Another Stress Test – Another Media Circus

Hmm…must be that time of year, or something..  Anyway – European bankers are gearing up for another stress test. Yes, their third. But, hey! This time they promise to get it right.  The ECB has even hired the best external stress tester in the business to do the job.  US-based financial consultancy firm Oliver Wyman, a company who has a proven track record for coming up with the right numbers. However, not always the most accurate ones.

“This is the last opportunity to reestablish confidence in the European banking system.”

Jörg Asmussen

Stress testing of European banks is actually one of the most entertaining parts of the financial crisis. It’s almost hilariously funny to watch the troubled bankers desperately trying to cork a swiss cheese with a soft gun – the holes just multiply and keeps getting bigger.

For every “the worst is over” statement, the laughter grows… We’ve gone from booing to cheering…

And the preparations for stress test #3 are also promising.

Last week the ECB announced that it had hired the US-based consultancy firm, Oliver Wyman, to conduct the test.   These guys are no strangers to the European stress testing.

• In 2006, it famously said the Anglo-Irish Bank was the best bank in the world. Three years later, the bank had to be nationalised and almost bankrupted the Irish state, which then needed a euro zone bailout.
• In 2012, during the Spanish bank bailout, Oliver Wyman provided the euro zone decision-makers with the numbers they expected and which were politically acceptable – around €60 billion instead of a much larger gap that the banks actually had.
• Also 2012, Oliver Wyman did consultancy work in the Portuguese bailout, according to the central bank of Portugal.

The EU observer writes:

“The worry in euro zone central banks, according to one insider, is that if banks are reviewed too thoroughly and their problems exposed, they will stop lending and revive the financial crisis.”

Thanks for carving it out, but I think we kinda guessed that already.

But there’s another factor in play this time.

You see, the ECB is planning to step up to the role as EU’s chief supervisor next year and I believe they want to know what they’re supposed to supervise.

The ECB plans to put 130 major European banks to the test before it assumes regulatory supervision of the institutions in the fall of 2014.

“This test is not a threat,” says Jörg Asmussen, former state secretary in the German Finance Ministry, now  a member of the executive board of the European Central Bank (ECB).

“But after two failed stress tests, this is the last opportunity to reestablish confidence in the European banking system.”

I’m sorry, but I think that ship sailed the moment you signed the deal with  Oliver Wyman, Mr. Asmussen.

Additionally, many substantial estimates have already been made over the potential magnitude of the gaps the test will uncover.

SPIEGEL Online reports that Deutsche Bank estimates that Europe’s banks will need €16 billion in additional capital. Depending on which criteria the ECB applies in its tests, the gap could be much bigger.

The Bundesbank, Germany’s central bank, has just estimated that the seven largest German banks alone need an additional €43 billion in capital to satisfy the new international capital requirements.

I don’t think any stress test dares to go higher than that!

A comparison with the United States gives indications on how bad shape the Europeans really are in.

US financial groups are reporting record profits, while banks in the euro zone have lost more than €80 billion ($108 billion) in the last two years. In the United States, 10 times as many ailing banks were closed and balance sheets were more consistently relieved of bad debt than in the euro zone.

The European leaders seem to have  failed to adequately address their banking crisis.

But they won’t give up!

So, what can we expect in the next 8 to 10 months?

My guess is – for what it’s worth – is that we will see a slow, dramatic build-up. with ECB’ers and politicians lining up to give their pledges about the truth and nothing but the truth, followed by a series of suspicious leaks, causing some market turmoil and a little bit of liquidity squeeze, and by this time next year the ECB will take on the European banking supervision with a huge off-balance sheet and the uncertainty of the euro zone bank sector will be unchanged.

And finally we start all over again with stress test #4.

We can party for ever!

