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Something is out there: Europe's banks

Gavin Hewitt | 13:33 UK time, Tuesday, 20 July 2010

Bank card in ATMFor a long time Europe's banks and officials have been haunted by the fear that something is out there. They have not been able to identify the monster alien but, like in the science fiction TV series, they are convinced it's lurking out there.

For months now they've been troubled by the spectre that there is something rotten in some of Europe's banks. It has troubled them to the point that they've been reluctant to lend. Inter-bank lending is still closed to some lenders.

So, rather belatedly, the Europeans edged towards stress-testing their banks. The Americans had done it last year and it managed to squeeze some of the suspicion out of the system. Of the 19 banks analysed, 10 failed and were told to go off and raise $75bn. But the worst was known and the banks loosened up.

Now the Europeans are looking at 91 banks. The markets have been concerned with three sectors. Firstly, the Spanish Cajas or regional banks. They were badly burnt by the collapsed real-estate market and have been scrambling to merge with each other.

Secondly, there are German Landesbanks, which were set up to promote regional development. Many of them were exposed to heavy losses in the American mortgage markets. Thirdly, suspicion has fallen on Greek banks and the debts they are holding.

So on Friday afternoon the Committee of European Banking Supervisors will deliver its verdict after the markets have closed. The prize is that a positive outcome will soothe market nerves and one more step will be taken towards managing Europe's debt crisis.

But this is a psychology test. The results have to be convincing to work.

Now already various ministers and officials are predicting happy outcomes. Twenty-seven Spanish banks are up for review. The Spanish Finance Minister, Elena Salgado, has said "when all the figures are known, we will see that the truth is that our financial system is solid and ready to face the future". She is not saying no Spanish bank will fail, but she is optimistic. The Greeks too are chirpy - the finance minister says Greece's banks will pass. Banking officials in Germany say there is no indication that any of the Landesbanks will fail. The French Finance Minister, Christine Lagarde, is not worried about French banks either.

So all looks good? Well, not exactly. Some, like Neil Mackinnon, strategist at VTB Capital, is warning of a "whitewash". Far from being stressful, he thinks it could be a stroll for the banks.

Others are asserting that some banks must fail in order for the exercise to carry conviction. "If its outcome is to be credible," says Nicolas Veron from the economic think-tank Bruegel, "it will necessarily reveal significant capital shortfalls in a number of banks". Analysts at Credit Suisse say $40bn of extra funding will be needed when the tests are done. Others put the figure closer to $100bn.

The grey area is the criteria used to assess a healthy balance sheet. "Stress-testing is a gamble," says Ken Wattret of BNP Paribas. The assessors are assuming that the EU economy will underperform. But the big dilemma is: what losses to factor in for sovereign debt? Do you reckon banks will take a 20% or even 50% hit on say Greek bonds?

So the stress test has to pass a credibility test itself.

Now if a bank fails then a plan to raise capital has to be in place by the time markets open on Monday morning. That, of course, could be difficult for governments in the midst of an austerity drive.

There have been and still are real concerns about the future of the eurozone. They may have retreated in recent weeks, but they have not gone away. But there is also perception. Those of us who have been following the eurozone crisis have watched fear morph. There was a fear that countries could default, a fear of debt, a fear of low growth and fear that the European banking system was unsound.

As the song says, "But I know there's something out there, something somewhere, I feel it all around". The test of the stress test will be whether the fear factor subsides.


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