ECB stress tests: The view of an insider – Guest post by Klaus Kastner

Klaus Kastner photoKlaus Kastner is a former banker from Austria who is also ‘afflicted’ with a deep concern for Greece; witness his excellent blog ObservingGreece. He has commented many times on this blog and, on the occasion of the ECB’s recent stress tests (and in response to this post) he sent me the following comment. His first hand experience of European banks renders is both useful and interesting. Read on…

Any stress test like the one which the ECB has performed is a good thing because, that is for sure, it got the bankers’ attention. I can say that from personal experience: the Austrian bank from which I retired a couple of years ago was one of the six Austrian banks subject to the stress test. Whenever I met former colleagues during the last months, I noticed that the stress test was on the top of their minds. In short: they were nervous. And it is always a good thing when bankers are nervous. Nervous about making bad loans; nervous about buying the wrong securities; nervous about getting caught at doing untoward things.

Having said that, it would be an illusion to think that all those banks which passed the test are ‘safe’. I looked up the figures of Deutsche Bank as of June 30, 2014. Their loans were only 23% of total assets. Financial assets of all kinds were almost 60% of their assets. Unlike loans where there are borrowers, behind financial assets there are counterparties and in the majority of cases they are not valued based on some notional amount or based on some tradeable value in a public market but, instead, based on complex formulae. If those formulae cease to be valid (like they did with LTCM back in 1998), the value of the assets is in the dark. More importantly, Deutsche’s consolidated equity was only 4% of total assets or a leverage of about 24:1. That’s a lot better than the 50:1 which it had a couple of years ago but it is still in the hedge fund category. Put differently, Deutsche is still a hedge fund with a small commercial bank attached to it. That’s a risk which cannot really be measured in terms of numbers.

As far as I know, the stress test did not at all take into account the interrelationship between banks (i. e. they examined banks on their own merits). Anyone who is interested in what those interrelationships can cause is well advised to read up on the history of LTCM back in 1998.

In summary, the stress test undoubtedly had a positive impact (at leat a short-term one) on the conduct of banks and bankers. However, anyone who concludes that the EZ financial system is on solid grounds is living in an illusion. The leverage of the large banks (mostly German and French) is far too high and they are far too reliant on ‘hot money’ for their refinancing. And structural issues have not been addressed at all. Many of the countries are totally overbanked leading to the situation where no bank on its own can make enough money without entering into undue risks. To me, the only answer is to increase the equity requirement based on notional balance sheet amounts (instead of only risk-weighted assets) which would lead to the necessary consolidations.


  • Very useful and direct comment by Kastner.
    Yanis, we met in Mexico city with Adalberto Palma

  • Why such a concern for German banks? I know they have exposure to sovereign debt but nevertheless they are operating in a 0% interest rate environment and a <1% 10 year bond environment.

    Perfect situation for investments that take advantage of the difference between 0% and the prevailing rates in mortgage instruments or other quality bonds. Add 10x leverage and you have a steady stream of earnings.

    On the other hands Greek banks are another story. They operate in a 7-8% 10 year bond environment and are totally at the mercy of the ECB and the Greek politicians. Until a month ago Mr. Draghi was playing games with what collateral he could accept.
    Their deposits have moved from 340B to 160B courtesy of the fear mongering by the likes of Angela Merkel and the Dutch Economic Minister. The balance of 180B has all moved under the mattresses or to safe heavens on or off-shore. After all the EU has a free flow of capital and Merkel signals that it is safer to keep money in Germany or the UK.

    Even DT owner of OTE the telecom monopoly takes the cash of the Greeks daily and transfers to Germany. At least that was the routine during the crisis period.

    So Mr. Kastner, there is no concern for German banks, the issue at hand is whether the EU will ever start thinking as a Union and not as Germany. The effect of the policies for Greece have been devastating.

3 Trackbacks