The state of Europe’s banks is far from steady

Bank investors rejoice! The European Banking Authority declares stress tests should no longer be about pushing fresh capital into the system, as they were five years ago, or drilling down in to asset quality, as in 2014. Nope. The good news is that we are now in a world where "steady-state monitoring" is what's needed.

So will this "steady state' policy pronouncement provide the confidence and assurance investors need? I hate to say it but I'm not convinced. Even if the stock prices overall bounce a bit this week, the banking sector did not get off to a good start Monday. I fear the market will continue to apply their own version of stress tests and find both the banks - and the regulators for that matter -lacking.

I asked European Central Bank President Mario Draghi at the last policy meeting if investors were over-exaggerating the risks.


Getty Images

His response was cautious but positive. ''I don't want to underplay the situation, to say it's not a solvency problem, it's a profitability problem doesn't mean that one underplays but figure wise, we see from a solvency viewpoint, our banks are better off than years ago but our banks do have profitability issues, especially those with a high share of NPLs (non-performing loans), but not only those with high share of NPLs, some of it has to do with weak growth performance of the past few years.

Draghi added that he was pretty confident that "strong supervision, robust regulation and better communication by supervisory authorities will still improve the situation and the perception in the rest of the world's eyes."

Call me cynical but I'm not sure the EBA's "steady state" monitoring communication is quite what investors are looking for. Especially when you have a panel of respected academics including ZEW's Sascha Steffen suggesting this month that European banks need 900 billion euros ($1 trillion) of fresh capital to convince investors they are robust. Who knows? But just compare that to the 280 billion euros the EBA says has been pumped in since 2011.

Plus the report's authors also point out that the 34 listed banks in the latest stress tests results have lost on average 33 per cent of their book value since the last stress tests were done less than two years ago. A clear sign in my mind that the market still had significant concerns about the health of bank balance sheets and their ability to make profits.

That's not to say plenty of progress has been made on capital levels and liquidity. Yet as Barclays Chief Executive Jes Staley told CNBC Friday that, for all that progress, the European banks are weighing on the region's growth. "If you look at the top 12 banks across Europe, on average they're trading at about a 50 percent discount to book value. That's not healthy for the financial system, that's not healthy for the European economy."

Mario Draghi has alluded that there are a few different issues here. Fears about a lack of capital and then the ability of banks to make profits particularly in a zero or negative interest rate environment (the latter wasn't even accounted for in the current stress tests but that's another issue).

Banks are adapting to meet the challenges although Staley argues for more work on that front, telling CNBC "the banks need to get into a better position of profitability."


Perhaps the best example of the challenges of growth and profitability lie in the Italian banking sector. Where return on equity has on average been below 2 percent for the last decade.

Its not just a NPL story. The economy is "over-banked" - I've read there are more banks than pizzerias. Many of the small and medium-sized banks are insolvent and should have been laid to rest long ago.

Meanwhile growth has languished since the financial crisis. Three stress tests later and we simply haven't seen clear communication by governments and regulator on these issues.

As predicted, Monte dei Paschi di Siena, which on Friday launched an emergency fundraising, was the worst of 51 banks tested. Other Italian, Irish and German banks were also among the weakest.

That's the best news I can find in this whole exercise. It's what investors expected to hear.

Eurostoxx banks are down 40 percent in the last 12 months, selling most heavily in the wake of the shock Brexit vote (the impact of which was also not included in the stress test).

So once again I fear we will have another failed attempt to bring confidence back to Europe's banking sector. No pass or fails, a lack of clarity over capital requirements, no testing for the impact of negative rates on profitability and a declaration of a "steady state" which if Jes Staley is right means the anemic growth continues.

I struggle to find an analyst who's comfortable buying banking stocks even at this level. Normally when you get to point where there's a resounding level of bearishness on a sector it's worth asking yourself whether it might be time to buy. For the European banks however, I think that confidence still needs some work.

Julia Chatterley is a CNBC anchor and European reporter covering key business and political events, as well as regular Eurogroup and EU leaders summits in Brussels. Follow Julia on Twitter: @JChatterleyCNBC

Follow CNBC International on Twitter and Facebook.