Euro Bank Stress Test Tomorrow

As we reported in last week’s Weekly Wrap this Friday has the potential to send shockwaves through the already fragile European banking sector as the bi-annual European bank stress test is published.  Recently we saw Europe’s biggest, Deutsche Bank, fail the US Fed’s stress test and the IMF name it as the greatest systemic risk to the global financial system.

We’ve written about the Italian bank situation with its 18% NPL’s (bad loans).  Whilst Greece is worse at nearly 35%, the size of the Italian situation dwarfs it.  The world’s oldest bank, Monte dei Paschi di Siena (MPS) is the one everyone will be looking at after it failed the last test, is Italy’s 3^rd largest bank, has already been bailed out twice before, and is already widely regarded as needing more capital.

Possibly to prevent any hysteria, they have reduced the number of banks being tested to just 51 from 124 last time and there won’t be the usual pass and fail outcome.  That said, the 51 are the largest and it will be evident to analysts if they have ‘failed’.  Maybe it will be like school these days and you get an ‘encouragement’ or ‘participation’ award…

The problem is that whilst the 51 banks cover around 70% of the Euro banking sector it excludes any from Greece, Cyprus and (maybe critically), Portugal by sheer scale.

Why we point out Portugal is that whilst the other PIGS, Ireland and Spain, have improved (albeit Ireland is still at 14.9%), Portugal (along with smaller Greece) has continued to deteriorate and is now up to 12.8% and worsening.  Last December their Novo Banco bank was one of the first to ‘bail in’ taking €2b from bond holders.  They were to plug the rest via a sale but that sale is not working and is likely to lead to the need for more capital. Barclays recently estimated that Portuguese lenders could need up to €7.5bn to resolve a “systemic banking crisis” that was bringing the country under “close market scrutiny”.  They went on to say 

“Some banks are in need of a large capital injection…. This means any material losses from the sale of Novo Banco could end up having to be met by the sovereign, as the capacity of Portuguese banks to absorb them is rather limited.” 

When they say "the sovereign", they mean taxpayers, and we are then back to Italy’s problem of EU regs saying no more bail-outs (Government via debt and taxpayers), only bail-ins (share and bond holders, and depositors).  The stage is set for a lot more pain in the EU, hard calls for the EC, and the obvious potential for more Brexit type EU revolts.