Asset Anxiety

In Europe's Banking 'Stress' Test, Jockeying for Position

Not more scenes like this
Stress tests are designed to avoid bank runs like this, in 2013 in Cyprus.
  • Why it matters

    Why it matters

    The success or failure of the ECB’s first stress test of banking health is likely to have a major effect on investor confidence in the European single currency.

  • Facts

    Facts

    • The ECB will publish results of its first “stress test” of euro zone banks in October.
    • In the review, 128 banks, including 24 in Germany, are being scrutinized
    • Banks are pushing the central bank for advance notice of their results.
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    Audio

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Less than two months before the European Central Bank publishes its first “stress test’’ on the health of the biggest banks in the euro zone, negotiations are taking place between banks and the regulator over how much advance warning financial institutions will receive of negative, potentially embarrassing findings, according to people familiar with the talks.

At stake is the credibility of financial heavyweights such as Commerzbank, Deutsche Bank and German state regional banks, and also the Frankfurt-based central bank itself, which wants to be seen to be imposing new, effective controls on the financial sector to ward off another currency crisis.

Some banks are asking the ECB to give them the results of the stress test before they are published, the people said, so the banks can take corrective action and appear to be on top of the problem. But such advance notice is problematic because if the ECB provides them with results banks would be legally required to pass those on to shareholders under financial disclosure rules.

The central bank has an interest in showcasing the effectiveness of its new stress test, showing market watchers around the world that its new monitoring has teeth, and is forcing banks to raise more money to meet tougher reserve requirements. If all euro zone banks are able to take corrective action before the results become public, it could undermine the ECB’s test.

“Really from a legal perspective it’s a tricky thing, the outcome of a political decision to create a stress test of this kind,” said Andreas Steck, a lawyer at the firm Linklaters in Frankfurt who specializes in banking supervisory law. Mr. Steck said “careful maneuvering will be required’’ both by the banks and the ECB on the release of the report card results.

The ECB this month plans to begin a final round of talks on the tests with the 128 largest banks in the euro zone, including 24 in Germany. The central bank has been in talks with the banks since last November, and plans to release results of its new stress test in late October.

Martin Hellmich, a professor of financial risk management at the Frankfurt School of Finance and Management, said those banks most worried are those that are unsure of the outcome of the test, which will need to quickly raise capital if they fail.

“It’s pretty clear who has done badly,’’ Mr. Hellmich said, declining to specify which banks he thinks will do poorly. “But there are some institutions stuck in a gray area, which can’t be sure how they’ve done. The nerves here are pretty frayed.”

The stress test, which the ECB refers to as a “comprehensive assessment,’’ is the central bank’s latest attempt to bolster confidence in Europe’s financial system.

Two previous European “stress tests” conducted by the European Banking Authority, the ECB’s predecessor as a pan-European supervisor, failed to bolster trust in the wake of the 2008 financial crisis. The ECB has said its stress test – being conducted together with the EBA – may be the last chance to get it right.

Government and bank policymakers in Germany have been reluctant to criticize the opaque process surrounding the release of the results, fearing that questioning the tests could unleash another wave of doubt about Europe’s banking system.

“Europe already wasted many years before launching an examination of the European banking system that really has bite to it,” Gerhard Schick, a member of the German Bundestag who is a spokesman on financial matters for the Green Party, told Handelsblatt Global Edition. “I can understand all the complaints. But I don’t see how else it could have been done.”

 

ECB Nouy-Reuters
Getting a closer look at European banks’ assets, ECB Supervisory Board Chair Daniele Nouy. Source: Reuters

 

The test’s success is also critical for the ECB’s credibility. The central bank is set to become the euro zone’s primary banking supervisor in November, taking over from 18 national regulators that had each monitored their domestic banks. The latest stress test was designed to give the ECB direct insight into the exact state of the banks it is supervising.

The ECB test is two-pronged. One part examines in new detail the quality of a bank’s assets, and whether those are indeed concrete and liquid enough to hedge risks. The other is a theoretical “stress’’ test of how each bank would fare under a new financial crisis.

Banks that don’t have enough reserves will be deemed to have failed the test and will be directed to raise money to deal with shortfalls. The money could eventually come again from European taxpayers, although banks are expected to try raising the money on capital markets first.

While the tests are concrete, the timing of the report cards is not. In July, the ECB said it would inform banks of how they did on the tests “very close to the time of public disclosure.” Some observers have interpreted this to mean as little as 48 hours before the results are released to the public.

A bank that fails the test will have two weeks to present a plan to raise the necessary money, and if approved, will then have up to nine months to raise the funds. Their plans will have to be approved by the ECB, which could force banks to take additional steps if it is unhappy.

The stress test, which the ECB refers to as a “comprehensive assessment,’’ is the central bank’s latest attempt to bolster confidence in Europe’s financial system.

The banking sector in Germany is pushing to get the results far ahead of their publication.

The Association of German Banks, or Bankenverband, the industry’s main lobbying group, in July called 48-hour advance notification “completely inadequate,” and criticized the ECB for not issuing specific publication guidelines.

Their member banks, the German industry association said, will need “considerably more” than two weeks to present a capital plan to raise money. Thomas Schlüter, a spokesman for the association, last week said the issue had not yet been addressed. The ECB would not comment on the ongoing talks.

Advance notice is legally tricky. German law requires publicly traded companies to inform shareholders “without undue delay” of market-moving information. The law is meant to discourage insider trading.

 

Mario Draghi's "whatever it takes" speech has silenced many critics. Source: DPA
Mario Draghi hopes the ECB’s stress test will finally revive lending in the euro zone. Source: DPA

 

Still, the ECB can give plenty of clues. The ECB could ask banks to present a series of hypothetical capital plans for different possible results. “A lot of information falls between the lines,” said Mr. Hellmich, the Frankfurt banking professor.

The ECB has suggested it may try to spare banks unpleasant publicity by telegraphing the results.

In July, the ECB said the final round of talks with banks that begins this month will be a “partial and preliminary” review of the stress test’s results. Banks will be told “the key elements and the main individual drivers of the outcome,” but the central bank added, “It is important to note that no bank will be given certainty concerning the full overall result on this occasion.”

Some banks have already taken action to shore up their finances.

A few banks have already warned investors they might fail the test. Germany’s HSH Nordbank, a state-backed lender based in Hamburg last Friday said it “cannot be excluded in principle“ that its Common Equity Tier1 capital ratio – a commonly used gauge of the strength of a bank’s reserves – might end up below the 8 per cent threshold required by the ECB.

While not disclosing the results, the ECB has encouraged banks to be proactive, warning that the market for fresh funds could tighten once the results are released next month. Nearly €200 billion ($266 billion) in capital has been raised since July 2013, the ECB has said.

“We are telling banks they should put their house in order, prepare themselves for the outcome of the exercise,” Daniele Nouy, the head of the ECB’s new supervisory board, said in July. “The sooner they do it, the better. If they are not sure about the amount, they should go for more, not for less.”

Spokespersons for Deutsche Bank and Commerzbank declined to comment for this story.

Anatoli Annenkov, an analyst with Societe Generale in London, said the ECB has been made the process as transparent as it can. The steps taken by banks to shore up their capital positions have also already been priced into the market, he added

“This is why the market is relatively relaxed about the potential for big surprises,” Mr. Annenkov said.

But while some market participants may be relaxed, some of Europe’s largest banks are anything but.

The author is an editor at Handelsblatt Global Edition in Berlin. Contact: cermak@handelsblatt.com 

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