Letter from Berlin: after the bank stress tests, ECB backroom tension lingers.

Author:Engelen, Klaus C.

The surprisingly positive outcome of the ECB's health check for German banks may be something of a reprieve for the strained relations between Germany and the evermore-powerful European Central Bank under its controversial Italian president, Mario Draghi. But for the ECB, the real stress and tests are yet to come for the supervisor tasked with making hard decisions with far-reaching consequences for member states, their governments, and their financial sectors.

Berlin's political leaders had not expected that Germany's banks would come out at the top of the health check ahead of the launch of unified banking supervision in the euro area. On the one side was the common view that with the ECB empowered as top eurozone bank supervisor, a comprehensive health check of bank balance sheets and a tough stress test in cooperation with the London-based European Banking Authority would be needed.

On the other side was apprehension that the ECB could bungle this major challenge on the way to much deeper financial integration. And--with a short list of German potential problem banks circulating--there was apprehension that the highly fragmented German banking system could come out as loser. Such worries led German supervisors to force Landesbanks with major shipping loan portfolios such as HSH Nordbank to substantially increase their capital. BaFin and the Bundesbank point to the fact that German banks had strengthened their balance sheets by 14 billion [euro] in preparation for the asset quality review and stress test exercises.

As it turned out, only one of Germany's twenty-five banks failed the test of capital strength under the ECB's "adverse scenario," and none fell short after 2014 capital boosts were taken into account. Only Munchener Hypothekenbank missed the requirements for the region's systemically important 130 banks at the December 2013 cut-off date. By raising 408 million [euro] this year, the special lender is off the hook.

Some German Draghi watchers express a bit of schadenfreude that Italy's banking system--for years supervised by Banca d'Italia chief Draghi--turned out to be the biggest loser. With nine of the twenty-five failing banks and four of the fourteen banks still short of capital, Italy's central bank supervisors are not looking good. This may explain why Draghi didn't show up on October 26 to present the ECB's health check results himself, but left the job to his vice president, Vftor Constancio.

As to the deteriorating...

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