Stress Tests as a Policy Tool: The European Experience During the Crisis

Transcription

1 Stress Tests as a Policy Tool: The European Experience During the Crisis Athanasios Orphanides MIT Frankfurt, 6 June

2 GDP per capita in the US and the euro area Index 2007Q4= United States Euro Area GDP per capita in the US and the euro area 2

3 Why the difference? In both the US and the euro area a deep recession in late 2008 and 2009 weakened the banking sector. Restoration of confidence in the banking system was crucial in both economies to facilitate recovery. Initial response in late 2008 and 2009 was similar in the US and euro area. Consistent with sound crisis management principles, focus was on providing support to help the economy. Subsequent responses differed. In the euro area, government decisions in 2010 and 2011 undermined confidence, causing a second recession. 3

4 Successful vs destructive stress tests Stress tests were used in both economies with a similar aim to restore confidence. In the US, a system-wide stress test was performed in 2009 (Supervisory Capital Assessment Program) and succeeded in restoring confidence. In the euro area, system-wide stress tests were bungled up in The stress tests added to stress conditions rather than alleviate them. The result was a credit crunch and recession in the periphery. 4

5 Micro vs Macro stress tests: I Stress tests developed as part of micro-supervisory toolkit. An adverse scenario can check resilience of a bank to specific risks. A capital need identified for a specific bank is corrected in a confidential manner, as other supervisory matters. Raising capital for one bank in isolation not disruptive to economy. 5

6 Micro vs Macro stress tests: II Macro stress tests developed to solve a generalized confidence problem during a crisis. Capital needs identified during the crisis for several banks have consequences for whole economy. A crucial aspect of rebuilding confidence in system is the knowledge that capital needs identified will be covered in the aggregate through a clear ex ante identified backstop. In the absence of a backstop, concerns about capital needs that may trigger resolutions later on add to the uncertainty and become counterproductive. Capital preservation incentives cause a credit crunch and a recession. 6

7 Macro stress tests: US vs euro area In the US, test was properly designed. Emphasis was given on ensuring that a common backstop was available and would be used to cover any shotfall. Incentives given to banks to raise capital, and confidence provided to investors that uncertainty was resolved, increasing willingness to invest in banks. In the euro area, the governments decided not to make a common backstop available. This added uncertainty in banks based in weak member states. The stress test without a common backstop caused a credit crunch and recession in weak member states. 7

8 Credit-crunch induced recession in the euro area Percent Credit growth GDP growth Credit growth reflects loans extended to NFCs and households, deflated by HICP inflation. GDP growth deflated with GDP deflator. -6 8

9 Policy-induced credit crunch in the periphery Percent Germany France Italy Spain Lending rates to corporations 9

10 Why the problem in the euro area? Crisis management in 2008 started with a common objective to contain crisis cost for the benefit of Europe as a whole. As of 2010, an adversarial approach among governments dominated, with emphasis on shifting crisis-generated losses to others. This was highlighted in Deauville, where governments deliberately impaired sovereign markets for other governments in the euro area. With regard to the stress tests, the need for a common backstop had been recognized and proposed but was consistently vetoed. 10

11 Initial response to the crisis in Europe The European Council reaffirms its commitment that in all circumstances the necessary measures will be taken to preserve the stability of the financial system, to support the major financial institutions, to avoid bankruptcies and to protect savers deposits. Inter alia, such measures aim, in conjunction with the central banks and supervisory authorities, to ensure sufficient liquidity for financial institutions, to facilitate their funding, and to provide them with capital resources so that they can continue to finance the economy properly. (Council of the European Union, 16 October 2008) 11

12 What changed in ? Policy decisions in the euro area from 2010 on worsened the crisis and added stress to sovereings and banks. The stress tests and PSI decisions in 2011 raised questions about the value of sovereign debt holdings by banks. Government decisions reduced the mark-to-market value of bank assets and forced banks to raise their capital ratios to account for that without providing a backstop for the capital raising exercise. Lack of a credible backstop led to deleveraging in periphery, causing a policy-induced credit crunch and recession. 12

13 US: A credible backstop We have strongly encouraged institutions requiring additional capital to obtain it through private means, including, for example, new equity issues, conversions, exchange offers, or sales of businesses or other assets. To ensure that all of these firms can build the needed capital cushions, however, the Treasury has made a firm commitment to provide contingent common equity, in the form of mandatory convertible preferred stock, as a bridge to obtaining private capital in the future. (Bernanke, 11 May 2009) 13

14 Euro area: No credible backstop The ideal sequencing would have been to first have a firewall in place, then do the recapitalisation of the banks, and only afterwards decide whether you need to have PSI. This would have allowed managing stressed sovereign conditions in an orderly way. This was not done. Neither the EFSF was in place, nor were banks recapitalised, before people started suggesting PSI. It was like letting a bank fail without having a proper mechanism for managing this failure, as it had happened with Lehman. (Draghi, 14 December 2011) 14

15 The consequences Mishandling the stress tests deepened the euro area crisis. The deep recession has ended, but much of the euro area is faced with a severe growth and employment deficit. Lack of availability of credit in periphery remains a problem. 15

16 The impact of the policy-induced credit crunch Index 2007Q4= Germany France Italy Spain GDP per capita in four largest member states 16

17 Going forward The mishandling of the crisis highlighted that the current construction of the euro is not sustainable. Either the euro area should be unwound or its financial sector should be fully unified. A true banking union could have contributed to unification of the financial sector. Unfortunately, a true banking union has been rejected by governments. Remarkably, a new stress-test without a common backstop is in process. 17