Demand In Europe Is the Elephant In The Room

The results of the eurozone's stress tests released on Sunday are pretty bullish. Most of the 130 banks reviewed were relatively healthy, based on the ECB's assessment. Twenty-five banks had a capital shortfall prior to the end of December, when the assessment concluded, but only 13 still need raise more money. Those banks have to come up with a total of €9.5 billion ($12.9 billion), which is basically peanuts in terms of the whole system: The 130 banks in assessment account for €22 trillion ($27.9 trillion) in assets.

But there is one colossal elephant in the room that the European Central Bank's comprehensive assessment did not look at - that's because it is out of their hands.

Here's the real problem with the major European banks, in one graph:

It is easy to see the issue: Banks are not lending enough.

But if very few of the eurozone banks are distressed, and the so-called problem ones only need to raise a small of amount capital to be in good shape, then shouldn't those lending figures bounce back pretty soon?

This all leads us to real issue, which does not have to do with the banking system, but with demand for credit.

Here's what analysts had to say Monday morning:

• "Blockages are concentrated on the credit demand side rather than credit supply," said Soc Gen's Michala Marcussen.
• "A marked acceleration in bank lending cannot be expected against a backdrop of weak demand growth," said Jakub Lichwa at Daiwa Capital Markets.
• "It's worth recalling that regardless this exercise is unlikely to draw a line under the Eurozone's low-growth crisis, which has far broader structural roots," added Rabobank's Michael Every.

Raj Badiani at IHS Global Insight sums it up nicely: "The economy remains enveloped by downturn characteristics, choking of the demand for credit."

The eurozone's banks are undoubtedly damaged, and the continent would benefit from a more unified financial system. But consumer confidence, household spending, business investment, and most other measures of economic health have struggled to return pre-crisis levels in the eurozone, even six years after the financial crisis.

Making sure the eurozone's financial system is in better order than it has been - and more suited to a monetary union - are worthy goals.

But it's a mistake to pretend it's going to solve a problem that is beyond the remit of financial regulators.