410 million to meet the shortfall.


Dombredt Koenig dpa
Elke Koenig of the supervisory board Bafin and Andreas Dombret, Bundesbank board member. Source: DPA


But there were plenty of other close calls.

HSH Nordbank, IKB, Landesbank Berlin and Wüstenrot would all be left with capital reserves of between 6 and 7 percent in the event of a crisis – just above the “stress” scenario threshold of 5.5 percent. That compares to an average equity ratio for Germany’s banks of around 10 percent.

DZ Bank also would have only scraped through were it not for the bank having raised capital this year.

Italy fared worst. Nine banks failed as the ECB not only found lacking reserves but in some cases shoddy accounting, though only four still need to raise fresh funds.

The Genoa-based Banca Carige, which was not expected to fail, has to raise €814 million. But then, Italy’s banks were never saved, a point that the Bank of Italy, the country’s central bank, was quick to make on Sunday.

While Germany’s banks were bailed out for E250 billion in the aftermath of the crisis, the Italian government shelled out only E4 billion for its own banking sector.

After the initial euphoria subsided, some investors began to focus on the banking woes in Italy. Those concerns, some analysts said, wiped out today’s initial gains in Germany’s banking stocks, sending the DAX into negative territory by noon CET.


Christopher Cermak has covered economics and finance in Frankfurt and Washington for nearly 10 years. He is now an editor for the Handelsblatt Global Edition in Berlin. Yasmin Osman, Peter Köhler, Laura de la Motte, Robert Landgraf and Jens Münchrath contributed to this story. To contact the author:

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