For over a year, the European Central Bank’s Asset Quality Review has loomed over the eurozone banking sector. Now the results are just two weeks away — but analysts still don’t know whether they will bring celebration or woe.
High hopes are riding on the Comprehensive Assessment, which also includes stress tests by the European Banking Authority. Optimists believe that once the ordeal is past, banks that have been straining every nerve to polish their balance sheets will feel a wave of relief — and start lending with new vigour.
“These stress tests are important for the credibility of the European banking system,” said George Osborne, UK finance minister, yesterday. The weakness of the European banking system had been one of the big drags on economic growth, Osborne said, contrasting it with “the strength of the UK banking system,” which he attributed in part to the UK’s own stress tests.
But while some believe banks largely know what to expect and have raised the capital they need, others insist the results on Sunday October 26 will hold surprises.
“The banking sector has met the challenge of solvency — we are now facing the challenge of profitability,” said a cheerful Frédéric Oudéa, CEO of Société Générale. He called the AQR and stress tests “a fantastic benchmarking exercise at a scale never done before” and said the eurozone’s introduction of a single bank regulator would help harmonise bank risk models.
But Nicolas Véron, senior fellow at thinktank Bruegel, warned: “It’s going to be more murky, complicated and confusing than many people expect.”
The headline numbers on which banks needed to raise capital would not be the whole story, he said. “The ECB is going to add a number of Pillar 2 provisions, using its discretion as a supervisor. And the definition of capital differs by country — they might need more for fully loaded Basel III compliance.” Banks might, he said, need to raise more capital than what the ECB initially requested.
UNCLOGGING LENDING
Sorting out the banks really matters. As Alberto Gallo, credit strategist at RBS, pointed out, Germany’s €6bn fiscal injection for childcare and the European Investment Bank’s extra €60bn of lending in 2013-15 pale beside the post-crisis shrinking of corporate loans — €600bn in peripheral Europe alone.
Analysts at Morgan Stanley predict that the AQR will be “a critical enabler of unclogging the lending channel”.
“Most banks are quite a long way above their [capital] targets,” said Bernard De Longevialle, managing director in financial services ratings at Standard & Poor’s.
But there are pessimistic views too. If the AQR censures many banks, it could sideline them from lending until they have raised capital, and even depress sentiment about the sector in general.
“The large banks are healthy, but a lot of mid-tier banks are still weak,” said Gallo. “Especially in Italy and Spain, the big two banks can’t take up all the slack.”
And banks might be fit to pass the stress tests, but still not be “fit for purpose”, Gallo warned. Deferred tax assets, for example, count as capital, but are questionable.
The other gloomy take on the AQR lies in between: it may not hamper banks, but will not unleash any new lending drive, either. “The simple answer is that the AQR is a necessary but not sufficient condition [for a recovery in lending],” said Andrew Milligan, global head of strategy at Standard Life. “In theory the TLTRO and Comprehensive Assessment might lead to a release of lending power, but there are a lot of hurdles to jump and there are questions about demand for loans.”