The symbol for the Euro currency sits in front
of the European Central Bank's headquarters in Frankfurt, Germany. Photo: Daniel
Roland/AFPGetty Images
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Summary
The recent stress tests by the European Central
Bank offered few surprises and did not cause any significant political or
financial reactions in the Continent. However, these tests were only the
beginning of a complex process to build a banking union in the European Union.
Unlike the stress tests, the next steps in this project could create more
divisions in Europe because national parliaments will be involved at a time
when Euroskepticism is on the rise. More important, the stress tests will not
have a particular impact on Europe's main problem: tight credit conditions for
households and businesses. Without a substantial improvement in credit
conditions, there cannot be a substantial economic recovery, particularly in
the eurozone periphery.
Analysis
The European Central Bank had two basic
short-term goals for this year's stress tests. On one hand, it had to come up
with a test that was tough enough to be credible after tests held in 2010 and
2011 were widely seen as too soft and lacking in credibility. On the other
hand, the tests could not produce results dire enough to generate panic. The
European Union is going through a phase of relative calm in financial markets,
and the European Central Bank was not interested in creating a new wave of
uncertainty over the future of Europe's banks.
While the tests did attract some criticism, the
central bank achieved both goals. Of the 130 banks involved in the tests, 25
had capital shortfalls, a finding slightly more severe than forecasts
projected. Of those 25 banks, 13 must raise fresh capital and come up with 9.5
billion euros ($12.1 billion) in the next nine months. None of the failed tests
came as a surprise, however. Italy's Monte dei Paschi, the worst performing
bank in the tests, has been in trouble for a long time and had to receive
assistance from the Italian government in 2012. Other failing banks are located
in countries such as Slovenia and Greece, which have been severely affected by
the financial crisis. And while the price of several banks' shares dropped
during the Oct. 27 trading session, no collapses occurred.
The tests were not perfect -- they used data
from December 2013 and were mostly done by each participating state. The
methodology and scenarios were also criticized. For example, the most extreme
"adverse scenario" included in the tests considered a drop in
inflation to 1 percent this year, although the rate has already fallen to
around 0.3 percent. The decision to include only 130 "systemic" banks
while turning a blind eye on smaller -- and probably weaker -- institutions
also drew criticism. But overall, markets considered the tests legitimate,
especially in comparison with the weak tests that have taken place since the
beginning of the European crisis.
The stress tests, however, are only the
starting point in the much deeper and complex process of creating a banking
union in Europe. The issue has traditionally been very controversial in the
Continent. As Europe became more integrated, several policymakers proposed the
creation of a banking union to complement the Continent's internal market and
common currency. Nationalism and diverging political interests, however, made
this quite difficult, and the idea was abandoned during the Maastricht Treaty
negotiations in 1991 and again after it was reconsidered during deliberations
for the Treaty of Nice in 2000.
But the eurozone crisis -- and the fear of
financial instability spreading among the countries that share the euro -- has
reignited the debate about a banking union. Simultaneous crises in countries
such as Spain and Ireland, where national governments were forced to request
international aid to rescue failing banks, made Europe consider the need to
break the vicious circle between banks and sovereigns.
The Upcoming Political Debate
In 2012, the European Union announced that the
banking union would be implemented in two stages. During the first stage, the
European Central Bank would centralize the supervision of participating banks'
financial stability. At a later stage, Brussels would introduce a "Single
Resolution Mechanism" and a "Single Resolution Fund" to be
responsible for the restructuring and potential closing of significant banks.
The first stage of the banking union was controversial because some member states
refused to give the central bank full power to supervise every single bank in
the European Union. A compromise was eventually found, and the bank was given
supervisor powers over banks with holdings greater than 30 billion euros or 20
percent of their host nation's gross domestic product. This was not a minor
compromise. National regulators remained in charge of supervising smaller banks
such as Spain's cajas and Germany's Landesbanken,
institutions generally having strong ties with local political powers -- and
troubled balance sheets. The stress tests were a precondition for this stage of
the banking union implementation process.
As the November implementation of the banking
union's first stage draws nearer, the Europeans will have to make difficult
political decisions regarding the second phase of the project. Twenty-six
members of the European Union (Britain and Sweden decided not to participate)
signed an intergovernmental agreement in May to create a special fund and a central
decision-making board to rescue failing banks. According to the agreement, the
fund will be built up over eight years until it reaches its target level of at
least 1 percent of the amount of deposits of all credit institutions in all the
participating member states, projected to be some 55 billion euros. The fund
will initially consist of national compartments that will gradually merge into
a single fund. The agreement also made official the "bail-in"
procedure for future rescue plans.
Members of the European Parliament have said
the fund should be larger because it may not be enough to deal with a new
banking crisis. There is also the question of how the Single Resolution Fund
will be financed. On Oct. 21, the European Commission proposed that the largest
banks, representing some 85 percent of total assets, contribute around 90
percent of the funds. Opponents have criticized that instead of designating the
contributions in proportion to the risks each bank presents, the proposal
assigns contributions using a bank's total assets. The European Council, which
represents member states, will have to ratify this proposal.
More important, the transfers of banks'
contribution to the Single Resolution Fund are scheduled to start in January
2016. Before that happens, however, the parliaments of member states will have
to ratify the intergovernmental treaty that was signed in May, a difficult
proposition in the wake of rising Euroskeptical parties. In addition, a group
of German professors have said they would challenge the banking union before
the German Constitutional Court. According to this group, the banking union
represents a huge risk for German taxpayers while leaving Berlin without any
oversight authority. This is the same group that is currently challenging the European Central Bank's Outright Money Transactions bond-buying program.
The Real Problem: A Lack of Easily Accessible
Credit
While the stress tests and asset quality review
offer a clearer view of banks in Europe, most European households and
businesses are facing more immediate problems. On Oct. 27, the central bank
revealed that loans to the private sector fell by 1.2 percent year-on-year in
September after a contraction of 1.5 percent in August. The data shows a slower
rate of contraction in credit lending but does not signal a strong recovery of
credit in the eurozone. The data also confirmed that credit conditions remain
particularly tight in the eurozone periphery.
Since banking credit is crucial to households and companies, credit conditions are intimately
linked to Europe's economic recovery. The European Central Bank has recently
approved a battery of measures, including negative interest rates and cheap
loans for banks. However, as banks are still trying to clean up their balance
sheets, lending remains timid. Even in those cases where banks are willing to
lend, they tend to impose strict conditions that are hard for customers to
meet. There is also a demand problem. With weak economic activity and high
unemployment in the European periphery, many households and companies are
simply not asking for credit.
Finally, the central bank's latest policies
have created significant disagreement within the institution. Some members of
the governing council -- most notably Germany's Bundesbank -- are wary of
measures that could finance governments and weaken the pace of economic
reforms. The Germans are also concerned about the legality of measures such as
quantitative easing and its potential impact on inflation.The current frictions within the central bank
are representative of the wider debate that is taking place in Europe between
countries led by Germany that believe reforms should come before stimulus
packages, and those led by France that think crises are not the best time to
apply deep spending cuts. In the coming weeks and months, this debate will be
key in deciding the future of the European Union.
"Europe: Building a Banking Union is republished with permission of Stratfor.", October 30, 2014
"Europe: Building a Banking Union is republished with permission of Stratfor.", October 30, 2014
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