Some banks need to fail to make stress tests ‘credible’

Some banks need to fail a sector-wide review of their financial health in order to make the exercise credible, the head of the euro zone’s new banking supervisor told the Financial Times.

As part of a broad push for closer integration of Europe's banks to avert future crises, the Single Supervisory Mechanism (SSM) will monitor the bloc's largest lenders from November under the auspices of the European Central Bank.

Before then, the SSM is running the rule over the quality of the assets on the balance sheets of the bloc's 128 biggest banks. That will run in parallel with broader stress tests of the whole banking sector under the control of Europe's regulator, the European Banking Authority (EBA).

ECB president Mario Draghi said last year there needed to be bank failures to make the battery of tests credible, comments SSM head Daniele Nouy underlined in an interview published today. "It seems precisely what markets expect from such an exercise; so, yes, probably that's the case," she told the FT. "I do not have any idea of how many banks have to fail. What I know is that we want to have the highest level of quality. ... A failure of a bank may happen."

Previous EBA stress tests in 2009, 2010 and 2011 were widely criticised for not being rigorous enough. Among others, they gave clean bills of health to the banking sector in Ireland, which then had to ask for an international bailout. Combining "bad banks with good banks" was not a solution, Ms Nouy added, saying that it needed to be accepted that some banks had no future.

Speaking to reporters in the Swedish town of Linkoping, the country's finance minister Anders Borg said he was not concerned about the state of its banks, though it would "surely turn out" that some banks did not have enough capital. The euro zone banks to be tested include subsidiaries of banking groups outside the bloc, including Sweden's SEB.

Mr Borg urged the ECB to ensure a smooth transition, and "that's why I think it is wise - like Mario Draghi is doing - to discuss whether they need to shift to direct asset purchases."

The ECB is assessing which tools it might need to deploy next, and Mr Draghi said last week a revitalisation of the asset-backed securities market for packaging loans or bank loans would be “a very important instrument” to improve credit flows.

Reuters