Can the ECB’s latest stress tests prevent another round of banking failures? | Video

Transcript

This year, the European Central Bank will conduct stress tests in an attempt to prevent against future banking failures. Gerard Lyons, Chief Economic Advisor for the Mayor of London, discusses whether this year’s stress tests are doomed to fail, whether lack of transparency threatens global recovery, and if being exempt from the tests gives London an advantage

Europe’s banking system is headed for an overhaul, with the European Central Bank set to supervise the largest banks in the Eurozone later this year. The move is aimed at preventing another round of banking failures that were said to contribute to the global financial crisis. I’ve come to speak to Gerard Lyons, Chief Economic Advisor for the Mayor of London, to see how the ECB supervision and stress test will affect the recovering banking sector.

World Finance: Well Gerard, the ECB will be conducting stress tests to gauge how the banks would fare if economic conditions deteriorated. Do you think the ECB should step in, or should there perhaps be greater demands made by shareholders?

Gerard Lyons: This whole process I think is a real positive development, a step in the right direction, not just in terms of Europe, but in terms of the global economy. The financial crisis was in many respects a banking crisis, and it became global, so there are many different aspects to that banking crisis that are being addressed and some that still need to be addressed. So what was seen here is the European Central Bank really addressing the issue head on.

This whole process I think is a real positive development

World Finance: How will these tests differ from previous ones, as Europe’s stress tests in 2010 and 2011 were said to have failed on all fronts?

Gerard Lyons: We have to bear in mind here that the European and indeed the world economy was in a very different shape a couple of years ago. The good news is that the economies are turning a corner, policy is being seen to work. The European Central Bank in terms of Europe I think has done an incredibly good job to basically prevent the self-feeding downward spiral that we saw a few years ago and to actually turn the European economy around. There are still problems, as the IMF pointed last week, in terms of demand and inflationary risks, but in terms of the banking sector itself this stress test is different, because there’s really two parts to it. There’s the first part that we had before, the actual stress test, how would the banks perform under different adverse economic scenarios. But the difference this time, the second part, is the asset quality review, the ability to actually see what the assets are worth.

World Finance: Well Europe’s economy depends on banks for credit much more than that of the States for example, making strong balance sheets vital for the banking system. Do you think there is enough transparency when it comes to balance sheets in Europe?

Gerard Lyons: The capital markets play a far bigger role in the States compared to Europe, and indeed one of the ongoing issues in recent years is whether Europe could benefit from moving more towards that US capital markets approach. But in terms of transparency, I personally don’t see an issue here. I think the real issue is not only the state of the European economy, and included within that the UK economy, but also the future role and the financial role in particular the banking sector plays.

[I]n terms of transparency, I personally don’t see an issue here

World Finance: Well as you just said, European bank tests are different than those applied in the United States, where do you stand on the argument that universal standards should be put in place?

Gerard Lyons: As we saw in the crisis, to coin the phrase of the former governor of the Bank of England, in life banks are international, in death banks became national. It was the taxpayer, the domestic economy shall we say, that became the backstop for the banks, not just in Britain but in terms of other countries. So it’s important from a domestic perspective that individual taxpayers, people, businesses, and policymakers are confident about the strength and the resilience of their own banking sector. But more particularly, in reference to your question, it was a global crisis, and we saw that banks were international. Therefore, ideally we want to have a global response.

World Finance: Obviously the UK is not part of the Eurozone, what does the UK have in place that’s similar to the ECB stress tests?

Gerard Lyons: The Bank of England put out a discussion paper at the end of last year about the whole stress test issue, and they were taking responses. The idea is to have an annual concurrent stress testing here in the UK, but given that we have a very strong financial regulatory environment in place, we’ve had big changes put in place here in Britain in the last few years, very much highlighted at The Bank of England. We now have a financial policy committee, we already had different institutional frameworks in place, with the same aim to make the financial sector resilient, and indeed as transparent as possible. But further annual stress tests look likely I would argue, or suggest, here in the UK.

World Finance: And will not being part of the ECB stress test give London, as a financial capital, an advantage over the rest of Europe?

Gerard Lyons: The UK being outside the Euro has led to this issue in the last couple of years about the Eurozone versus the non-Eurozone. But those challenges I think have been addressed in the last couple of months, and so London is Europe’s financial sector, it’s important that the UK in my view stays part of the EU, but we clearly in the UK will not join the Euro, so that relationship that seems to be working well at the moment between Eurozone and non-Eurozone members needs to work well in the future as well.

I think the key thing is…to make sure that the recovery continues to gather momentum

World Finance: Well if the perception of EU banks is weaker following the test, how will it affect Europe’s competitiveness on the world stage, and will this have a knock-on effect for the UK banking sector?

Gerard Lyons: I don’t think it’s about just the banking or financial sector, I think it’s about the economy overall, and the world economy is changing quite significantly. The world economy has grown pretty strongly in the last few years, we now have multi-speeds in terms of the speeds at which different countries are growing. Some of the emerging economies are slowing down, the US economy is picking up speed, the UK and European economies are also picking up speed at different rates. So I think the key thing is, from a policy perspective, to make sure that the recovery continues to gather momentum.

World Finance: Gerard, thank you. 

Gerard Lyons: Thank you.