Tests of EU banks are a whitewash, some critics say
European banking authorities are set this week to reveal which of the European Union region’s banks are in good shape and which aren’t, in a bid to reassure investors worried that the continent’s financial sector is a disaster waiting to happen.
But experts are already raising concerns about the credibility of the banking “stress tests,” wondering whether they have probed deeply enough or asked the right questions of an industry not known for being transparent.
The long-awaited results of the tests are to be released here in London on Friday after Europe’s financial markets close for the weekend, to avoid an instantaneous effect on already-volatile stock exchanges.
Regulators are examining the health of 91 institutions, which account for 65% of the financial sector’s business in Europe. The tests are loosely patterned after an exercise in the U.S. last year that was credited with reviving confidence in American banks after months of nervous speculation over their soundness.
But whether the European version can have the same effect is increasingly being called into doubt.
Critics have been less than impressed with the secrecy that has surrounded the tests, especially in comparison with those conducted in the U.S. The officials running the tests, holed up in offices in a London skyscraper, have declined to divulge the specific criteria being used to judge whether a bank is in decent shape.
Many analysts agree that, to be taken seriously, the tests need to subject banks to a worst-case scenario that includes the possibility of huge losses from a national government defaulting on its debts. Some of Europe’s biggest banks are major holders of bonds from debt-ridden, financially shaky countries like Greece and Portugal.
But leaks to the news media suggest that the study underway doesn’t include this scenario, leading some critics to call it a whitewash in the making.
“It doesn’t test the banks for what investors are fearful of,” said Simon Tilford, chief economist at the Center for European Reform in London. “Stress tests are the way to go, but of course the tests have to be tough enough.... I don’t think these tests are of particularly enormous value.”
Tilford and others lament what they see as a lost opportunity for Europe to rejuvenate its banking sector and, by extension, the economy of the European Union, which relies heavily on banks to finance businesses and other enterprises. Since the worldwide financial crisis spiraled, lending between banks, a crucial activity, has been sluggish, as institutions worry whether they’ll be paid back. Properly conducted stress tests can help rebuild trust between banks and can jump-start lending.
Of particular concern in Europe are regional banks in Spain and Germany, where exposure to bad property loans is uncomfortably, but often invisibly, high.
With Spain already under fire because of its budget deficit, the fear is that a tottering banking system could be a time bomb. Madrid could be forced to bail out failing banks, but that would heavily strain its resources at a time when the government is trying to cut spending.
Ironically, Spain has been the most vocal proponent of publishing the stress test results and naming the banks in trouble, whereas Germany, despite its reputation for financial discipline and prudence, has been resistant.
That’s because Spain is confident that most of its banks will be given a clean bill of health — and wants investors to know it. Germany opposed full disclosure on the grounds that markets could misinterpret the findings and penalize one of its banks unfairly. Only after pressure from Spain, France and the U.S., which has pushed Europe to conduct stress tests, did Berlin relent.
How the markets will respond to Friday’s test results is hard to predict, given the questions surrounding their credibility.
Some experts suspect the results will be carefully groomed, with enough banks on the blacklist for the stress tests to be considered meaningful but not so many that confidence in Europe’s banking sector as a whole will be shaken.
But investors will be on the lookout for any signs of manipulation.
“This whole process is about rebuilding trust … in the banking system,” said Nicolas Veron, an analyst at Bruegel, a Brussels-based think tank. “But if this thing is not done well, it will become a source of distrust.”
