BlogSpot - October 27th, 2014
Results of the Asset Qualitative Review in Eurozone
Benign outcome of the stress tests—Most of Europe’s biggest banks would be able to survive a financial crisis or severe economic downturn. The results of the stress test and of the ECB’s Asset Qualitative Review (AQR), testing the vulnerability of banks to stressed environments, were released—with 25 of the 130 largest banks in the euro zone area failing at the end of last year with a total capital shortfall of 25 billion euros (see the press release and official assessment, with commentaries from the FT, the WSJ, and Reuters). Twelve of them have already raised 15 billion euros to reduce their capital shortfall. The AQR resulted in a gross adjustment of asset values by €47.5bn and identified additional non-performing exposures (NPEs) of €136bn, concentrated in corporate and real estate portfolios. Under the adverse stress test scenario, the total capital depletion over three years equals €263bn. Nicolas Veron (Bruegel) notes that other potentially weak banks were identified, notably large local cooperative banks in Germany. The test was more comprehensive (130 banks in the AQR instead of 91 previously in past exercises) and tougher (with a 3-year recession scenario), though EuroIntelligence notes that deflationary scenarios were not included.
Silvia Merler, in a Bruegel blog entry, highlights the poor performance of Italian banks, 4 of the 13 banks still failing in 2014—due to structural weaknesses that have increased during the crisis, including the close bank-sovereign link, a strong home bias, low (or negative) profitability due to high costs and inefficiencies (see also RBS’ Alberto Gallo), high reliance on Eurosystem liquidity, She notes the striking contrast with the improvement experienced by Spanish banks. Francesco Garzarelli of Goldman Sachs (hat-tip Wall Street Journal) writes that the fundamental problem is the combination of a weak outlook for growth and weak banks, with an overwhelming need for bank restructuring in Italy.
A window of opportunity—Veron (Bruegel) welcomes the results of the stress tests, which set the ground for the ECB to take over its new role as the licensing authority of all the euro area’s banks and direct supervisor of the largest ones. According to RBS, November will mark the start of a new era. With the ECB as European bank regulator, mid-tier inefficient banks should start consolidating, and the playing field should be a more open to cross-border mergers. Over time, this should make Europe's banking system more efficient, but the road is long, and the ECB may have to buy more time during the process. By providing greater confidence in the banking sector, the stress tests also open a window of opportunity for governments to undertake much needed structural reforms, according to Mohamed El-Erian (in Spiegel) and Christian Noyer (hat-tip BarCap).
The real impact of the stress tests—Padraic Halpin and John O'Donnell (Reuters) write that the stress test will allow bank to lower their costs of funding (a point also made by analysts at Barclays) but the impact on the real economy may be limited as the incentive to lend may remain low. José Carlos Díez notes that there is no correlation between good performance in the stress tests and credit to the real economy—Spain being a good example, where credit to firms and households has dropped the most in the last year, but where banks performed well in the tests. Matthew Dalton argues that the stress tests will not have much of an impact on credit, as what matters is that the real interest rate in the eurozone is too high and that unless the ECB engages into substantial QE, this will not be resolved. Wolfgang Munchau (hat-tip EuroIntelligence) writes further that the real problem is credit-demand, to be addressed with urgency. RBS research team argues that after years of lending contraction, a real recovery will take a long time, because (i) many banks are still weak (24% scored a "narrow pass" in the ECB tests, that will likely keep their focus on capital rather than lending), (ii) regulation favors holding securities vs lending, (iii) there is little support for the ECB ABS program.
Lending activity is unlikely to restart soon even after the test, as many banks remain focused on strengthening capital, magnifying the problem of Europe remaining too reliant on banks as discussed by Yves Mersch. To fix the system policymakers will need to do a lot more – consolidation and restructuring of fragmented banking systems (especially Italy and Germany) on the one hand, and development of capital markets on the other (hat-tip RBS).
European free movement at the core of the debate in Great Britain
Immigration is becoming a central issue in the debate about the UK’s European “commitment”—a source of worry according to José Manuel Barroso (Project Syndicate). Barroso writes that plans to cap migrant entrance and control access to welfare system are against EU freedom of movement rules, though David Cameron suggests that he is implementing voters’ expectations (Reuters). Open Europe looks at possible options for David Cameron: (i) an « emergency brake » (i.e., temporarily control over the entrance of migrants), (ii) creating permanent quotas on all EU migrants or, (iii) put in place differentiated quotas for high-skilled and low-skilled migrants. The first option requires approval of a majority of EU countries. The second and third options require a treaty change, a complicated task given the Swiss experience (the Economist).
Away from the political debate, evidence is much more positive. British public opinion shows its highest support for EU membership since 1991 (Real Time Brussels), according to a poll by Ipsos MORI. Looking at public opinion survey on immigration, Simon Wren-Lewis (Mainly Macro) shows that public perceptions are quite differentiated—depending on income levels, education, and location, i.e., more educated, higher income and people living in areas with relatively high migration are less concerned about its potential negative impact. Carlos Vargas-Silva (Migration Observatory) actually finds a positive fiscal impact of migration, and that only migration from outside the EU has a negative impact on unemployment within the context of an economic downturn (see the paper). Bruegel additionally notes that migration has a positive impact on investment and bilateral trade with migrants’ country.
Inequality on the policy agenda
The recent widening in inequality reflects several trends: in a no-growth environment “someone is getting hurt” (Michael Spence), recoveries are supported by low wages, as in the case of Britain (Free Exchange); fiscal policy has limited room to play a redistribution role (Mohamed El-Erian), while expansionary monetary policy implicitly favors the wealthy, who hold a disproportionately large share of financial assets. This finding is analyzed in a Bruegel BlogSpot by Jeremie Cohen-Sutton that finds that the redistributive impact of monetary policy is greater than in the past, with 5 channels identified by Olivier Coibion et al.
Inequality is associated with high economic and social costs, as noted by Cardiff Garcia (FT Alphaville). El-Erian points to the dangerous erosion of social cohesion with increasing inequality—magnified in specific regions: the OECD Regional Outlook 2014 shows that in 10 OECD countries, over 40% of the national rise in unemployment since the crisis was concentrated in one region.
By Lisa Kerdelhue and Adrien Régnier-Laurent
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