Austrian banks are complaining that the eurozone stress test is biased against central and eastern Europe.

What’s happening?

The European Banking Authority and Central Bank (ECB) are currently carrying out a stress test of all major EU banks, with scenarios devised by the European Systemic Risk Board (ESRB). The test includes explicit adverse economic growth scenarios for central and eastern Europe (CEE), together with currency devaluations of 15% for the Czech Republic, Croatia and Romania, and 25% for Poland and Hungary. The results will be disclosed in October 2014.

Unrealistic scenarios?

Eurozone banks with extensive business in CEE, led by the Austrians, are complaining that the scenarios are not intellectually coherent in their treatment of CEE economies.

With the exception of Poland, the CEE countries are projected to fall into recession for all three years of the scenario. The Czech Republic, Romania and Croatia will all see deviations of more than 10 percentage points from their baseline gross domestic product (GDP) projections. This compares with a deviation of 6.1% in Italy and 7.8% in Portugal, while Germany is projected to exit recession in 2016.

“If there is an exchange rate shock, then this should drive export performance in CEE as their export prices will become more competitive. And the German economy is the main market for many CEE countries, so why are economies such as the Czech Republic projected to perform so poorly if Germany remains resilient?” asks Rainer Muenz, head of the research centre at Austria’s Erste Group Bank.

Mr Muenz feels the scenario for CEE seems to be modelled on the performance of the eurozone periphery during the most recent crisis. But eurozone members such as Italy, Greece and Portugal cannot boost growth by adjusting their exchange rates. This forced them to make an internal devaluation that led to a prolonged economic slump.

Andreas Schwabe, a financial analyst at Raiffeisen Bank International (RBI) in Vienna, is also bemused by the 15% devaluation scenario in Croatia. The Croatian National Bank manages the exchange rate against the euro, owing to a high level of euro usage and debt indexation in the domestic economy. In an International Monetary Fund (IMF) report on Croatia published in May 2014, IMF staff “agreed that large exchange rate fluctuations are undesirable. The central bank argued forcefully that the quasi-peg needs to be maintained.” Even in the months following the collapse of Lehman Brothers, while other CEE currencies fell more than 20%, the Croatian kuna lost little more than 5% of its value against the euro. Mr Schwabe says this may have resulted in an unintended distortion in the stress test.

Reg rage anxiety

“It is not clear why the 15% depreciation in Croatia has a severe impact on GDP that gets worse in each of the three years, while the larger depreciation in Poland has almost no GDP impact at all. Possibly because the kuna has weakened so little in the past, the ESRB has taken past GDP effects from small depreciations and scaled them up. The other countries have seen much larger currency fluctuations in the past, so the GDP translation is more reliable,” he says.

Does it matter?

Erste Bank increased its capital by €660m in 2013, while RBI engaged in a rights issue for almost €3bn in 2014, so both should now pass the stress test safely in any case. But if stress testing is to become a key tool for the ECB’s newly established single supervisory mechanism, then the relationship with non-euro host countries will remain sensitive.

In theory, regulators in the CEE host countries were consulted by the ESRB to compile the adverse scenarios. But Marton Nagy, executive director of financial stability at the Hungarian National Bank, says: “The adverse scenario should be regarded as a compromise, as not all suggestions of competent authorities could be accepted. The size of the exchange rate shock for some non-euro area countries is larger than what we apply in our regular top-down stress tests.”

One banker is less diplomatic. He believes the core scenarios originated in the ECB before being referred to the ESRB for approval. This has resulted in a stress test that favours the interests of the eurozone, potentially at the expense of the credit supply to CEE. Multilateral organisations coordinated by the European Bank for Reconstruction and Development (EBRD) launched the Vienna Initiative in 2009 to forestall the risk that events in developed markets would lead to a sharp pullback in bank credit from CEE.

“The stress on capital could make banks think about exiting a little bit faster from some of their markets that are marginal for them. For the banks, this has limited significance, but if you are a small economy and four of your five largest banks are foreign owned and they are busy retrenching and withdrawing, it can have a big impact on the local market,” says Nick Tesseyman, head of financial institutions at the EBRD.

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