15 Jan 2014

Falling short of expectations? Stress-testing the European banking system

Viral V. Acharya / Sascha Steffen

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Before the ECB takes over responsibility for overseeing Europe’s largest banks, as foreseen in the establishment of a eurozone banking union, it plans to conduct an Asset Quality Review (AQR) throughout the coming year, which will identify the capital shortfalls of these banks. This study finds that a comprehensive and decisive AQR will most likely reveal a substantial lack of capital in many peripheral and core European banks. The authors provide estimates of the capital shortfalls of banks that will be stress-tested under the AQR using publicly available data and a series of shortfall measures. Their analysis identifies which banks will most likely need capital, where a public back stop is likely to be needed and, since many countries are already highly leveraged, where an EU-wide backstop might be necessary.

Viral V. Acharya is C.V. Starr Professor of Economics, Department of Finance, Stern School of Business, New York University; Research Affiliate of the Centre for Economic Policy Research in London and a Research Associate in Corporate Finance at the National Bureau of Economic Research, Cambridge, MA. Sascha Steffen is Associate Professor, European School of Management and Technology, (ESMT) in Berlin.