December 1, 2023

Europe Looks for Hope in Bank Test Results

Europe’s festering debt crisis may well be approaching its own post-Lehman Brothers moment, when fear of the unthinkable finally prompted British and American governments to take radical action and force most of their capital-thin banks to accept government money — whether they liked it or not.

But to the frustration of many, Europe seems far removed from such a drastic move.

Instead, the euro zone’s top banking supervisor will announce on Friday the results of its latest examination into the health of its financial institutions. It is an exercise that an increasingly desperate European Union hopes will quell investor fears that the region’s banks have become too impaired by holdings that may be seriously overvalued to provide the loans needed to stimulate economic growth.

While European finance ministers pledged this week that they would have a backstop plan for vulnerable banks, in practice that task will be left to national banking regulators, who have varying levels of resources and political will.

The banks’ stress test results come at a time of cresting market anxiety, spurred in particular by worries of a strike by domestic buyers for Italian government bonds. On Thursday, the yields on two-year Italian bonds — an accurate gauge of short-term market sentiment — were at 4 percent, higher than Spain’s and double what they were a year ago. (For Greece, two-year money is available at a rate around 30 percent.)

And the overnight Euribor rate — what banks in Europe charge each other for short-term loans — more than doubled over the last week, to 1.47 percent from 0.6 percent, as banks within the euro zone have become more reluctant to lend to each other.

That is still well below the high of around 4 percent reached after the Lehman collapse. But bankers say the increased jitters in Italy are leading investment banks to demand higher amounts of collateral and cash to back up their loans to Italian counterparties.

The stress test is the third in three years but only the second in which results are being made public. It is being overseen by the European Banking Authority, based in London, which has scoured the balance sheets and capital levels of 91 banks, focusing on the exposure banks have to the dubious sovereign debt of Greece, Portugal and Ireland.

The survey last year was widely condemned after Irish banks failed just months after receiving passing grades. Regulators have tried to strike a different tone this year.

“There will be a certain number of banks that will not pass and others that barely do so,” said Michel Barnier, the European Union commissioner for internal markets. That fact, he said, “will be strong evidence that these tests are credible.”

The new tests will require a reserve benchmark of 5 percent core Tier 1 capital and that the banks be able to handle a 0.5 percent economic contraction in the euro zone in 2011, a 15 percent drop in European stock markets and potential trading losses on sovereign debt.

Since the last stress tests a year ago, the banks have raised 67 billion euros ($94.2 billion) in new capital, according to Morgan Stanley, a relative pittance given that European banks have on their books 1.1 trillion euros in government debt from Greece, Ireland, Portugal and Spain.

For some large and systemically important banks, the margin for error is thin indeed.

At the French bank Crédit Agricole, Greek holdings are about equal to its equity. (Société Générale and BNP Paribas also have significant Greek bond exposures but benefit from larger capital buffers). And for the Royal Bank of Scotland, which is majority owned by the British government, the same is the case for the Irish loans on its books.

Landon Thomas Jr. reported from London and Jack Ewing from Frankfurt. Floyd Norris contributed reporting from New York.

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