ECB Unveils Ingenious Strategy to Reduce Banking Stress

Trying to prop up confidence by hook or crook.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Things have been pretty stressful of late in Europe’s banking sector. The introduction of the banking union’s bail-in rule has caused bondholders and stockholders to have second thoughts. The Euro Stoxx Banks Index has plunged 20% year-to-date despite the recent rally, and is down 38% since July.

Many of the worst affected bank stocks are those of so-called systemically important institutions. Deutsche Bank’s shares are down 50% from highs last July, while Spanish behemoth Santander’s shares have plumbed depths not seen since the 1990s. Concerns have also emerged about the ability of big lenders to turn a profit in a negative-interest-rate environment, following disappointing earnings by Societe Generale SA, HSBC Holdings Plc and Standard Chartered Plc.

In recent years, TBTF institutions like HSBC, Santander, Societe Generale and Deutsche have become so hideously big, complex and interconnected that it’s impossible to get an accurate impression of what’s really happening on and off their books. It is supposedly for this reason that the world’s two biggest central banks – the Fed and the ECB – began conducting regular stress tests of the financial sector to gauge just how effectively such banks would withstand a severe deterioration of macroeconomic conditions.

In the Fed’s last stress test, in May 2015, only two banks out of 31 failed to meet the grade: the U.S. units of Deutsche and Santander. One thing that is clear: European banks remain woefully under-capitalized compared to their U.S. counterparts.

Santander’s failure, its second in two years of taking the test, “was a clear signal that it hasn’t made enough progress on the issues the Fed had identified the previous year,” the Wall Street Journal reported at the time. Santander’s US chief executive, Scott Powell, said the bank still had “meaningful work to do to meet our regulator’s expectations and our own standards of excellence”.

Judging by an article just published in El Confidencial, the bank still has a long way to go:

Although officially speaking the U.S. banking supervisor still hasn’t published the findings of its Comprehensive Capital Analysis Review (CCAR)… at Santander’s headquarters in Boadilla del Monte it’s already taken as a given that it will have to wait at least another year before passing the stress test.

In light of Deutsche’s recent Co-Co fiasco in Germany, one assumes that the bank is in the same leaky boat. Which begs the question: with banking risk surging and investor confidence crumbling, how exactly will the ECB’s European Banking Authority be able to conduct its own rigorous (ha!) stress tests of large European banks without setting off further alarm bells and creating even more stress in the markets?

The answer is quite ingenious.

The London-based EBA will intentionally ignore many of the worst stress points in the system while conducting a test that not a single bank will be able to pass or fail. The reason the test has no pass mark to identify capital shortfalls is that banks have apparently emerged from the financial crisis. No, seriously. In the words of the EBA, they are in a “steady state” and are therefore expected to remain that way.

Among the severe stress points the supervisor has said it will be paying no attention to are the four biggest banks in Greece, a country that only eight months ago was in the grip of one of the worst bank runs of living memory. According to Danièle Nouy, the Chair of the ECB’s Supervisory Board, there’s no need to assess the resilience of Greece’s biggest banks because they “already went through a stress test in 2015.” The supervisor will also be ignoring Portugal’s Novo Banco, the so-called good bank recently salvaged from the smoldering ruins of Banco Espíritu Santo.

The “Adverse Scenario” for this year’s health check, published by the EBA, exposes banks to recessions in the EU this year and next followed by anemic growth in 2018. It also assumes continued low oil and commodity prices and GDP rising by only 3.4% in China this year, compared with a baseline projection of 6.5%. In Russia and Brazil, 2016 GDP plummets 8.1% and 5.9%, respectively.

It sounds disturbingly similar to today’s reality, with one glaring omission: the EBA’s test completely overlooks the threat posed by negative interest rates. As Reuters reports, negative interest rates — seen as one of the biggest obstacles to banks making money — feature only among the shocks to assets held in trading books, and not to overall balance sheets. The reason? “To avoid shaping expectations of future monetary policy.”

A financial stress test is only as good as the scenarios on which it is based. In its latest test the scenario cooked up by the EBA not only fails to reflect the risks posed by a likely future reality, it doesn’t even reflect the risks posed by the current one.

Ever since it began conducting its annual stress tests in 2009, the EBA has spectacularly failed to restore trust in Europe’s broken banks. Many of the Continent’s worst banking failures, including Bankia BFA and Dexia, happened after the banks had passed the stress tests – sometimes weeks earlier.

