Analyst Doubts Adequacy of European Bank Stress Tests

The stress tests on eurozone banks run by the European Central Bank (ECB) “will not be enough,” according to senior analyst Tom Elliott of independent financial advisor deVere Group.

Elliott, the group’s international investment strategist, commented two days ahead of the results of the high-stakes tests, which will be made public on 26 October.

“Despite the desirability of having a light shone on the balance sheets of European banks, the European Banking Authority (EBA) bank stress test is unlikely to be a constructive tool in repairing the region’s banking sector unless something altogether more ambitious is also announced by the ECB,” said Elliott.

“On Sunday, the ECB should announce the creation of a bad bank. A bad bank needs to be created to relieve eurozone banks of their bad assets, resembling a eurozone replica of the National Asset Management Agency [NAMA] in Ireland. This could be funded by the ECB, which would exchange bonds under its own name for these assets.

“If member states object to the ECB issuing its own bonds, they could guarantee bonds raised on capital markets for this purpose, similar to the programmes used to bail out peripheral countries. A condition of an ECB-funded bad bank must be that strong banks in one country can take over weak banks in another, and so promote consolidation. Although the UK’s banks are vulnerable to swings in the housing market, they are relatively strong thanks to government bailouts and so do not need to be included.”

Elliott added: “If the stress test is too strict, and fails too many banks, European tax payers are likely to end up footing the bill for re-capitalising their balance sheets, since private capital will have all its worst fears about weak bank balance sheets confirmed. This will put pressure on government budgets at a time of regional austerity, and make a joke of the 3% budget deficit limit that eurozone members are supposed to be aiming for and which France and Italy will already be breaching. German and Italian mid-tier banks look particularly vulnerable.

“One of the objectives of the stress test is to promote merger and acquisition [M&A] activity to consolidate the sector, and to create a network of regional rather than national banks. This will help break the link between European sovereign debt crisis, bank failures and recessions. However, increased state control of the sector will hamper this, as governments will find it easier to support and protect national champions.

“However, the strongest European banks will find it easier to raise capital and their share prices will rise relative to the sector.”

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