×

Why stress tests are unlikely to reassure bank investors

European Union banks are much better placed to cope with serious economic shock, according to stress tests released on Friday night.

So surely newly-reassured investors should be piling back into these lenders, many of which have share prices currently trading at close to half of where they began the year, and even getting close to 2011 territory.

Let's not forget, in 2011, Ireland, Greece, and Portugal were in the early stages of a bailout and Greece seemed dangerously close to leaving the euro zone.

Moody's, the ratings agency, wrote reassuringly that the "majority of European Union banks have robust capital levels" to deal with nasty surprises.

Yet merely "a small positive market impact" was expected Monday morning, analysts at Danske Bank wrote in a research note.


Businessmen carry bags past a bank, financial
Jason Alden | Bloomberg | Getty Images

Bad loan bother

What investors are really worried about is what lies beneath the headlines on bank stress tests. Alex Dryden, global market strategist at JPMorgan Asset Management, told CNBC that they were stuck in a "triangle of trouble where they have got regulation, overbanking and negative interest rates".

There are still close to 1 trillion euros ($1.12 trillion) worth of non-performing loans (NPLs) on euro zone banks' balance sheets. This makes them more vulnerable in the case of a crisis. Investors are worried that banks have neither sufficient capital nor sufficient ability to raise capital in the event of another crisis.

Fresh capital of close to 900 billion euros for EU banks is needed to reassure investors, according to a report by a trio of respected academics: Sascha Steffen, head of the research department at the Center for European Economic Research (ZEW); Viral Acharya, professor of finance at NYU's Stern School of Business and Diane Pierret, assistant professor at the University of Lausanne.

However, it has become near-impossible to raise capital this year in Europe. The amount raised by European banks this year so far is 73 percent less than at the same time in 2015, according to Dealogic figures.


Earnings, earnings, earnings

This earnings season has, so far, painted a picture of a sector in trouble. As a sector, banks are reducing headcount and many are selling off less profitable parts of their business. Yet investors are not convinced that this process is happening quickly enough to address the problems, such as low-to-negative interest rates hurting profits.

"All European banks are, to varying degrees, exposed to income and profitability pressures for a longer period," Carola Schuler, managing director at Moody's, told CNBC.


The tests may not have been stressful enough

While the tests ran banks' balance sheets through scenarios including a 7.1 percent drop in gross domestic product, and a collapse in the real estate market, they did not test for some of the potentially biggest medium term stresses on the sector in real life - including the departure of the U.K. from the European Union, known as Brexit, or a prolonged period of negative interest rates.