Euro Banks Stress Test Results

Late Friday night when markets were closed for the weekend the European Banking Authority (EBA) released the results of their 2016 stress test we wrote of last week.  As expected they did not use the pass and fail mark but the results spoke for themselves.  As predicted Italy’s Banca Monte dei Paschi (MPS) clearly failed, having a negative capital ratio (bust) under the ‘adverse circumstances’ scenario and needs a €5 billion bank bailout.  EBA set the ‘bar’ at just 7% for the CET1 (Tier 1 core equity capital : total risk-weight assets ratio).  On that measure 4 banks failed the test.  To give an idea of the sensitivity and implications of setting this bar, if it had been 8% an additional 6 banks would have failed and that would have included A-listers (TBTF’s) Commerzbank, Unicredit, Barclays, and you guessed it… Deutsche bank.  The latter also failed the US Fed’s stress test and is the IMF’s #1 GSIB.

There has been a lot of commentary after the report’s release amongst analysts that it appeared a market appeasement exercise rather than a robust stress test.  For a start, as we discussed last week, 51 banks is less than half of the 124 banks tested last time and excludes all the real problem childs in Greece and Portugal.  Secondly the ‘adverse circumstances’ scenario saw a real GDP growth rate of -1.2% in 2016, -1.3% in 2017 and +0.7% in 2018, all of which pales next to what we saw at the onset of the GFC.  Thirdly, a major threat to Euro banks is negative interest rates killing profitability and that was not included in the stress test.  As we reported in Friday’s Weekly Wrap, Deutsche Bank last week announced its second-quarter net income fell 98% from a year earlier, as one such example.  Finally there was disbelief that the stress test made no mention, nor medium term scenario modelling for Brexit implications.

And so the market spoke and the Stoxx index of European banks was down close to lows seen during the financial crisis.  Finally if you want another example of ‘everything is fine, nothing to see here’ market appeasement, just hours ago the Stoxx Europe 50 index announced it was booting out Europe’s 2 biggest banks – Deutsche Bank and Credit Suisse, effective 8 August.  They are being replaced by much better performing companies….  Spot below which are out and which are in… All fixed.