European Bank Stress Test: Preview

The results of the latest stress tests on
European banks are expected to be released
at 10:00 am CET (5:00 am ET). 
  The tests cover a little more
than 50 of Europe’s largest banks, with around 80% domiciled in the
eurozone.  

The banks will be
tested
under two scenarios. 
The first scenario is EC’s
economic forecasts made last year.  That is the baseline.  The second
is a stress scenario developed by the European Banking Authority (EBA) and the
European Systemic Risk Board.  This scenario includes shocks in numerous
markets.  

Indications from officials indicate there will
not be a pass/fail test.
  The key is whether capital levels remain
sufficiently robust.  If not, the bank will receive “guidance”
from the ECB.   Simply because a bank is
found
in need of capital, it does not mean that it must address the need
immediately or be immediately subject to resolution procedures. 

The focus has been on Italian banks. 
A local paper reported today that of the five Italian banks that were tested, only one would require more capital.  It is not surprising that it is
Banco Monte Dei Paschi di Siena that needs capital.  The report indicated
that Intesa, Bano Popolare, and Ubi Banca
are the upper end of the EBA’s capital
range, while Unicredit was in the middle to the high
part of the range.  Monte Paschi, in contrast, is classified as a higher
risk.  

Italy is not the only country engaged in
negotiations with EU officials over state aid for banks, so is Portugal. 

Its banks are perceived to be undercapitalized and saddled with bad loans
(estimated ~30 bln euros).   Estimates of the amount of capital
needed by Portuguese banks is up to around eight
bln. 

Between three and four
bln euros may be needed just to
compensate for the bank-financed
resolution fund that bailed out Portugal’s Novo Banco (2014). 
 
The government is trying to facilitate a sale of the bank, but last September
rejected all three shortlisted bids.  An announcement about another
attempt is expected next month, though the EU has extended the official
deadline until August 2107. Portugal is also in talks with the EU over
recapitalizing state-owned Caixa Geral de Depositos, the country’s largest
bank.    Reports show a wide
range of estimates of its capital needs–2 to 5 bln euros. 

However, it is not just about the periphery. 
Germany’s largest bank has been in the news.  It reports its earnings two
days before the stress test results.  There are some reports that suggest
some Nordic banks may be pressed tough scenario for Sweden and house prices. 
Austrian banks may also be at risk from bearish economic assumptions and
contagion from central and eastern Europe.  Some reports also suggest The
Netherlands may have some issues too that will surface in the stress
test.  

The issue is not whether the state can inject
capital into the banks; they can.
The
issue is what private sector investors have to take a loss (bailed in) before
taxpayer funds can be used.  There
are various and conflicting proposals, but everyone says they want to adhere to the rules.  However, it is almost like
a sporting event, where the violation of the rules (fouling) is incorporated
into the rules themselves.  

Specifically, taxpayers money could be used to
cover a capital shortfall, according to
the Bank Recovery and Resolution Directive, without being a resolution event
(bailing in subordinated creditors) when it needs
to avoid “a serious disturbance in the economy of a member state and
preserve financial stability.”
What makes this particularly relevant in Italy is that a painful resolution process
would jeopardize the country’s financial and political stability.  

It would likely make it less likely that the
referendum for constitutional changes (emasculate the Senate) would fail. 

Italy’s Renzi has indicated he would resign if the referendum is not
approved.  Although he was trying to make a point, linking the referendum
to the tenure of the government is
reckless.  It might be even on par with Cameron’s EU referendum. 
Polls suggest the Italian referendum not drawing stronger support. 

The Five-Star Movement (5SM)has become the
largest party in Italy, according to some surveys
.  The 30-year old
inexperienced and uneducated (formally) leader of the party in parliament,
Luigi Di Maio wants to the full nationalization of Monte Paschi and a
(non-binding) referendum on EMU membership (not EU).   The 5SM is
also opposed to the constitutional changes Renzi proposes on grounds that it
concentrates too much power in the premier.  Maio may be emerging as
Renzi’s most likely challenger.   

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