Column: The ECB’s mega-test
The ECB is in the midst of a so-called comprehensive assessment of euro zone banks. This has two elements: an “asset quality review” (AQR) to determine whether the loans and other assets held on their balance sheets are valued properly; and a “stress test” to check whether they could withstand a severe economic downturn.
To pass the test, banks are supposed to have a “common equity tier 1 capital ratio”, a measure of balance sheet strength, of 8% in the baseline scenario; and a ratio of 5.5% in the adverse scenario. The whole exercise is supposed to be finished by October before the ECB officially takes over from national authorities in November as lead supervisor for the zone's banks.
The hope is that investors will at last have confidence that the numbers in bank balance sheets are accurate and lend to banks more freely. Banks would also lend to each other. With the money markets functioning normally again, banks would have more confidence to lend to companies and consumers, giving a boost to economic activity.
That is what happened when the United States and the UK put their banks through severe stress tests five years ago. Unfortunately, the euro zone put