After the Asset Quality Review and Stress Tests, now what?

Hats off to our two main domestic banks, Bank of Valletta and HSBC Bank (Malta) for passing the Asset Quality Review (AQR) and Stress Tests (ST) with a lot of margin to spare even though the tests were very rigorous assuming a scenario as if our national economy was going to fall off a cliff.

Victor Costancio - Vice President
ECB

The stiffer the better one may argue as the Maltese saying goes "ahseb il-hazin biex it-tajjeb ma jonqosx". ( assume the worst so that the better will not fail to materialise)

In essence however the whole European Banking sector performed well. Less than Euro 10 billion required as new equity ( after adjustments) on an aggregate Balance Sheet of Euro 28 trillion i.e. 0.035%, is clearly not a significant game-changer.




This means that there are two ways to interpret the broad results of the AQR/ST conducted by the ECB and EBA:

Either
                              the tests are not credible

Or
                              the tests are credible but the banks are not the problem behind the flat            growth and  lack of credit demand across Europe.


The ECB seems in no doubt that whilst addressing problems about the supply of credit is a necessary step to fix the European economy, on its own it is not sufficient.   In fact Vice-President Victor Constancio was very measured in his words:

"the economic recovery will not be hampered by credit supply restrictions coming from the banking sector, provided there is enough aggregate demand"

As ECB President Draghi pointed out in his August Jackson Hole speech and repeatedly since then, monetary policy cannot carry the whole responsibility for economic revival in the Eurozone - it needs to be re-enforced by growth friendly structural reforms ( Italy Greece Spain and France please listen) and more flexible fiscal policy ( Germany please note).

To avoid a protracted recession Europe needs all three arrows: loose monetary policy and strong banking sector to deliver it where it matters, supportive fiscal policy and growth oriented structural reforms.

The ECB is doing its bit to provide time for politicians to get together and fire the other two arrows.   But there is not much time left if we are to keep Europe from falling into a deflationary debt trap from where it will be almost impossible to climb back.