One of the European Unions’ lingering problems is widespread
uncertainty regarding the health of its largest banks. The European
Central Bank is trying to address these persistent concerns by conducting a
rigorous round of stress tests early next year ahead of the date when it assumes
supervisory responsibility for the zone’s largest banks. This will be the
first time that these banks are held to the same set of standards.
Unfortunately, these stress tests also look likely to cause
a new set of problems for the E.U.’s financial integration project. In
order to be credible and have their intended confidence-boosting result, they
must be significantly tougher than the prior two rounds of stress tests.
But the prospect that a few banks are likely to fail the tests is causing
problems. Someone, simply put, will be on the hook to recapitalize these
under-performing banks.
Fears have arisen because of a new rule that requires the
conversion of subordinated debt into equity ahead of any taxpayer-funded bank
bailout. The rule, strongly backed by a handful of E.U. countries, concerns
ECB President Mario Draghi, according to a recently surfaced letter. As
opposed to reducing uncertainty, he fears that the interplay between the rule
and the stress tests could add to uncertainty by making it hard for banks that
fail the stress test but remain solvent to raise capital on the private
markets.
Investors still can’t conduct a side-by-side comparison of
E.U. banks because of differing capital standards, and many banks are still
undercapitalized. By contrast, the U.S. recapitalized its banks in the
immediate aftermath of the financial crisis. This is just further proof
that financial integration is easier said than done in the context of a
multi-state system.
For more on this story, read MNI
and Bloomberg
BNA. Additionally, this article in the Financial
Times provides a superb background on the new rule requiring banks to
convert subordinated debt into equity before receiving a taxpayer-funded bailout.
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