EU Agrees to Disagree on Banks Stress Tests

The International Monetary Fund’s (IMF) call earlier this week for Europe to conduct stress tests on individual banks has again put the solvency of European banks and the EU’s efforts to clean up bank balance sheets into the spotlight. The solvency ratios of European banks are often lower than those of their US counterparts, making them more vulnerable to write-downs and requirements to raise further capital. The IMF likened the stress tests to a good “spring cleaning.”

Most estimates show that European banks still have significant write downs ahead of them, which in turn will make further government interventions necessary. For instance, the Belgian government on Thursday had to step in to help its troubled banking sector by offering guarantees to KBC Bank. The measure became necessary through the possible default of MBIA Inc, the New York-based bond insurer.

However, European banks argue that US-style stress tests are less applicable to their institutions, because the economic fundamentals and accounting rules are different. The EU officials are also satisfied that individual national regulators have long been conducting stress testing and that there is no need to make them public.

German Finance Minister Peer Steinbruck on Wednesday criticized the idea of EU bank stress tests, saying, "We are seeing that the stress test in the US is worthless because the central bank exercised influence as well as the Treasury.” Meanwhile, France’s Banking Commission would not comment on the IMF proposal. Last month, however, the commission’s chairman, Christian Noyer, who is also governor of the French central bank, said he has every confidence in France’s regularly conducted stress tests.

The debate on the fundamental issue of who should supervise and perform stress tests seems likely to continue with widely diverging views represented. The Commission’s upcoming proposals for a new financial supervisory infrastructure in the EU are therefore much anticipated and will be closely scrutinized.

The early feedback on the stress tests in the United States is positive. The results of a Gallup Poll, released 13 May, show that Americans’ confidence in banks has improved “slightly, but to a statistically significant degree” since the Treasury posted the stress test data. In a Wall Street Journal survey of 52 leading economists, half rated the stress tests as helpful. Only time can tell if the stress tests will prove to be a significant factor in restoring US financial stability. Certainly the Obama Administration believes what Treasury Secretary Geithner has said, that “the bank stress tests should advance the process of repairing our financial system and provide a better foundation for recovery.”

An Agreement and a Commitment to Deliver

International summits are frequently more about atmospherics than they are about substance. The G20 meeting just concluded in London was no different from the norm. On a substantive level, the most consequential outcomes were the $750 billion in IMF capitalization ($500 billion in loans and guarantees and $250 billion in Special Drawing Rights) to aid emerging nations, $250 billion in trade credits from the IMF, and $100 billion in loans from other multilateral institutions. Certainly a substantial allocation of resources, but hardly a package that required heads of government for approval.

What did require the presence of the leaders of these nations was the display of common purpose that emerged from the meetings. While no concrete steps were agreed to, the mutual commitments to expand trade, tighten financial regulation, establish global monitoring systems and support greater transparency in executive compensation demonstrate a recognition of many of the key elements that led to the current crisis. The communiqué issued at the conclusion of the meeting touches on all these issues.

While not a crucial issue in the discussions, the matter of regulation of tax havens came into focus in the American media because of President Obama's reported role in bridging a divide between French President Nicholas Sarkozy and Chinese Premier Hu Jintao. According to an account from the White House that was corroborated by French and German government sources, Obama pulled the two leaders aside, first separately and then together, to negotiate a language change that papered over the differences that had emerged between the two during the group discussions. American media have reported widely on this sideshow because it is viewed as reflective of the difference in style between this U.S. President and his predecessor.

As expected, the issue of stimulus spending received scant attention in the final product of the meetings. The Obama team beat a tactical retreat on that issue as it became clear their efforts to push for an agreement on stronger stimulus would not succeed. The efforts to increase fiscal spending received strong support from the Party of European Socialists’ President, Poul Nyrup Rasmussen, who commented that the failure to agree a new stimulus was a major disappointment and that European conservatives Sarkozy and Merkel had blocked what the world most urgently needs: a new stimulus to create jobs.

Whether or not the meeting was a success will be for history to judge. If one looks at the concrete results, it is hard to see how the meeting produced any immediate change on the issues lying at the core of the current financial problems in the G20 countries. Further joint action in all areas discussed in London will likely be required. However, the meeting succeeded in clarifying that these key leaders are on the same page as to the fundamental issues needing attention and on the importance of working together globally. As regards the EU, the G20 agreement will probably act like a booster for the many and far-reaching policy proposal that the Union has under way. The extra momentum created by the commitments made by the leading European states at G20 will allow the EU to continue its vast reform program.

