The not-so-stressful European bank tests

The sovereign debt crisis still worries financial markets because it can never be managed effectively by politicians and business leaders resorting to hype of glossing over the underlying weaknesses in the governance of the eurozone.

When the European Banking Authority published the results of the latest Europe-wide bank stress tests, political and bank leaders that passed the test successfully gloated about their achievements. They want us to believe that we need not worry as long as we trust them.

But financial analysts are less impressed. The post-stress test analysis by Reuters, Bloomberg, the Financial Times and The Economist ridiculed the credibility of these tests. There was general agreement that the tests “fell short of what’s needed to restore confidence” in the troubled financial markets.

Michael Symonds, credit analyst at Daiwa Capital Markets in London, said the fact that so few banks failed meant “it wasn’t the solution to restore confidence”.

The columnist Schumpeter writing in The Economist summed up the feeling of most analysts: “an air of unreality infects today’s stress-test result for European banks: most institutions are fine unless there is a sovereign-debt crisis. The 2011 stress-tests still look doomed to irrelevance: too soft to reassure the markets, too unenforceable to prompt the recapitalisation that is needed.”

This does not mean that the tests were a waste of time. It identified the weaker banks that need to beef up their capital if they are not to fail or face the humiliation of being rescued by taxpayers’ money. Where these tests failed is in the area of predicting the likely affect on European banks should one or more eurozone countries default.

As long as the markets remain doubtful on how well European banks will fare should Greece, Ireland, Portugal, Spain or Italy default, the markets will remain nervous, speculators will stir up panic selling of bonds, and economic recovery will be delayed.

While local banks have little exposure to eurozone troubled sovereign debt, they are far from justified in gloating about their resilience should they be impacted by an unforeseen economic event. Those who really want a reliable health check report on our banks should read the Financial Stability Report for 2010 issued by the Central Bank, rather than rely on the self-congratulatory comments of some of the ‘inspirational’ leaders of our banks.

Let me make one point very clear: our banks are much stronger than many European banks of similar size or even bigger. But, as clearly stated by the CBM report, this is not a reason for complacency as some of our banks face substantial challenges partly as a result of structural weaknesses in their balance sheets.

The main risks facing our banking system include “a possible weakening in global macroeconomic conditions which would impact negatively the Maltese economy”. With the crisis of European and even US sovereign debt being far from resolved, it is very possible that the global economy will once again face another recession.

Our banks also have to deal with concentration risk that has different aspects. One of the aspects of this concentration risk is the local banks’ exposure to the property market which most analysts would agree is passing through a very tough phase. Our banks have a multi-faceted exposure to the property market. They lend money to developers; they provide mortgages to home buyers; and they have 84 per cent of their collateral in the form of residential and commercial property.

The Central Bank report has clearly highlighted the need for our banks to boost their provisions and increasing their capital to cater for the increasing risk of default. The MFSA, as the banking regulator, will undoubtedly take note of the CBM’s recommendations and insist on banks to increase their provisions and strengthen their capital base. The MFSA needs to once again assert its authority in a decisive way and not tolerate being treated disrespectfully by operators in the local banking market.

Stress tests have their validity, even if in the recent past they have proven very ineffective in preventing bank failures. But these tests often fail to capture and measure important elements that make a bank successful. One of these elements is the way that a bank’s strategy and tactics put the interest of the customer at the centre of their actions.

Sadly, we know how much our banks need to work on this front if they are to win the confidence of their customers.

jcassarwhite@yahoo.com