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Confidence won’t last if banks don’t get busy

A good appetite has long been seen as a sign of good health. And with the results of the European Central Bank’s comprehensive assessment showing that the eurozone’s banking system is, broadly speaking, healthy, banks need to start showing some of the signs of life they’ve been lacking since the crisis. Namely: lending.

The ECB seems to have cemented its reputation as the most competent regulator in Europe, having successfully undertaken the most thorough assessment of banks' balance sheets to date and handed investors, for the first time, millions of lines of data allowing them to compare banks with one another across jurisdictions.

The market reacted jubilantly on Monday after the results were announced, with the stress tests having been seen as satisfactorily tough on banks, without destroying the confidence in the banking sector that the exercise was meant to restore.

And even though bank analysts now potentially face months of staring at data points and trying to make sense of it all, most seem ecstatic to have the chance.

“Having this much information is a gift,” said one, who was at the office until 3am on Sunday glued to his screen like a child in front of his new PlayStation.

But given how fragile the psychology of capital markets is, the shine could soon wear off if banks don’t get back to the business of taking risk.

The outlook isn’t great for lending. Many in the market doubt that the Targeted Long Term Refinancing Operations will actually result in lending or that the take up will even be big enough to make much difference. Demand for loans from small businesses is said to be on the floor and, with the spectre of deflation looming, that doesn't look likely to change.

It’s often been said that banks haven’t been lending because they are focused on raising capital. If that’s true, it won’t change. Banks have unprecedented levels of capital, with a weighted average common equity tier one ratio of 11.1% after AQR adjustments, but market participants expect the real rush to begin soon, in particular in the additional tier one market.

More likely, however, is that banks simply don’t have the appetite for risk. And lenders say the opportunities they do have don’t pay enough for the risk involved.

At a group discussion earlier this year, one banker asked the room of eight others, after they had reached a consensus that banks wouldn't be doing much lending in the foreseeable future: “Who will take on the risk?”

Another answered: “Shadow banks.”

So the question we need to be asking now is how healthy is a banking system that has no risk appetite? The end of the comprehensive assessment doesn’t represent a clean bill of health. What it represents is the opportunity to look a bit more closely at why banks are still sick and what can be done to get them back in shape. 

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