ECB evaluation of banks: A key step towards banking union

The European Central Bank published the results on the 26th October 2014 of the Assets Quality Review and the Stress Tests of those banks considered to be the most important in Europe. This analysis of the banks' balance sheets was a requirement for joining the Single Supervisory Mechanism, one of the key elements of the European Banking Union which is operational since the 4th November 2014.

The eurozone debt crisis revealed the need to complement the economic and monetary union with the establishment of a banking union. The primary objective of this union is to break the vicious circle between banking and sovereign risks – a vicious circle that was the source of credit market fragmentation along national borders. More generally, its purpose is to promote a more solid and integrated financial system through stronger, unified governance.

The first two pillars of the banking union are the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). Under the SSM, since November 2014, the European Central Bank (ECB) directly supervises the 130 banks deemed to be the most significant. The asset quality review conducted by the ECB, coupled with the European stress tests, constitutes a financial health check required before being included in the SSM. The purpose of the SRM, which is backed by a single resolution fund, will be to manage more effectively any potential bank failure, protecting depositors and taxpayers.

This process should strengthen confidence in the eurozone banking system, by promoting greater transparency, independent supervision of national contingencies and more consistent application of prudential regulations. Of course, it is still too early to assess the impact of this process, but it has already led a number of banks to speed up the process of cleaning up their balance sheets in order to pass the entrance exam.

The banking union is the most significant addition to the monetary union since its creation in 1999. Although its primary objective is to focus on financial stability, it will also have medium-term implications on the structure of the European banking system. Initially, banks' priorities will be to adapt to single supervision and complete the clean-up of their balance sheets. However, at a later stage, we should expect some reshaping of European banking with increased cross-border market integration.

Olivier Garnier, Chief economist of the Group