By the Blouin News Business staff

Euro zone banks: The back stops here

by in Europe.

european-central-bank-headquarters

European Central Bank headquarters. Photo Credit: AFP Photo/Daniel Roland

When the European Central Bank (ECB) takes over supervision of the euro zone’s banks from national regulators in a year’s time, it wants to be sure it is acquiring as sound a set of charges as it can get. To this end, it is conducting a third round of stress tests and balance sheet reviews of 128 of the region’s largest banks, which together account for six-sevenths of the assets in the euro banking system.

Mario Draghi, the ECB’s governor, says some banks need to fail those tests to establish the credibility of the process. He starts off on the back foot given that the two previous stress tests failed to spot problems that led to taxpayer funded bailouts in Ireland and Spain. Draghi’s carefully chosen bluntness did, however, reduce what little confidence was left among investors that the tests’ capital standards would be a relatively low bar to clear.

Bank stocks fell on his words, with those in the shakier parts of the euro zone, such as Italy, falling by as much as 3%. To avoid spooking investors too much, Draghi make a point of saying that governments within the euro zone had committed to recapitalizing any banks that the tests show need it. “Backstopping” is the term of art for this process of redistributing taxpayers’ euros to bankers.

There is the rub. Not all governments like the idea of backstopping banks, especially those elsewhere in the euro zone. Not all governments would include, most importantly, Germany’s.

Even before its recent general election, Germany had hardened its opposition to giving troubled banks direct access to the (taxpayer funded) euro zone rescue fund. It wants the first call for fresh capital to go to shareholders (as does the ECB), but then bond holders should be on the hook before taxpayers are tapped. Angela Merkel’s new coalition government with the center-left Social Democrats will hold fast to that line. It will argue that national authorities should manage the resolution of troubled banks — i.e. national not German taxpayers should foot the bill.

The continued dissonance over public backstops if banks can’t plug any holes on their balance sheets that the ECB stress tests show up is going to keep bank stocks volatile for the duration of the year-long process. It will also keep investors guessing whether the January 2015 deadline for establishing a common European system for the resolution of troubled banks — a key milestone on the road to Europe’s banking union — can be met.