 

Full history of European bank stress testing:

• Yippee! Another European Stress Test Festival!
• The EU Stress Test: Working The Media
• Weekly Outlook: The European Post Stress Test Syndrome
• EU Bank Stress Test: Commentaries & Market Reactions
• EU Bank Stress Test: Here’s The Full Package
• To Europe From Goldman Sachs On The Stress Test Eve
• Financial Authorities See No Point In Stress Testing Norwegian Banks
• Norway: Most Banks Fail In Stresstest
• All Nordic Banks Will Pass Stress Test, Nordea Says
• European Bank Stress Tests Are Loosing Credibility
• EU Stress Test May Trigger Capital Injection Of EUR 85 Billion
• Global Markets Mental Health Test

Other articles:

• ECB hires firm that said Anglo was world’s best Bank to stress test EU banks (politics.ie)
• National backstops expected to be in place for European banking stress tests – Draghi (irishtimes.com)
• CORRECTED-ECB’s Asmussen: ESM needs rule change to be used as resolution backstop (xe.com)
• ECB Policy Makers Say Stress Tests Risk Market Confusion (bloomberg.com)
• Draghi Warns Banks Long-Term Loans Can’t Replace Capital (bloomberg.com)

European Crisis Not Contagious – Banks Are

The International Monetary Fund (IMF) have released a stack of reports and papers over the last couple of days, including the one stating that the Greek bailout operation has been more or less – a fiasco, so far. But there’s more: New research indicates that the international banking  is continuously increasing their risk taking and that more any more trouble with the European banks may have severe spillover effects on  financial institutions outside Europe,

“Both German and French banks mostly transmit/receive shocks to other European banks, especially in the UK. French and U. banks pre-crisis also appear to have strong spillover to Russia. Outside of Europe, spillover are largely confined to the US.”

Hélène Poirson/Jochen Schmittmann

The average sensitivity to European risk, specifically, has been steadily rising since 2008. Banks that are reliant on wholesale funding, have weaker capital levels and low valuations, and higher exposures to crisis countries are found to be the most vulnerable to shocks. The analysis of bank-to-bank linkages suggests that any globalization of the euro area crisis is likely to be channelled through UK. and US banks, the research paper says.

The report “Risk Exposures and Financial spillover in Tranquil and Crisis Times: Bank-Level Evidence” provided by Hélène Poirson and Jochen Schmittmann was released yesterday in the shadow of IMF’s Greek audit report.

(Transcript of IMF press briefing on Greece here.).

This report is not necessary reflecting the official IMF view, but provides some interesting details on who will influence who if more trouble occur.

The researchers have discovered a clear pattern of interconnectedness between European banks.

“French and German banks co-move strongly only with selected US financial institutions, while UK banks are connected strongly with both Asia (pre-crisis only) and the US (in both periods).”

“This last finding suggests that the estimated spillover effects capture pure risk transmission across banks (contagion) rather than shared sensitivities to macro-financial variables.”

“This last finding suggests that the estimated spillover effects capture pure risk transmission across banks (contagion) rather than shared sensitivities to macro-financial variables.”

Moreover, the researchers have mapped the connections between the individual institutions.

“The estimation framework allows us to highlight the presence of “clusters” of interconnected banks that tend to co-move together more strongly than with other banks, either due to inter-bank linkages (counterparty relationships, interbank-lending) or the exposure to common vulnerabilities.”

A few examples

.

.

• Large German banks appear to co-move strongly either with other German banks or with other European banks.
• Spillover from German banks to other European banks are most pronounced in the case of French and U.K. banks and, to a lesser extent, in the case of Dutch, Belgian, and Swiss banks.
• During the subprime crisis and in the post-crisis period, a Franco-German cluster can be detected comprising Deutsche Bank and BNP Paribas and a UK-German cluster comprising Commerzbank, Barclays, and RBS.
• None of the banks from peripheral crisis European countries (GIIPS) are found to co-move in a significant way with the largest German banks.
• Spillover from German banks to other regions appear limited to the US: prior to the subprime crisis, two of the large German banks seem to co-move significantly with banks in the U.S. (namely, Deutsche Bank with Lehman Brothers and Hypo Real Estate with Goldman Sachs)25; during and following the subprime crisis, Freddie Mac and Fannie Mae have synchronized returns with the largest German financial institutions (Deutsche Bank, Commerzbank, and Allianz), which in turn can be traced back to the latter’s sizeable holdings of subprime portfolios and related exposures to US real estate.

Conclusions

“Similar to German banks, the spillover of French banks to other regions are largely limited to U.S. financial institutions and can only be detected since the onset of the subprime crisis.”

