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.