Europe’s Stress Tests Fall Short in Alleviating Investors’ Concerns About the Banking Sector by Reuters

By Huw Jones

LONDON – The latest assessment of prominent European Union banks has not alleviated concerns regarding profitability within the sector, with the exclusion of risks such as negative interest rates and the impact of Brexit diminishing its significance.

The European Banking Authority (EBA) released the results of its health evaluation of 51 banks across the EU on Friday evening, post-market closure. The findings provided a generally optimistic outlook for the industry.

However, there were unexpected outcomes. Notably, two major Irish banks and Barclays underperformed compared to expectations, while German banks Deutsche Bank and Commerzbank exceeded performance assessments. Overall, the results indicated that banks have significantly improved their capital reserves since 2014.

Analysts remarked that this year’s stress test, being the third in the EU and the first without a pass or fail designation, was "no panacea." Crucial aspects were absent, particularly the effects of negative interest rates on profitability and a consideration of the UK’s decision to leave the EU.

"Overall, I find the results reassuring, but the real challenges facing the sector, particularly low interest rates, were not examined," stated Dirk Becker, chief financials analyst at a major investment firm.

As of 1045 GMT, the Stoxx index of European banks was down 1.9 percent, nearing lows reminiscent of the financial crisis. Since the UK’s vote to exit the European Union on June 23, the index has declined by 13 percent, exacerbating concerns over banks’ profitability and their capacity to manage non-performing loans.

"This is merely a step in the right direction; these results should not be overinterpreted," said George Karamanos, a banking analyst. "We maintain an underweight position in the sector."

BAD LOANS

Experts cautioned that while the tests enhance transparency, the underlying issues persist.

"We estimate that there are still around a trillion euros in non-performing loans affecting banks’ balance sheets across Europe," remarked Edward Chan, a banking partner at a law firm.

Analysts suggested that this year’s EU stress test is unlikely to resolve investor skepticism regarding banks, which have seen their book values drop below those of U.S. counterparts.

"I wouldn’t say it completely resolves the banking crisis," stated Gary Greenwood, a banks analyst. "At some point, we have to acknowledge that the ongoing challenges stem from management’s failure to address persistent issues."

Greenwood further noted that book values will likely improve as companies retain profits, rather than as a result of a stress test.

With Italy’s Monte dei Paschi viewed as the only institution needing significant capital raises, analysts believe that the stress test results will not add further downward pressure on overall book values. Shares of Monte dei Paschi rose by 4.4 percent following the results.

Regulators, including the European Central Bank, will utilize these results to determine capital requirements for the 37 eurozone lenders assessed by the end of the year.

"The main challenge for banks will be to prove that their data quality and risk models are robust enough to reliably identify future risks and that they have effective processes in place to manage these risks," remarked Burcu Guner, a senior director at Moody’s Analytics.