THE TRUTH ABOUT BANKS Will the confidence in the European banking system return after the stress tests?

The European Central Bank (ECB) and the European Banking Authority (ABE) yesterday published the results of the stress tests that 123 European banks were subjected to. As shown by the data recently leaked to the press, 25 banks of systemic importance did not meet the minimum capital adequacy ratio, and the additional required capital is about 25 billion Euros.

According to data from the ABE, of the 25 banks that did not pass the test, 12 have already raised the additional capital needed. Thus, between January 2014 and September 30th, 2014, the European banks have increased their capital by 53.6 billion Euros through stock issues, (39.2 billion Euros is the net amount, which does not include buybacks and repayments) and 39.1 billion Euros through issues of convertible bonds.

As part of the pessimistic scenario for 2016, the biggest capital deficit came was seen by Eurobank Ergasias of Greece, (4.63 billion Euros), followed by Italian bank Monte dei Paschi, with a deficit of 4.25 billion Euros.

Large deficits were also seen by National Bank of Greece (3.43 billion Euros) and Banco Comercial Portugues (1.14 billion).

The EBA's list of banks that are insufficiently capitalized includes Österreichische Volksbanken, Dexia, Piraeus Bank, Münchener Hypothekenbank of Germany, eight other Italian banks and the top two Slovenian banks, Nova Ljubljanska and Nova Kreditna Banka Maribor.

For the pessimistic scenario that was applied, the passing requirement was the CET1, Common Equity Tier 1 ratio of 5.5%. The share capital increases performed in the beginning of the year have caused the capital deficit of the top 25 banks to shrink to 9.52 billion Euros.

As a result of the program for the valuation of the quality of banking assets, the ECB has caused banks to decrease their assets by 48 billion Euros, according to the press release published on the website of the institution. Furthermore, non-performing assets with a face value of 136 billion Euros were found on the banks' balance sheets.

The biggest downward adjustment has to be applied to the value of the assets of the Italian banking system, of approximately 12 billion Euros, 7.6 billion in the case of Greek banks, and 6.7 billion Euros in the case of German banks.

"In the case of the opposing scenario, it is estimated that the banks' aggregate capital will fall by approximately 263 billion Euros by the end of 2016", the ECB report further states. Capital losses would affect the most Italian banks (35.5 billion), followed by those in France (30.8 billion) and Germany (27 billion).

The numbers published by the European authorities are sizeable, but do they reflect the true ability of the banking system to withstand the new crisis that has appeared on the horizon?

In mid October, the Center for the Management of Risk of the University of Lausanne (CRML) has published the latest results of an alternative stress test applied to European banks.

The main hypothesis in this case was the steep decline of the global financial markets, by up to 40% within six months. That is truly a stress test, as that kind of drops of the international markets have only happened three times in the last century: 1929, 2000 and 2008. Furthermore, the massive decrease of the interval between two crises should represent an additional factor for concern.

What have the Swiss researchers found? That Deutsche Bank would need 75 billion Euros in additional capital, and BNP Paribas almost 75 billion Euros, even as both received good passing grades from the ECB and the ABE (see chart 1).

For 31 of the 123 banks appraised by the ECB, the total capital deficit amounts to 484 billion Euros. Under such a scenario, the capital deficit of French banks would reach 267 billion Euros, which represents over 10% of the GDP, and the deficit of German banks would reach 127 billion, or almost 4% of the GDP (see chart no. 2).

Given these factors, will the stress tests of the ECB have sufficient credibility in the markets? Perhaps, but only if we compare them to the previous ones, which were a disaster in terms of perception.

Will confidence in the European banking system return? Highly unlikely, which is precisely why the central banks are using every means at their disposal to prevent the collapse of markets that have long since become uncoupled from the fundamental aspects of the global economy.