Jürgen Fitschen was the image of composure. German banks wouldn’t be stressed by the European Central Bank’s “stress test,” the head of Germany’s private banking association quipped early last October on the sidelines of the International Monetary Fund’s annual meeting in Washington. Fitschen, who is also co-CEO of Deutsche Bank, seemed confident that German lenders at least had learned their lesson from the financial crisis and would have taken the right precautions as a result.
But the broad review of lenders’ viability by the eurozone’s future banking regulator is apparently not progressing as smoothly as Fitschen predicted last year. The ECB’s Daniele Nouy, who had said early in March that the central bank would not be cutting corners or making compromises in testing the eurozone’s 128 biggest banks, nor flinch at letting some unviable lenders go bust, has had to backtrack after just a few weeks. The main concern now is ensuring that the banking check is completed, sources in the ECB say.
Weighing balance sheet risks
In collaboration with the banks the ECB is searching for ways to conduct the audit both thoroughly and feasibly, given the tight schedule it’s facing. Altogether the ECB plans to assess risks in balance sheets totaling 3.7 trillion euros. It has hired external auditors who for several weeks now have been reviewing the pertinent files of the 128 banks, including 24 in Germany. The risk assessment is due to be completed in August. Also in the summer, together with Europe’s EBA regulatory authority, the ECB will conduct a “stress test” to evaluate the resilience of these banks in the event of a severe recession, stock market crash or slumps in certain other markets.
Meanwhile, German and French banks have been leading a chorus of warnings against overburdening the sector. The time frame was extremely tight and data requirements extremely high, they said. “The banks are groaning, and not just in Germany,” observes Michael Kemmer, General Manager of the Association of German Private Banks. A letter to public supervisors by the joint lobby for Germany’s banking industry referred to “great risks.” The sector in Germany is concerned chiefly over the planned ECB standards on assessing risks associated with mortgages and other real estate loans. The banks reject additional evaluations. Existing standards in Germany have proven themselves and are sufficient, the lenders maintain.
Eurozone equity shortages
French banks are likewise worried. The planned extent of the ECB tests should be reduced to a sensible level, the French banking association has written to Bank of France Governor Christian Noyer. On November 4 the ECB takes over supervision of the eurozone’s biggest lenders. By that point the central bank wants to have tested these banks’ resilience and uncover possible legacy issues and capital shortfalls in their balance sheets. The banks would have to fill any gaps with fresh equity. The primary goal of the exercise is to restore market confidence in the EU’s banking sector. For now it’s still hard to guess just how much equity the banks will need. Estimates range from the tens of billions up to 700 billion euros.
But the likelihood of facing such a disastrously high sum is considered very low. Even ahead of the stress test, many lenders substantially slimmed down their balance sheets, sold off non-performing assets or raised fresh capital on financial markets. Most analysts therefore expect the ECB to require only moderate improvements. Klaus Regling, chief of the EU’s ESM financial stability mechanism, is among the optimists. “I’m not expecting any surprises from Spain, Portugal or Cyprus. The same goes for Greece and
Ireland,” he has said.
Bad loans rising
Yet far from all experts are convinced that policymakers will be able to keep their pledge of shielding taxpayers from having to once again rescue banks in trouble. A study by the Cologne Institute for Economic Research, the IW, has pointed out the high levels of loans threatening to default currently held mainly by banks in southern Europe. By the end of 2012 the troubled credit had already reached a volume of 876 billion euros. And given the still-anemic economies of these crisis-hit countries, it can be assumed that that volume has since increased further, the study concluded.
German banks shouldn’t feel too secure either. Although Deutsche Bank has managed to substantially improve its equity cushion, and Commerzbank is making faster progress than expected in shedding its non-performing assets, analysts still see possible writedowns or a need to build up cash reserves against legal expenses, exotic derivatives and financing or commercial real estate and ships. The lenders most affected here would be Deusche bank and, especially, Commerzbank. Its capitalization is anything but lavish and the bank is having trouble earning money from its ongoing business, sources say. Another troubled lender is the publicly owned regional HSH Nordbank, which is sitting on billions of euros in shipbuilding loans.
Klaus-Dieter Oehler has worked for more than 20 years as a financial editor for the daily Stuttgarter Zeitung