Financial markets appear to have been cheered by G20—for the time being. It remains to be seen how the individual leaders will act on the principles discussed in London once they return home.

Pre-G20 Stress

On Monday's post, we pointed out the potential for posturing at the G20 due to the high stakes and the short-meeting format. On Tuesday, French President Nicholas Sarkozy threatened to walk out of the meeting if there was not agreement on strong international regulation of financial markets.

The draft communiqué for the meeting, which has been circulating for several days, includes a call for broader regulation of hedge funds and other financial firms and products but leaves unclear how strong international regulatory bodies would be in relation to national ones. President Obama is certain to resist any effort to include language that would suggest placing an international body in a superior position to US agencies. If Sarkozy were to make good on his threat, it is difficult to predict who would be injured.

The most concrete piece of business to emerge from the G20 may well be the pledge to add $500 billion to the International Monetary Fund (IMF) credit facility. The United States is pledging $100 billion towards the total, but it is unclear if that will be accepted as an adequate figure from the US and how much will come from other nations. The US appears to be pushing for a substantial EU contribution in that a significant part of this facility is likely to be used for Eastern European countries. Will the G20 meeting result in the $500 billion being fully subscribed?

With only one day left before G20, the summit's host, Gordon Brown, is thus doing his best to downplay the differences among his guests. While the G20 countries appear to agree that their problems have common causes that warrant joint responses, they at present seem unable to sing from the same hymn sheet. It could be argued that the citizens of the G20 countries have the right to expect more from their leaders in terms of striving towards a common accord as per their commitment made in Washington a few months back.

As if any further reminders about the seriousness of the crisis were necessary, the OECD yesterday issued its latest economic assessment, predicting an unprecedented 4.3 percent contraction in the 30 richest economies this year with unemployment reaching double digit figures. World trade is expected to decrease by 13.2 percent in 2009.

Besides the drama surrounding Sarkozy, warranted or not, G20 may tell an important story about the degree of cooperation between the leaders gathered in London.

G20 - The Beginning of a New World Economic Order, After All?

On Thursday, U.S. Treasury Secretary Tim Geithner unveiled the Obama administration’s comprehensive framework for reforming the regulation of the financial system. The plan will be a hot topic ahead of next week’s G20 summit in London and is being closely scrutinized in capitals worldwide.

In his testimony yesterday before the House Financial Services Committee, Geithner told the panel,

“Our hope is that we can work with Europe on a global framework, a global infrastructure which has appropriate global oversight, so we don't have a Balkanized system at the global level, like we had at the national level."

He added that that the financial sector needs to be tightly regulated so that it can never again threaten the collapse of the wider economy.

Geithner said the administration is first focusing on systemic risk because the issues around it require the most global cooperation and will be at the center of the G20 agenda. Clearly, the Obama administration is moving towards a position that would enable substantive discussions with European leaders. Such discussions may result in new roles and powers for international organizations, including the Financial Stability Forum and the International Monetary Fund (IMF).


Dominique Strauss Kahn, the Director General of the IMF, speaking on French television on Thursday night laid out the significance of global coordination in addressing the crisis and also emphasized the need to adapt existing international organizations to take on new responsibilities. To that end, Strauss Kahn a few days ago had welcomed the proposal for the Committee on IMF Governance Reform that moves in that direction.

The benefits of emphasizing international cooperation have also been highlighted by Pascal Lamy, Director-General of the World Trade Organization (WTO), who, like Strauss Kahn, will be present at the G20. According to the WTO, tariff and subsidy cuts for trade in goods already on the table in the Doha global trade talks were equivalent to a new stimulus package of $150 billion. Other trade liberalizing moves under discussion could more than double that. However, in the absence of a Doha deal, average tariffs worldwide could legally be doubled, slashing the value of world trade.

The historic importance of the road to the G20 in London, and beyond, was also emphasized by British Prime Minister Gordon Brown, who spoke at New York University on Wednesday, 25 March:

“Think back to the 1940s. In the era after the Second World War people saw the need to create global institutions to deal with the global problems, and the national problems at that time, so in this massive work of visionary leadership, Americans in particular created an International Monetary Fund, a World Bank, a United Nations, the World Trade Organisation, which was to be the world trade organisation GATT, and the Marshall Plan, which reconstructed the whole of Europe. We need the same vision and leadership now to enable us to solve problems, without which you cannot have the progress in each of our countries that we need for the future.”