European Bank Stress Tests Worked: Sort Of
A week after the authorities released results of stress tests on the largest European banks, market data is starting to provide an indication of whether the exercise had the desired effect on confidence. The answer: sort of.
Bank stocks rose in the past week, and the risk premiums on European government debt fell — particularly for Spain. Several large banks successfully issued bonds. The euro, the ultimate barometer of global investors’ faith in the common currency, strengthened against the dollar. But the shift in market sentiment was not drastic. And one key indicator of the rate that banks charge each other for short-term loans showed that institutions remain wary of each others’ creditworthiness.
“Although the initial indications are positive, it is too soon to tell whether the stress tests will have any durable impact on sentiment,” analysts at Royal Bank of Scotland wrote Friday in a note.
For the European banking system to return to normal, weaker banks need to take steps to increase their capital reserves, countries like Greece need to keep making major strides in reducing their budget deficits, and the European Union needs to improve the way it oversees financial institutions, analysts said.
“There will need to be a series of confidence building measures, and not just one thing that will turn sentiment around,” said Sandeep Agarwal, head of financial institutions debt capital markets in Europe at Credit Suisse.
First some of the positive news. Bank shares as measured by the Stoxx Europe 600 banks index rose almost 6 percent this past week. Analysts’ cautioned that some of the rise reflected investor relief about new banking rules proposed by the Basel Committee on Banking Supervision. The international regulations would be easier on banks than expected.
In another positive sign for sentiment, the cost of insuring against debt default by European governments or European banks continued to fall, according to several indexes. For example, the Markit iTraxx SovX Western Europe index, which measures the cost of credit default swaps that protect against a European sovereign default, has fallen 12 percent since the end of last week. The corresponding index for European banks has fallen 13 percent.
The stress tests, widely criticized as too easy because just seven of 91 banks failed, were less important than the new information that came out as a result, said Gavan Nolan, a credit researcher at Markit in London. Banks detailed their holdings of Greek and other government debt, clearing up speculation about which institutions were most at risk from a default.
“The fact that banks have opened up their books to let everyone see what their sovereign exposure is, that is a clear positive for the market,” Mr. Nolan said.
The stress tests had a particularly salutary effect on Spain. Five savings banks, known as cajas, failed the tests. But the examination, made especially rigorous by the Bank of Spain, helped raise confidence in the country’s stronger publicly listed banks. Banco Santander and BBVA both issued bonds in the past week at lower interest rates than before the stress tests.
Total bond issuance by European banks rose to more than $10 billion in the week through Friday, from $2.6 billion the week leading up to the stress tests, according to Dealogic. But large institutions dominated the bond sales. “We are yet to see weaker banks coming to the market,” Mr. Agarwal of Credit Suisse said. Questions about shakier institutions may not be put to rest until the banks bolster the amounts of stock and low-risk securities they hold as a cushion against market shocks.
“Especially in terms of recapitalization there is a great deal to be done,” said Nicolas Véron, a senior fellow at Bruegel, a research organization in Brussels.
The Spanish cajas have already begun taking steps to raise more money. Only days after the stress tests were released, the association that represents the cajas was meeting with investors in London, Frankfurt and other cities to pave the way for the banks to sell shares.
Jorge Gil Lozano, director general of the confederation of Spanish cajas, explained that the number of cajas has already dropped to 18 from 45 through mergers, and is likely to fall further.
“The whole purpose of the reform is to raise new capital,” Mr. Lozano said during a presentation in Frankfurt.
Credit for Spanish banks remains tight, though, and many remain dependent on the European Central Bank for financing. There are some signs of improvement, Jorge Gost, chief executive of the Spanish bank Pastor, told Reuters, “but there is still no fundamental change.” Pastor narrowly passed the stress tests and was the worst-performing Spanish commercial bank.
Reform of the cajas has not been emulated by Germany’s public-sector landesbanks. Though all passed the stress tests, analysts remain wary about the landesbanks as well as hundreds of German savings institutions known as sparkassen, which were too small to be included in the stress tests. “The perception that the biggest country in Europe has not really risen to the challenge of the systemic crisis, and continues to blame all the problems on foreigners, does not help the situation,” Mr. Véron said.
While most market signals were positive, one money-market indicator created a nagging doubt about whether the stress tests would achieve their ultimate goal of loosening up the amount of credit available to European business and consumers. The three-month Euribor/OIS spread, a measure of the difference between interest rates on three-month interbank loans and overnight loans, rose to 0.342 percentage point from 0.320 point the week earlier.
Banks’ reluctance to lend to each other has been at the core of Europe’s financial crisis. If the stress tests were working, the spread should decline toward 0.25 point, according to analysts at Royal Bank of Scotland.
“The Euribor/OIS spread — which is the indicator of systemic risk in the banking system — moved in the wrong direction,” R.B.S. analysts wrote Friday. “We would really like to see this pushing down to be comfortable that the world is a better place.”