MacroScope

Stress, stress, stress

By Mike Peacock
October 23, 2013

The European Central Bank will announce the methodology which will underpin the stress tests of about 130 big European banks next year.

It is caught between the devil and the deep blue sea. Come up with a clean bill of health as previous discredited stress tests did and they will have no credibility. So it is likely to come down on the side of rigour but if in so doing it unearths serious financial gaps, fears about the euro zone would be rekindled and there is as yet no agreement on providing a common backstop for the financial sector.

France, Spain and Italy want a joint commitment by all 17 euro zone countries to stand by weak banks regardless of where they are. Germany, which fears it would end up picking up most of the bill, is worried about the euro zone’s rescue fund, the European Stability Mechanism, helping banks directly without making their home governments responsible for repaying the aid.

The pecking order is clear – a bank’s shareholders, creditors and large depositors would get hit first with national governments picking up the slack thereafter. But if it stops there, the “doom loop” of weak sovereigns propping up stricken banking sectors and each dragging the other down will be unbroken.

Moreover, ECB chief Mario Draghi has intervened to say bondholders shouldn’t be hit in all circumstances, for fear of investor flight.

A deal is supposed to be signed off by an EU leaders’ summit in December but if that slips, the harder deadline that the European Parliament must vote through any deal before it faces elections in the Spring hoves into view. The lack of a German government is not helping. The risk is that disaffected European voters could elect the most eurosceptic parliament yet seen which may not be keen on further integration.

ECB policymaker Peter Praet said on Monday that supervision of the euro zone’s largest 130 banks could be delayed beyond November 2014 if necessary. Not long ago the start date was mid-2014. Now could it be some time in 2015?

Draghi has been crystal clear, saying: “The effectiveness of this exercise will depend on the availability of necessary arrangements for recapitalising banks … including through the provision of a public backstop. “These arrangements must be in place before we conclude our assessment.”

For the ECB’s test methodology, a crucial question is how banks’ holdings of sovereign bonds will be treated, following a push by the German Bundesbank to reflect more adequately the varying degrees of risk attached to bonds issued by different governments.

Coalition talks between Angela Merkel’s CDU and the centre-left SPD begin in earnest with an entire policy slate to be thrashed out, suggesting we’re weeks away from a functioning government yet. SPD Chairman Sigmar Gabriel said the aim was to have one by Christmas which puts a question mark over banking union progress.

The SPD leadership has pledged to secure 10 demands it called “non-negotiable”, including a minimum wage of 8.50 euros per hour, equal pay for men and women, greater investment in infrastructure and education, and a common strategy to boost euro zone growth.

Ireland will exit its bailout in December and is now preparing the ground. Today, Finance Minister Michael Noonan meets Draghi and appears to be undecided as to whether to seek a precautionary credit line. He may be trying to ascertain if any strings would be attached. Either way, ECB bond-buying support looks unlikely and it’s hard to argue that Dublin needs it.

The Bank of Spain is due to publish its monthly bulletin in which it will give its forecast for Q3 GDP, the first official indication that Spain has emerged from a two-year recession.

Turkey’s central bank delivers its latest interest rate decision. It has held a number of dollar-selling auctions since the summer to shore up the lira but has insisted it won’t use official interest rates to that end. No change in rates is expected this time.

Finance Minister Pravin Gordhan announces South Africa’s mid-term budget with little leeway for any giveaways. With revenues under pressure as growth remains weak by emerging market standards – around two percent this year — he is expected to keep a tight leash on spending and placate ratings agencies worried about profligacy before elections next year.

Gordhan will probably also widen his budget deficit forecast for fiscal 2013/14 to 4.9 percent of economic output from the 4.6 percent seen in February, according to a Reuters poll of economists.

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