Analysis: Germans stressed out over EU stress tests

By Paul Taylor

PARIS (Reuters) – As a rule of thumb, the vehemence of opposition to transparency is directly proportional to the size of the skeleton in the closet.

How, then, should we interpret Germany’s dogged resistance to stricter criteria for the European Union’s second wave of bank stress tests, to public disclosure of the results and to making provisions in case of a capital shortfall?

Berlin is rightly eager that European authorities should shine a light into the darkest corners of Greek public finances, Irish banking books and Portuguese public sector accounts to flush out liabilities that could burden the German taxpayer.

But when it comes to opening the can of worms that is its own system of publicly owned regional banks, the Landesbanken, Germany pleads special circumstances for shunning the light.

“There are skeletons that no one wants to be uncovered, and there are also people who say skeletons are a normal part of life but don’t want the European Banking Authority sticking video cameras in their closets,” said Nicolas Veron, an expert on financial regulation at the Bruegel economic think-tank.

“In the German case of the Landesbanken, they are terrified by what they’re hiding right now,” he told Reuters.

Ever since the start of the global financial crisis in 2007, German banks have sought exceptions from more stringent international rules for capital adequacy.

Up to the last minute, the Berlin government, the Bundesbank and German banking regulators insisted on allowing a unique German debt-equity hybrid known as “silent participation” to count as core capital in the EU-wide stress tests.

That would enable ailing German institutions Commerzbank (CBKG.DE: Quote, Profile, Research) and West LB (WDLG.UL: Quote, Profile, Research), both of which have received state-backed hand-outs from bail-out fund Soffin, to pass.

“Silent participation,” which accounts for a quarter to half of the capital reserves of Germany’s Landesbanken, savings banks, cooperative banks and private banks, cannot absorb losses while a bank is still in business.

Senior EU officials are also strongly critical of Germany’s failure to set aside funds to recapitalize banks once results of the stress tests are released, probably in June.

Berlin officials shrug off such criticism, arguing that no one in the market doubts that Germany, Europe’s strongest economy, has the resources to help any bank that might need it, as it did with failed lender Hypo Real Estate (NUEG.UL: Quote, Profile, Research) in 2008.

MORE CREDIBLE

The EBA is trying to make the new tests more credible than the flawed first exercise last July, when only seven out of 91 EU banks failed, and all Irish banks passed, months before their collapse forced the Dublin government to seek a bailout.

However, the new pan-European supervisor faces political constraints, because EU governments are not prepared to test the scenario of a sovereign default in a euro zone country such as Greece, even though credit markets are pricing one in.

Regulators will not assume any discount on euro zone government bonds held to maturity on banking books. Since sovereign debt holdings will be disclosed, EU officials argue that investors can make their own calculations.

Some other assumptions, such as a 15 percent fall in equity prices, are milder than in last year’s softball exercise.

Critics say regulators also underestimate the likely fall in real estate values in countries such as Spain, and the resultant rise in bad loans.

Expectations that the tests will restore confidence in the European banking system, normalize interbank lending and wean troubled banks off European Central Bank liquidity, are low.

“At this point, the market consensus is that whole exercise is worthless, so they can only surprise on upside,” Veron said.

One sign of progress would be if the EBA prevails in insisting that Core Tier 1 capital, consisting only of equity and retained earnings, is taken as the key pass mark, he said.

Another would be if governments were required to take action to strengthen banks that nearly fail the new tests.

A European Commission spokesman said the EBA would require a minimum Core Tier 1 capital ratio of 5 percent — less that the 6 percent imposed on Irish banks last week — but regulators are still fighting over how that capital will be defined.

Some problems exposed by the first round of tests have still not been fixed, eight months after the results were published.

For example, Greece’s state-run ATEbank (AGBr.AT: Quote, Profile, Research), one of the seven that failed, has still not raised the necessary capital to meet EU standards. It announced a 1.26 billion euro rights offer last week in an effort to avoid bankruptcy after a takeover offer by Piraeus Bank (BOPr.AT: Quote, Profile, Research) fell through.

Some countries with banking problems, such as Spain, have tried to get ahead of the market and rebuild confidence by merging, restructuring and recapitalizing savings banks.

While few investors believe the overhaul will cost as little as the 15 billion euros estimated by the Bank of Spain, at least Madrid is seen as willing to bite the bullet.

By contrast, German Chancellor Angela Merkel’s government seems determined to sweep its banking problems under the rug for as long as possible, at the risk of lumbering the country with zombie banks unable to fund the economy.

“The recapitalization of the Landesbanken, which are highly politicized, is very difficult as regional elections are rolling over the country,” said a euro zone source familiar with the negotiations on the stress test.

“It would be an admission that the German taxpayer is not paying money to bail out lazy southerners but to bail out rich German bankers, who were not properly supervised by German authorities,” he said.

No wonder Germany is stressed out over the stress tests.

(editing by Ron Askew)

Analysis: Germans stressed out over EU stress tests