‘ECB can’t ease up on stress tests’

The ECB cannot ease up on bank stress tests this year, otherwise the eurozone risks being lumbered with a zombie banking system and stagnant growth for the foreseeable future, according to a leading banking expert.

Nicolas Veron, who is a senior research fellow at the internationally renowned Washington-based, Peterson Institute for International Economics, says that if the ECB pursues a “rigorous” line with the stress tests in an attempt to purge the banking system of its bad assets and return it to profitability, then there will be a number of flashpoints over the course of 2014.

“Some member states, including the largest, might push for ‘forbearance’ — hiding the bad news — for fear of the political and financial consequences of publicly-led bank restructurings. The ECB has strong incentives to resist them. Its credibility is at stake, not only as a supervisor but more broadly as a European institution, with possible spillovers to its reputation as a monetary policy authority,” said Mr Veron.

He estimates that the scale of the problem banks is in the “double digits” that will need roughly €100bn in recapitalisation. “Thus, the conflict between the ECB and member states will escalate. It is likely to trigger significantly more financial- market volatility in 2014 than Europe has witnessed in 2013, in spite of sizeable internal shocks this year such as the February election in Italy and the March developments in Cyprus, and external ones such as the turmoil in emerging markets and the recent US fiscal drama.

“If the assessment is lax, the risks are a major loss of ECB’s reputation and thus further weakening of an already fragile euro area and EU, which would be compounded by a final loss of hope in Europe’s ability to address its now many- years-old banking problem.

“By contrast, if Europe’s leaders choose the more rigorous option, they have the opportunity to allow trust to return to Europe’s banks and pave the way towards a much more resilient financial system. They will need to be clear-sighted about the consequences of their choices in the weeks and months ahead.”

There are still many unresolved issues about the stress tests including the extent of bail-ins of shareholders and bondholders in a failed bank and where the funds will come from for a public backstop. The European Banking Federation has thrown its weight behind the stress tests and the wider banking union.

It met with Vitor Constancio, vice president of the ECB in Brussels yesterday.

“This is an important exercise in which transparency towards investors will be crucial. A thorough and robust process will be essential to ensure its success,” said Christian Clausen, president of the European Banking Federation.