Now, as Europe’s financial edifice once again totters on its flimsy foundations, the ECB has set a test that not a single bank is able to fail. This is supposed to inspire confidence, because confidence is the name of the game in banking. However, setting the standards this low is unlikely to inspire confidence. Instead, it reeks of desperation. By Don Quijones, Raging Bull-Shit.

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  12 comments for “ECB Unveils Ingenious Strategy to Reduce Banking Stress

  1. Bob Miller says:

    “exposes banks to recessions”

    Recession is a word. And that’s all it is—a word. But it’s a great word for people like me. As the limo takes me to the airport for a flight to London or to Port Everglades for a cruise, the word recession explains in the briefest possible way the long lines at unemployment offices, food banks and homeless shelters. I really appreciate that because I am a self-serving, recreational nut and don’t have the time to keep up with what the shepherds and their flocks are doing.

    A recession in the US amounts to nothing more than a rest stop to clean the weapons and reload while the powers that be plan the next invasion. Don’t let the word “invasion” fool you. It doesn’t necessarily mean a military action on foreign soil. It could be subprime loans, derivatives, quantitative easing (QE), the Centers for Disease Control (CDC) teamed up with the pharmaceutical industry to test a new drug for, say, Ebola. I mean, if you plan on your military using germ warfare, then you had better have a cure, or at least an antidote, unless of course you are a holy man like the late reverend Jim Jones. So don’t fear the word recession. It’s simply an elongated word for recess. I can’t speak for the other kids, but I always looked forward to recess.

  2. Taco says:

    @Bob Miller
    Recess? Wow only a baby boomer whose generation piled on debt screwing over the next generation by kicking the can would see it that way…unreal, you are so disconnected with the reality of people losing jobs, crime increasing, and the overall living standards degrading that a recession brings…so go ahead and ‘take your limo’ to your exotic locations while the rest of us pay for your greed and selfishness.

    • NotSoSure says:

      It’s called sarcasm.

    • Bob Miller says:

      “The truth is always an insult or a joke, lies are generally tastier. We love them. The nature of lies is to please. Truth has no concern for anyone’s comfort.” – Katherine Dunn, Geek Love

      “There are only two mistakes one can make along the road to truth; not going all the way, and not starting.” – Buddha

  3. Jonathan says:

    Not sure if I understand this correctly, but its the very ZIRP/NIRP/QE policies of CBs that forced their underlying commercial banks to abandon their traditional business of obtaining profits through traditional rate spreads and headon into high yielding junk.

    Is so, this has to be most ironic thing ever to happen in financial engineering especially if they became the ignition for the next recession.

  4. ML says:

    The assumption is up-and-down.

    A recess or recession is a time to take stock and gather wits about us in preparation for the next up.

    Generally it is easier and requires less effort to go down than up. So perhaps recession is a more relaxing state to be in?

    The growth boys would have us believe that the only way to growth is up and if we do not have the resources then we must borrow to get there, but that is not true. It is possible to grow down. In any event. the process also requires in-and-out without which the way leads to disharmony and imbalance.

  5. Chicken says:

    Crook is about right, they’ve been off shoring Boomer jobs for decades. Hopefully some of those come back to Millenials, not counting on it though but at least Millenials with obscene student loan debt have $15/hr jobs flipping burgers.

    Let them learn what it’s like to have a hostile government that only knows how to tax throw money away, and confiscate their wealth. Too funny, they complain about the currency, their one asset that has outperformed for better or worse.

    I think they know nothing of the world but want to change it for the better just like we did, history repeats.

  6. overtheedge says:

    “In the Fed’s last stress test, in May 2015, only two banks out of 31 failed to meet the grade: the U.S. units of Deutsche and Santander. ”

    One might ask if the metrics used by the Fed are any more believable and/or valid than ECB’s EBA.

  7. NoOneOfConsequence says:

    Just an FYI – as a 20 year professional in the security and enforcement industry, I can tell you that crime is NOT increasing.

    In fact, crime has been showing year over year declines for a decade now.

    It has been identified as a big risk to our future profitability that one day the average person would find out that crime is actually on the decline, and a significant decline. We deal with this every day. How do we continue to turn profits and grow sales when crime is significantly decreasing? Marketing of course!

    Hence the reason that the REPORTING of crime is increasing year over year.

    But the facts are in – and you can find them too if you look….crime, ALL CRIME is declining year over year.

    Our society is getting safer, cleaner and healthier.

    I know it’s hard to believe…but this is a proven fact in the industry, and a significant risk to our profitability going forward.

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