“The financial spillover of U.K. banks, by contrast, reach beyond Europe in both periods. Pre-crisis, there is empirical evidence of strong co-movement of US, Indian and Chinese banks with U.K. banks; during the subprime crisis and post-crisis, spillover to U.S. banks are dominant and the analysis does not detect any co-movement with banks in other regions.”

“In summary, we can tentatively conclude from the analysis of bank-level spillover that direct financial spillover from the EA banking and sovereign debt crisis transmitted through the equity markets outside of Europe are likely to be confined to US banks and financial institutions. Indirectly, however, given the role of the US as a global financial hub, such spillover – if they were to intensify – could potentially transmit more widely to systemic banks in other regions (Asia, Latin America, and Middle East).”

“The analysis in this study leaves unspecified the channels of transmission of financial spillover both within countries and across borders. While this undertaking is beyond the scope of this paper, it would be an important avenue for further research.”

Definitively!

(Download the full report here.)

.

More fun stuff:

• Please, Don’t Mention “Contagion”!
• IMF Director Christine Lagarde Sees “Crisis of Confidence”
• The Worlds Most Contagious Countries – Here’s The List
• Europe In Debt (Part 1): Creating a Monster
• Europe In Debt (Part 2): Poisonous PIIGS With Toxic Lipstick
• Europe In Debt (Part 3): Exit On Main Street
• In The Bright Minds Of IMF

Other possible related articles:

• IMF admits mistakes on Greek bailout (bbc.co.uk)
• Brussels fights back in Greek crisis blame game (guardian.co.uk)
• ‘Masters of Austerity’ Targeted as Blockupy Activists Shut Down European Central Bank (commondreams.org)
• German banks can´t withold Dibabank (yournovelty.wordpress.com)
• Brussels fights back in Greek crisis blame game (guardian.co.uk)

.

Deutsche Bank To Review Its Global Asset Management

Deutsche Bank announced on Tuesday that it is conducting a strategic review of its global Asset Management division. All strategic options are being considered, the bank says in a press release.

“The outcome of this review will be driven first and foremost by our fiduciary duty to, and the interests of, our clients.”

Kevin Parker

 

This is one of those interesting press releases where the most interesting stuff is what the releasing company is NOT saying.

When any company is reviewing the strategy of a whole division it is almost certain that there will be some changes.

Deutsche Bank do not say anything in today’s press release about what part of the asset management it will cut lose.

But the largest bank of Europe emphasize what it will keep:

“While the Bank remains committed to asset management, this review is part of the Bank’s continual effort to maintain an optimal business mix and be among the market leaders in each of its businesses.,” DB writes.

“All strategic options are being considered. The review covers all of the Asset Management division globally except for the DWS franchise in Germany, Europe and Asia, which the Bank has already determined is a core part of its retail offering in those markets.”

According to the bank is the strategic review of the asset management division focusing in particular on how recent regulatory changes and associated costs and changes in the competitive landscape are impacting the business and its growth prospects on a bank platform.

Kevin Parker, Global Head of Asset Management and a member of the Deutsche Bank Group Executive Committee, says in commentary:

“The outcome of this review will be driven first and foremost by our fiduciary duty to, and the interests of, our clients. Our aim is to find the best strategic option to maximize the performance and potential of the Asset Management division.”

Fiduciary duty? I had to look it up:

“A fiduciary duty is a legal or ethical relationship of confidence or trust between two or more parties. One party, for example a corporate trust company or the trust department of a bank, acts in a fiduciary capacity to one, who for example has funds entrusted to it for investment. In a fiduciary relationship, one person, in a position of vulnerability, justifiably vests confidence, good faith, reliance and trust in another whose aid, advice or protection is sought in some matter. In such a relation good conscience requires the fiduciary to act at all times for the sole benefit and interest of the one who trusts,” according to Wikipedia.

“A fiduciary duty is the highest standard of care at either equity or law. A fiduciary is expected to be extremely loyal to the person to whom he owes the duty (the “principal“): he must not put his personal interests before the duty, and must not profit from his position as a fiduciary, unless the principal consents.”

Now, who is “the principal” (or “principals”) of Deutsche Bank? I wonder…

Related articles:

• Deutsche Bank May Sell Asset Management Division After Recent Regulatory Changes (DB) (businessinsider.com)
• Deutsche Bank Could Transfer Financial Contagion: Simon Johnson (mb50.wordpress.com)