Most EU banks well placed to face more stress: Expert

Last week or so the financial system on both sides of the Atlantic saw some pretty crucial events take place. On Wednesday, US President Obama signed the regulatory reform bill into law and then on Friday, you have the results of the European banks’ stress test, seven out of 91 banks failing to make the cut and requiring an additional USD 4.5 billion in capital. Meanwhile wrangling has already begun on the new capital requirement norms being considered by the Basel committee of global banking regulators.

So it has been a cause and effect mantra, we have had the Fin Reg bill in a sense deal with the cause of the last crisis and the banks’ stress test in a sense deal with the effect of a potential in next crisis.

In an interview with CNBC-TV18, Charles Dallara, MD, Institute of International Finance, the world's only global association of financial institutions, discussed the status of the global financial system.

Below is a verbatim transcript. Also watch the accompanying video.

Q: Let me start by asking you what you make of the results of the bank stress test that were announced on Friday in Europe? Do you believe now that the weakest part or the weakest period of the global financial system is behind us?

A: I do believe that the result of these stress tests on the European banks is encouraging. It indicates clearly that the wide book, the overwhelming majority of European banks are well placed to face additional stress, should they emerge in the economic or financial landscape.

I do not believe that these stress tests are particularly weaker than those that were conducted by the United States a year or so ago as some credits have charged but rather believe that the stress tests are a sensible barometer of how these banks would perform if faced with either another economic downturn or other financial stress.

Q: Do you believe that we are faced now with almost no likelihood of a large financial institution failing in the developed part of the world because we have seen the US government cash out of Citigroup, make any profit if I may say so, we are seeing positive stress test results out of Europe so is it possible that there is almost no chance of a financial institutional failure now going forward over the next two-three years irrespective of how slowly the global economy recovers?

A: I would say that one could say something rather close to the way you framed it. I would think that the odds of a failure of a major financial institution at this stage is extremely low. But we are in an interconnected world and I do believe that it is important that the global recovery be sustained.

I believe it is important that the countries which are coming under fiscal pressure now demonstrate their results to tackle their fiscal deficits. The G-20 showed in its recent meeting in Toronto that there are wide ranges of views about how to tackle the current conundrum that is sustaining the recovery while tackling fiscal deficits and governments will have to be very careful to move down the path of more fiscal consolidation in my view in order to ensure that the rebuilding the market confidence continues.

Whatever the path however, I think that you are basically correct in the point that the odds of any major financial institutional failure are extremely low. But at the same time we should not take for granted that confidence would continue to be restored unless governments follow through both with impressive fiscal reform as you are seeing now in a number of governments in Europe especially I would say in Greece and Spain. But also with important structural reforms which can enable the supply side of growth to begin to drive economic activity in some of these countries again.

We are mildly encouraged by the measures that are around the table in countries such as Greece and Spain, Portugal and Ireland to increase the flexibility of their labour markets, to privatize states on assets, to read government structures of corruption and like a transparency. All of this is crucial to restoring the broader framework of a financial stability within which the major banks operate.