EU stress tests: Draghi gets nervous

Some take it as a deliberate attempt to fend off the sharp criticism his recent plea for leniency in State aid discipline drew. Pressing the Commission to waive its rules amounted to a serious blunder. The more so, as everyone interpreted his highly controversial move as a blatant bid to protect investors in many struggling Italian credit institutions from sharp haircuts and losses.

While taking an uncompromising stance does help to redress his personal record, Draghi seems fairly concerned about the damage the test might inflict. Should it be watered down, the ECB’s credibility would suffer. Moreover, failure to convince the markets could backfire, triggering further instability. But the prospect of implementing a severe probe in the absence of robust national or EU backstops, could lead to a hectic scenario if banks fail to raise on their own the extra funding requirements.

The capital gap individual banks are poised to face will ultimately depend on the overall ECB appraisal. Furthermore a number of qualitative factors are bound to be taken into account. But the test benchmarks and provisos will deliver a fair yardstick for gauging whether the final outcome matches the figures. While the ECB enjoys an ample room of manoeuvre in undertaking his examination, it cannot ignore sheer evidence.

European leaders are to blame for dragging their feet in setting up a credible backstop. They agreed to earmark € 50 billion in the European Stability Mechanism for ailing banks. But Germany is adamantly opposed to banks fishing in this pond unless shareholders and creditors lose their money in filling the gap. Even so, funding would require full guarantees being awarded by the concerned Member State. A scheme very close to the one implemented for Spain last year.

Draghi has good reasons to feel nervous. Unless solid backstops are put in place, he will face the unpalatable choice between a too demanding review inflicting damage to the banking system, or sacrificing the ECB’s reputation before it takes over its new supervisory tasks. But he shouldn’t worry too much. The key capitals will make the choice for him. In no way they would tolerate an outcome resulting in massive new funding needs. If only to avoid that speculation on the link between financials and public debt could surface once again.