A second round of EU banking stress tests - designed to bring transparency and hence confidence to shore up confidence in the eurozone, may well have served simpy to score another own goal.
The European Banking Authority said eight of the 90 banks it examined fell short of the required amount of capital under the tests' simulations of a deep, two-year economic downturn. Those banks faced a total shortage of €2.5 billion ($3.54 billion) of capital.
Compare these results to the last set of stress tests conducted a year ago that saw 7 banks fail, with a combined deficit of €3.5 billion. If this first attempt at flushing out banks with shaky foundations failed to inspire market confidence, do we really think this year's much vaunted round of weighty stats will do any better, the analysis of which adds just 2 more banks to the 'at risk' register with a valued shortage in Tier 1 Capital of a measly €2.5bn?
Sure, banks have raised tens of billions in the intervening period to increase their financial cushions, but is it enough if leading indicators deteriorate? Have current asset values on banks' balance sheets in the property markets of Southern Europe been factored in, or are lenders holding back on write-downs?
If stress tests are meant to determine the ability of banks to withstand the worst realistically imaginable scenario, how meaningful are the tests when they exclude the shock of a debt default by Greece or Portugal? Whilst such a default may be politically unpalatable, that isn't a good reason not to countenance it. What happens when the strengthened EU Stability Fund comes knocking asking for banks to take haircuts on their holdings of debt, assuming they've not already been sold on to the next institution down the line?
These sorts of impossibly difficult questions point to some of the potential challenges we might face in the months to couple of years ahead. In this scenario, we can expect stuttering growth, with sluggish consumer spending as banks restrict outflows and households pay down debt at record rates. The dismantling of rocky high street retailers will surely continue with an outcrop of liquidations in the faltering weeks following each quarter end.
This isn't to say that the EU banking sector is at risk, but simply to point out that lending to business and funding the consumer, whilst strengthening their own balance sheets and ensuring that they can transparently meet the stress tests' criteria are incompatible goals, with lending certain to take a back seat to the more pressing factors.
Meanwhile, companies will increase focus on investments that have a direct and immediate return. Firms that have built up strong cash reserves are in a wonderful position to pick and choose their moves and are very well placed for a consumer uptick, whereas those that are tight on cash will surely draw in their horns. This is the perfect backdrop for disruptive innovation, driven by market appetite towards lower cost, more transparent and direct ways of delivering value to buyers. In this context, business & marketing innovation, stellar reputation and strong cash flow truly matter.
