European stress tests to challenge banks' political defences

Tue Sep 16, 2014 3:00pm EDT
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By Carmel Crimmins and Andreas Kröner

DUBLIN/FRANKFURT (Reuters) - For the first time since its financial crisis struck in 2008, Europe is carrying out stress tests that could force change at banks with strong political connections.

The European Central Bank is leading the latest attempt to uncover problems that would endanger any lender's survival in a future crisis. Unlike the three previous efforts, which were hamstrung by national authorities' reluctance to expose their banks' weaknesses, Frankfurt has a vested interest in revealing problems before it takes over as supervisor in November.

"The last time the process was done at the national level by the same old supervisors," said Nicolas Veron, an expert on banking at the Bruegel think-tank in Brussels and the Peterson Institute for International Economics in Washington.

"Here, we have a completely new pair of eyes and the ECB has every incentive to be tough because the ECB doesn't own the present failures but it will own the future failures."

The tests are likely to force some banks into raising more cash to prove they can withstand another downturn without the taxpayer-funded rescues that a number needed in the last crisis.

But crucially, European Union rules restricting state aid have been toughened since the last stress tests in 2011. This means any bank seeking government money to fill a hole revealed by the ECB review may have to restructure its business, as well as forcing losses on shareholders and junior creditors if the European Commission decides the injection represents state aid.

Germany's HSH Nordbank [HSH.UL], majority owned by the local governments of Hamburg and Schleswig-Holstein and a major lender to the troubled shipping industry, flagged this restructuring risk in a note accompanying its half-year results.

HSH has said it is confident it will pass the tests, the results of which are expected in late October, but some analysts see it as one of the German lenders at risk of failing.   Continued...

General view of the headquarters of the European Central Bank (ECB) before the bank's monthly news conference in Frankfurt August 7, 2014.  REUTERS/Ralph Orlowski