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THE TRUTH ABOUT BANKSIs the commotion before the stress tests just the deceiving "calm" before the storm?

CĂLIN RECHEA (Translated by Cosmin Ghidoveanu)
Ziarul BURSA #English Section /

Is the commotion before the stress tests just the deceiving "calm" before the storm?

Anonymous sources have been feeding the rumor mill around the stress tests conducted on banks of systemic importance in Europe. The most pessimistic estimate, according to which 18 banks will not pass the test, came from the banking expert of Pimco, being quoted in an article by Reuters.

On the other hand, Gabor Steingart, the editor-in-chief of German newspaper Handelsblatt, yesterday brought good news to its readers: all of the 24 German banks passed the examination of the ECB. Steingart concedes however, that this "success" is mostly the result of the "degrading circumstances of the intimate ties between the public and private sector". Of course, the statement refers to the massive support given to banks, especially by guaranteeing their debts, by the local or federal authorities in Germany.

The experience of the previous stress tests has caused the European authorities to pay particular attention to the new program for evaluating the health of the European banking system. This is the last chance to regain the confidence of the markets and of investors.

In an editorial posted by Financial Times, Huw van Steenis, an executive director at Morgan Stanley, writes that "the market must think that the results published by the European Central Bank and the European Banking Authority are transparent enough", so that they can afford the recapitalization of the banks in an environment that is not affected by panic and contradictory statements from the authorities.

One fundamental element in evaluating the success of the stress tests is also represented by how "the capital increase and the restructuring of the banks is facilitated", the Morgan Stanley executive further writes.

And with that being the case, how important is getting a passing grade? Relatively so, but not crucial. "Don't let the passing grade monopolize your attention", an article by Bloomberg writes, which claims that what matters more is "by how much will the ECB reduce the valuation of the banks' assets" as a result of the Asset Quality Review program.

Of course the results of the AQR will have a major influence on the level of the capitalization, and that is where the problems start. A bank that fails to get the passing grade will have two weeks to present a plan for recapitalization and about nine months to raise the necessary funds.

How will the capital shortage be covered? Over the last few months, major banks have attracted funds by issuing convertible bonds (author's note CoCo, a hybrid security which shares bond and stock features, subject to fulfilling certain conditions).

The current regulations allow these securities to be included in the bank's tier 1 capital ratio and expose investors to the risk of a complete loss of their invested amount. In a recent article by Bloomberg, these instruments are called "high-yield hand grenades". Over the last 18 months, European banks have increased their "capital" through such issues worth a total of 60 billion dollars, as shown in the Bloomberg data, and "investors are not fully convinced that high yields (author's note: the average coupon was 7.25% this month) reflects the risk of a collapse of the issuing bank".

All of these experiments with the recapitalization of the major European banks are somehow reminiscent of the attempts of the Romanian governments back in communist times to convince people that the coffee surrogate sold domestically was as good as the real thing.

Unfortunately, the evolution of the economies of the European countries since the beginning of the year show that the hypotheses of the stress test may be far too optimistic, even in the context of the pessimistic scenario.

Moreover, the document that describes the manner in which the manner for evaluating the banks in the two stages (a. note: the evaluation of the quality of assets and the actual stress tests), published on the website of the ECB ("Comprehensive Assessment Stress Test Manual", August 2014), does not include any mention of the shadow banking system and the strong ties it has to the standard banking system.

The IMF has just warned about the dangers posed by this parallel financial system, which has an estimated value of about 70 trillion dollars, of which 22.5 trillion are "allocated" to the Eurozone.

The leaders of major banks on the continent are looking with optimism towards the aftermath of the stress tests, as they are convinced that the test represents "a major step towards unfreezing lending", according to statements published by Bloomberg.

But is that the case? Even in Italy, where the non-performing loans have reached an all-time high? Or in Spain, where the same non-performing loans are on the rise, in spite of the creation of a "bad bank" that has helped dress up the banks' balance sheets?

The hope for a resumption of lending in Europe will not yield any concrete results, because a good capitalization of the banking system is only a necessary condition, but it is not enough. The main problem remains the overleveraging of bank customers, be they individuals, companies or governments.

Unlike the cautious optimism of some bank executives or the "ominous" silence of the majority of the European governments, in Greece, the authorities are anxiously awaiting this week-end. Finance minister Gikas Hardouvelis has surprised his colleagues in the ECOFIN, in July 2014, by issuing a warning on the effects of the stress test on the Greek economy and the banking system. "The stress has been constant in the economy and the banking system of Greece over the last four years, and the ECB wants to increase that pressure even further", said Hardouvelis, according to an article in Kathimerini. "There is the risk of burying the economy just as it seems to be stabilizing", the Greek minister of finance concluded.

None of that matters. The stress test has to be a success for the ECB, in order to reinforce not just its image of a consistent and competent fighter against the crisis, but also that of the holder of the key to resuming economic growth in Europe.

But what actually lies behind the curtain? In an interview recently granted to online publication Deutsche Wirtschafts Nachrichten, Thomas Mayer, the former chief-economist of Deutsche Bank, said that "the architects and the players involved in the current monetary system have invested too much in it to voluntarily drop it".

About the politicians and the bankers in Europe, Mayer said that their refusal to openly present the problems of the Eurozone is a result of the fact that "they are responsible for them, but they do not want to take the blame".

The former chief-economist of DB also said that "my most pessimistic expectations have been exceeded and I don't see how the situation can continue as if nothing has happened". Mayer is convinced that the Eurozone can not survive in its current form.

In his opinion, the publication of the results of the stress tests will cause the beginning of a new wave of consolidations in the banking system which will lead to banks that would qualify even more for the "too big to fail" notion, amid the bigger trend to move to central planning.

"We are in an exceptional situation, which can not endure in the long run", Thomas Mayer told Deutsche Wirtschafts Nachrichten, speaking about the financing costs of the governments in the Eurozone.

The "European" will, however, says that it must, and for that purpose, representatives of the EU have participated in secret, in seminars in the US, where they have "trained" for the quick liquidation of troubled banks, Deutsche Wirtschafts Nachrichten says.

Under these circumstances, all we can do is to avoid "conflict areas", so that our bank accounts don't become "collateral victims" of the "saviors". No one is going to give us an advance warning on TV about a "bail-in code red".

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