While there is still a high degree of uncertainty, recent economic data confirm the positive underlying momentum of economic activity in the euro area. The sovereign crisis in Europe While economic prospects have improved, we still face challenges. The most important one is certainly “the sovereign crisis” in the euro area. Broadly speaking, opinions and views  BIS central bankers’ speeches  1  expressed on this by people outside the euro area can be divided into three categories: hostility, skepticism and support. First, outright hostility: gloomy predictions about the imminent demise of the euro came predominantly from deeply anti-European commentators. While these views, like all opinions, should be treated with respect, there is no point in trying to refute arguments that are largely irrational and mainly reflect wishful thinking. Second, skepticism: it comes mainly, but not only, from academic circles. Prestigious and well-respected economists have been pointing to the fact that the euro is not an optimum currency area and that some form of fiscal federalism is missing to compensate for insufficient labour mobility. Let me simply recall a few facts. The benefits of the euro cannot be assessed exclusively through the lens of the optimum currency area theory. The euro has brought to more than 300 million European citizens unprecedented stability: price stability, of course, with inflation averaging 1.97% over the past decade, but also financial stability. It is always useful to think of counterfactual (?) when assessing a situation.
Our “universal banking model”, based on a diversity of activities and sources of income has proven its resilience. Obviously, there is a circular causality between government debt and the banking sector. Spreads on public debt naturally act as floors for the funding costs of banks. And, conversely, doubts about banks’ solvency create expectations of public support and lead to a deterioration in public finances. This gives rise to multiple equilibria where sudden shifts in confidence can be self-fulfilling. In this context, the main purpose of stress testing is to break that circularity. Our first European tests included 81 banks, compared with only 19 for the United States. The basic exercise was sound and taken as such by analysts when it was published. Somehow clumsily, however, a few banks were added at the last moment, with only limited investigation, and these are precisely the banks which proved problematic afterwards and which undermined the credibility of the whole exercise. This mistake will not be repeated and the coverage for the new stress tests has been carefully examined. A lot has been made of the fact that no sovereign stress was made on the banking book. And indeed, as regulators, we did not want to give any credibility to a scenario that we consider unacceptable. However, there will be, like last time, full, total, and transparent disclosure of exposures to sovereigns for each individual bank. Everybody will therefore be free to make their own assumptions and calculations.