In 2012, the eurozone went through a near-death experience. Like climbers roped together on a cliff, its combined banks, markets and governments were found to be weaker through their interconnections. Banks were heavily invested in the debts of governments, which in turn were meant to guarantee the solvency of the same banks. Without being able to resort to printing money, those without financial strength found their bluff called in a crisis.
Three years ago, this “doom loop” between fiscally strained governments, tottering banks and a shrinking economy needed the intervention of the European Central Bank to prevent the breakup of the euro. A tangled system of cross-border interconnections underpinned by weak sovereign states needed fixing. This led to the promise of a banking union with a single resolution mechanism and European centralised supervision.
This week saw an important milestone with the publication of a “comprehensive assessment” of 130 large institutions. It marked a significant improvement on the stress tests of 2011, which were widely regarded as a failure and only further undermined financial confidence in the eurozone. As well as applying tougher underlying assumptions, the ECB carried out an Asset Quality Review (AQR) that found the banks examined were overvaluing their assets by €48bn.