10/26/2014 12:54 pm ET Updated Dec 26, 2014

The ECB Assessment of Eurozone Banks' Health Will Not Dissipate Fundamental Questions

After months of waiting, we just received the results of the assessment of the health of Eurozone banks by their new supervisory authority: the European Central Bank. They were predictable, but the exercise has limitations which result in delivering only a partial health bulletin.

What the numbers say

Of the 130 banks 25 have insufficient capital. Their aggregate needs amount to 25 billion euros, or 1% of the equity of banks in the Eurozone. Over-valuation of assets amount to 48 billion euros, or 0.15% of the assets of European banks. Those numbers are reassuring.

Of the 25 billion, Greek (8.7) and Italy (9.7) account for almost 75% of the missing equity. France (0.1), Germany (0.1) and Spain (0.0), the main Eurozone countries (with Italy), are in almost perfect health.

None of the 20 largest Eurozone global banks is included in the list of banks with insufficient capital.

This reading is reassuring, and given the methodology used, the results are indisputable.

What the evaluation does not say

While there are three Basel III ratios that banks will be required to comply (liquidity, leverage and capital adequacy), the analysis of the ECB is only focusing on lack of capital. The Asset Quality Review is in the context of capital adequacy.

The Asset Quality Review generally excludes any form of reduction in the nominal value of bonds issued by sovereign states of the Eurozone. They are considered worth their face value when they are detained in the core portfolio of Eurozone banks. This ignores that the Eurozone has violated its own dogma in the case of Greece and Cyprus. Unfortunately, the size of sovereign bonds create one of the systemic worries. Country risk is absent from this assessment and all state bonds are considered as strong as Germany. It would, of course, be extremely politically sensitive.

The absence of the 20 largest global banks in the Eurozone from the list poses a question: the choice of banks. Slovenia, Portugal, Slovakia and Estonia do not represent a systemic risk by themselves. Their presence in the sample was purely political and a matter of national pride. Monte dei Paschi alone, which would have fallen into bankruptcy without the intervention of the Italian government last year, can be considered systemic. Everything has been built so that only the less significant banks are caught in claws of the ECB.

Systemic risk is not taken into account. The vulnerability of banks in countries where they operate are not taken into account, especially those who are over-indebted, such as France, Greece and Italy. That is a shortfall since sovereign risks represent 115% of the equity of banks in the Eurozone.

The analysis of asset quality is also limited by a methodology that ignores "exotic" assets in the balance sheets of major global banks, and in particular the risk on derivatives. It's the same structured products. Such risks are generally absent from smaller bank balance sheets.

Risks associated with the universal banking model and the size of major European banks are not part of the debate. European banks continue to threaten the Eurozone with assets of 31 billion euro, representing 250% of GDP (against 75% in the US).

A reassuring health bulletin in the absence of crisis.

The assessment of the European Central Bank has merits: it pushed a number of major banks to take restructuring measures, sometimes at the last minute such as the capital injection of AXA into AXA Bank last Friday. Deutsche Bank took drastic measures and increase its capital in the first half. Until the last minute, it was unclear whether it would be affected by the AQR.

What the analysis does not touch, even if public statements are sure to pretend an absence of systemic risk, is that with 31,000 billion for 13,000 billion capital Gross Domestic Product, and the Eurozone is over-banked. As such, the taxpayer will have to bail out in the case of a collapse of a major bank, despite the new bank resolution mechanism set up by the European Union.