Bank investors rejoice! The European Banking Authority (EBA) has declared stress tests should no longer be about pushing fresh capital into the system or drilling down into asset quality. No. The good news is that “steady-state monitoring” is what’s needed.
So will this provide the assurance investors need? I’m not convinced. Even if stock prices overall bounce a bit this week, the banking sector did not get off to a good start yesterday. I fear the market will continue to apply its own version of stress tests and find both the banks – and the regulators – lacking.
I asked Mario Draghi at the last ECB meeting if investors were over-exaggerating the risks surrounding European banks. 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 a high share of NPLs, some of it has to do with weak growth performance of the past few years.”
Draghi added that he’s 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 that European banks need €900bn of fresh capital to convince investors they are robust. Just compare that to the €260bn the EBA says has been pumped in since 2011.
Plus the 34 listed banks in the latest stress test results have lost on average 33 per cent of their book value since the last stress tests less than two years ago. It’s 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 progress has not been made on capital levels and liquidity. Yet as Barclays chief executive Jes Staley told CNBC on Friday, for all that progress, 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 per cent discount to book value. That’s not healthy for the financial system, that’s not healthy for the European economy.”
Perhaps the best example lies in the Italian banking sector, where return on equity has on average been below 2 per cent for the last decade. It’s not just a NPL story. The economy is “over-banked” – I’ve read there are more banks than pizzerias in Italy. 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 per cent in the last 12 months, selling off most heavily in the wake of the shock Brexit vote (the impact of which was 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 Staley is right, means the anaemic growth continues.
I struggle to find an analyst who’s comfortable buying banking stocks even at this level. Normally when you get to a 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.