Europe’s far-reaching review of banks set off sharp drops in the shares of Italian lenders on Monday, after several of them failed the year-long exercise’s test of financial strength.
Investors and analysts sifted through the huge amounts of data released Sunday as part of the test results. Bank shares initially rose overall, on apparent relief that the continent’s largest banks were found to have adequate finances, but then fell, led by a plunge in Italy’s bank Monte dei Paschi di Siena. It had the biggest capital gap to fill among the 13 banks that flunked and must strengthen their financial buffers.
The key banking index, the Stoxx Europe 600 Banks, fell 1.73 percent amid a decline in the broader market.
Though most of the banks that failed the review were in Europe’s economically weaker countries, the results also raised questions about several banks in Germany. While they passed the main test, they fell short on a tougher measure of financial strength that will apply in coming years.
The review, conducted by the European Central Bank and the European Banking Authority, first checked the value of bank loans and holdings. Then, their finances were subjected to a stress test to simulate how their finances would hold up in a downturn.
In all, 25 banks failed the test, nine of them from Italy. But many had raised capital in the months since the review began, at the end of 2013. As a result, 12 of the 25 had already covered their financial gaps found by the review, and several of the remaining 13 had only small amounts to raise.
The test was aimed at restoring confidence in the eurozone banks as the ECB and governments try to get a stagnant economy moving again. It paves the way for the ECB to take over Nov. 4 as the main banking supervisor for the countries that use the euro.
Here are key takeaways.
ITALIAN BANKS FLUNK
Shares in Italian bank Monte dei Paschi di Siena, which had the biggest capital shortfall at 2.11 billion euros ($2.67 billion), plunged 21.5 percent on Monday. The bank’s board met Sunday and said it had hired advisers to “explore all strategic alternatives.” That could include a share issue, which tends to hurt the share price because it dilutes its value.
After racking up losses on Italian sovereign debt during the eurozone’s financial crisis, Monet dei Paschi di Siena started a five-year recovery plan that included a 3.9-billion-euro bailout and 13 billion euros in state guarantees. It has been under added scrutiny after disclosures it hid losses.
Other banks that were found to need smaller amounts of capital were Banca Carige, Banca Popolare di Milano and Banca Popolare di Vicenza.
The result “puts a cloud above the Bank of Italy’s reputation as a supervisor,” analyst Nicolas Veron of the Bruegel think tank in Brussels wrote in an analysis, referring to the national central bank.
QUESTIONS IN GERMANY
Germany’s big banks, Deutsche Bank and Commerzbank, both passed. But several smaller ones – Germany’s HSH Nordbank, DZ Bank and WGZ Bank – passed the basic test, but then fell short on a tougher measure of capital adequacy that will be phased in in coming years under an international agreement called Basel III.
HSH Nordbank, which is jointly majority owned by the city of Hamburg and the region of Schleswig Holstein, has specialized in ship finance, a business hit hard by losses and bad loans. The bank remains in compliance with current capital rules.
CEO Constantin von Oesterreich said in a statement that the test “confirmed that HSH Nordbank has a solid capital base in the present setting.”
Analyst Veron called the results for the three smaller German banks “possibly the biggest surprise” of the entire test. He added that “the fact that Germany and Italy, two of the euro area’s biggest countries, are not immune to the ECB’s inquisitiveness suggests that the assessment has been kept reasonably independent from political pressure.”
IT’S THE ECONOMY
Whether it was thorough enough or not, the review of banks is only part of a bigger range of actions that are needed to get the 18-country eurozone economy going, experts say.
The aim of the test was to force weak banks to improve their financial strength so they can lend to businesses, which would invest and hire more.
But even ECB officials admitted that will only happen when demand picks up.
“Although likely to improve credit supply, a large number of credit demand constraints will remain in place until other factors hampering eurozone growth are addressed,” wrote analysts Mujtaba Rachman and Federico Santi at the Eurasia Group.
The latest indicators suggested that an upturn isn’t happening yet. Germany’s Ifo index of business confidence fell in October for a sixth consecutive month, underscoring the problem on Monday.