Mario Draghi made it clear yesterday that he will make bank stress tests more stringent. All euro zone banks will be subject to these tests, which will scrutinize how much sovereign debt they have on their balance sheets. This is a slap in the face to peripheral European banks, because they hold the most of this debt class compared to banks in other EU nations.
The new stress tests will affect Spanish banks heavily. Spanish banks own 38% of all debt in circulation. Once again, the Bundesbank is putting pressure on other EU institutions. Its governor, Jens Weidmann, has asked time and time again to limit the amount of government bonds that banks can own. In addition to pressures from Germany, Draghi is also justified in enforcing stringent requirements on the banks.
When Draghi met last with Spanish banks to explain how the stress tests would work, he warned of the possibility of including sovereign debt in the tests. The European Central Bank (ECB) wants to reduce the banks? ties to this debt (a quarter of their earnings on interest come from carry trades? and, especially, look for strategies that galvanize lending for small companies and families.
It is inevitable that the decision raises eyebrows. It is also true that Spanish banks have bolstered their capital reserves (Sabadell and Popular, for example) and the current landscape, with its low interest rates and risk premium, is more favorable than before for the banks to divest of sovereign debt without experiencing any issues.
Critically, we cannot afford any economic backlashes, because the markets would put us back in the doghouse. For this reason, Rajoy and team have no alternative than to speed pending reforms.
