Oliver Q
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Oliver Q in European Markets,

Europe’s stress tests could lead to more bank bailouts

No one in their right mind wants to invest in a eurozone bank

Stress test is certainly the right word. This weekend — on Sunday to be precise — the European Central Bank will release the results of its audit of the European banking system. It is, however, the markets that are likely to end up as least as stressed as the banks under examination.

The ECB is likely to fail at least a few of the financial institutions it has been looking at. If it doesn’t, the tests will have been pointless. The trouble is, if those banks are forced to raise more capital to stay in business, there will be few takers for the shares.

The banks that fail won’t be able to raise capital and will have to turn to governments instead.

In reality, no one in their right mind will want to invest in a eurozone bank right now.

The region’s economic crisis is turning into a depression, with even Germany running into trouble. Deflation is looming, Unemployment is still rising. Even worse, those banks face all the same pressures from new technology as they do elsewhere, except in far more troubled circumstances.

The net result? The banks that fail won’t be able to raise capital and will have to turn to governments instead. That is the last thing the market needs.

It is hard to escape the conclusion that the ECB chose the rather odd time of noon on a Sunday to release the results because it knows the markets will be closed — and presumably it wants a few hours for people to digest the results before trading kicks off, first in Asia and then in Europe itself.

It has spent the best part of a year studying the capital position of 130 banks across the eurozone to assess their soundness. The findings are likely to make grim reading.

After all, there is plenty of evidence that many eurozone banks are dangerously short on capital, which explains why they have stopped lending over the last two years. True, a few investors may comfort themselves with the view that the ECB will simply whitewash the results. But they are likely to be disappointed.

The central bank is taking responsibility for regulating these institutions. If any of them go bust, it won’t want to leave itself open to charges of having glossed over their problems. In reality, it is going to lean in the direction of being overly harsh. The main interest of any bureaucracy is in covering its back and not getting blamed for things — and the ECB can only do that being being very tough in these tests.

“A chaotic period may ensue as banks caught short of minimum capital requirements scramble to sell equity, call in loans, and bundle up loans …to sell to the ECB,” argued High Frequency Economics in a note published this week. “All on short notice, and all at once.”

By

MATTHEW LYNN