Blog Post

Europe must take control of banking stress tests

Peter Bofinger, Christian de Boissieu, Daniel Cohen, Wolfgang Franz, Jean Pisani-Ferry, Christoph Schmidt, Beatrice Weder di Mauro and Wolfgang Wiegard warn against a false sense of security, which European governments seem to be lulled into, and propose common tests to evaluate the true state of Europe’s banking system based on common macro scenarios, common valuation […]

By: , , , , and Date: May 30, 2009 Topic: Banking and capital markets

Peter Bofinger, Christian de Boissieu, Daniel Cohen, Wolfgang Franz, Jean Pisani-Ferry, Christoph Schmidt, Beatrice Weder di Mauro and Wolfgang Wiegard warn against a false sense of security, which European governments seem to be lulled into, and propose common tests to evaluate the true state of Europe’s banking system based on common macro scenarios, common valuation rules and common stress assumptions. The authors believe these respective tests should be done for all the largest European banks simultaneously and the results should be published for each bank, leading to a centralised oversight of the tests, and aggregation of results.

After months of financial gloom, summer has brought some relief. However, there is now a danger that policymakers and market participants are lulled into a false sense of security, which would be likely to lead to another negative feedback loop. To prevent such an outcome, quick and resolute action is needed. In particular, Europe must complete the job of putting the financial system on firmer ground.
If one looks at earlier episodes of large-scale macro-financial distress, a number of key lessons emerge. Japan’s experience in the past two decades, in particular, make clear that a banking system populated by zombie banks is a major threat to recovery; banking systems remain dysfunctional until losses are fully recognised and disclosed; and procrastination increases the ultimate cost to the taxpayer. Sweden’s experience shows the benefits of expediting the clean-up.
A dysfunctional banking system would represent a particular challenge for Europe, whose economies are much more dependent on banks than
is that of the US. Big worries about the state of Europe’s banks remain, as current information is unsatisfactory and published accounts are not trusted. Recent International Monetary Fund estimates of potential future writedowns and recapitalisation needs have added to these concerns, as they suggest that the European Union trails the US in the recapitalisation process. Though European officials dispute the IMF figures, they have yet to produce alternatives.
In the US, stress tests have been used as an imperfect but effective tool to increase the public’s knowledge of the balance sheets of the major banks, and to identify further areas where action is needed. While the process of producing and disseminating results has proven challenging and subject to numerous caveats, what has been achieved represents an improvement over the previous situation.
In contrast, Europe’s approach to stress testing has been half-hearted at best. The European supervisors argue that assessment would and should be carried out at a national level, under an EU umbrella. However, tests would be only loosely harmonised by adopting similar macroeconomic assumptions. Furthermore, results would not be available before September, and publication (of aggregate results, not bank-by-bank data) would be at the discretion of national authorities.
This compromise is intended to preserve each supervisor’s remit, and fit the variety of their institutional status. But this comes at a high price as regards the value of the results. There is no guarantee that the test will ensure that results are consistent across countries and across banking institutions. As long as national supervisors have discretion, identical assets are unlikely to be valued the same way in all countries. Each supervisor will be tempted to pretend its banks are in good shape. As a result, the planned procedure will not elicit the degree of confidence that European economies urgently need.
We cannot wait another four months to discover that we do not yet know the true state of Europe’s banking system. Instead, a systematic European approach is needed. The respective tests should be based on common macro scenarios, common valuation rules and common stress assumptions. They should be done for all the largest European banks simultaneously and the results should be published for each bank. And there should be centralised oversight of the tests, and aggregation of results.
Admittedly, our proposal raises difficulties. As the US experience has shown, genuine stress tests require that governments stand ready to say without delay how they intend to deal with insolvent institutions – including, in Europe, those with large cross-border operations. But it is worth noting that proper stress tests would not require any formal transfer of supervisory authority from national to European level. Rather, it could be carried out by a temporary task force responsible for ensuring consistency.
Since the cost of procrastination is high, turf wars should not be allowed to block a potentially major step towards recovery. We urge European
governments to act now.

This comment was published in the Financial Times, Les Echos and the Financial Times Deutschland.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read about event More on this topic
 

Upcoming Event

Oct
20
13:00

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Maria Demertzis, Cornelia Holthausen and Jean Pisani-Ferry Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Past Event

Past Event

What is the link between biodiversity loss and financial instability?

Biodiversity loss impacts financial stability. How big is the risk of biodiversity loss for financial institutions?

Speakers: Sylvie Goulard, Romain Svartzman, Guntram B. Wolff and Michael Wilkins Topic: Banking and capital markets Date: October 5, 2021
Read article More on this topic More by this author
 

External Publication

Brexit and European finance: Prolonged limbo

It will take longer than many had anticipated for the dust to settle on the post-Brexit financial landscape and its respective implications for the EU and the UK.

By: Nicolas Véron Topic: Banking and capital markets Date: September 24, 2021
Read about event More on this topic
 

Past Event

Past Event

Setting up the EU as a new benchmark borrower

At this closed-door event Siegfried Ruhl, Counselor to the Director-General for Budget at the European Commission will discuss the EU's borrowing program.

Speakers: Rebecca Christie and Siegfried Ruhl Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 16, 2021
Read article More on this topic More by this author
 

Opinion

El Salvador’s great crypto experiment

Can bitcoin surpass the dollar in popularity and make El Salvador the first state to operate entirely with a private currency?

By: Maria Demertzis Topic: Banking and capital markets Date: September 14, 2021
Read about event
 

Past Event

Past Event

Sustainable finance

Bruegel Annual Meetings, Day 3 - In this session on the final day of the Meetings, our panelists will discuss the future of finance and its sustainability.

Speakers: Maria Demertzis, Alberto De Paoli, Pierre Heilbronn and Alexandra Jour-Schroeder Topic: Banking and capital markets, Green economy Location: Palais des Académies, Rue Ducale 1, Brussels Date: September 3, 2021
Read about event More on this topic
 

Past Event

Past Event

Monetary and macroeconomic policies at the crossroads

Bruegel Annual Meetings, Day 2- In this session we would like to discuss monetary and macroeconomic policies after Covid-19.

Speakers: Grégory Claeys, Per Callesen, Gita Gopinath, Jorge Sicilia Serrano and Lawrence H. Summers Topic: Banking and capital markets Location: PALAIS DES ACADEMIES, RUE DUCALE 1 Date: September 2, 2021
Read about event
 

Past Event

Past Event

European banks: under global competitive pressure?

Bruegel Annual Meetings, Day 2 - European banks have lost stature and remain generally low-profitability, low-valuation in comparison to their global peers. Is that a problem? If so, what can EU policymakers do to address it?

Speakers: José Antonio Álvarez Álvarez, Mairead McGuinness and Nicolas Véron Topic: Banking and capital markets, Macroeconomic policy Location: Palais des Academies, Rue Ducale 1 Date: September 2, 2021
Read article More by this author
 

Podcast

Podcast

Environmental, societal and governance criteria: hit or miss?

Is sustainable investing contributing to society’s climate and social goals, or preventing systemic change?

By: The Sound of Economics Topic: Banking and capital markets, Green economy Date: August 26, 2021
Read article More on this topic More by this author
 

Opinion

Small investors punch above their weight when it comes to improving corporate governance

Far from being irresponsible know-nothings, retail investors provide a vital counterpoint to institutional investors.

By: Rebecca Christie Topic: Banking and capital markets Date: August 25, 2021
Read about event
 

Past Event

Past Event

Financing for Pandemic Preparedness and Response

How can we better prepare for future pandemics? In this event, co-hosted by the Center for Global Development and Bruegel think tanks, speakers will present "A Global Deal for Our Pandemic Age", a report of the G20 High Level Independent Panel on Financing the Global Commons for Pandemic Preparedness and Response.

Speakers: Masood Ahmed, Victor J. Dzau, Amanda Glassman and Lawrence H. Summers Topic: Banking and capital markets, Global economy and trade Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 14, 2021
Load more posts