Inspecting euro-zone banks: Make or break - or fudge THE euro area's economic swoon may at last be ending, according to a cluster of recent business surveys. That makes it likely the European Central Bank (ECB) will stay its hand on interest rates on August 1st (after The Economist went to press). But any recovery will be anaemic as long as credit is constricted. The latest lending figures show that banks are as inert as ever. Uncertainty about what exactly is on banks" books is one factor holding things back. Without knowing what horrors lurk there, investors worry about whether banks have enough capital to cope with losses. That has a knock-on effect on banks" funding costs and their willingness to lend. Prior rounds of stress tests have failed to provide reassurance. The hope is that the ECB itself can do better. Before it takes full responsibility for supervising euro-zone banks in the autumn of 2014, it will undertake an "asset-quality review" (AQR), which will scrutinise the balance-sheets of 130 big banks, accounting for 85% of euro-zone banking assets. The ECB is now intending to provide guidance on the design of the AQR by mid-October. That will pave the way for the AQR to start in the first quarter of 2014, although it would be unsurprising if that deadline slipped to the second quarter of next year. From a standing start for the ECB, the work will still mainly be done by national supervisors, who in the past have been reluctant to blow the whistle on problems in their bailiwick. For the review to command credibility the ECB will complement the local supervisors with teams from other countries. It will also involve auditors as well as bringing in specialist consultancies such as Oliver Wyman. The review will be followed by stress tests, showing how banks would be affected in adverse scenarios, but it is the AQR itself that will be crucial in identifying capital shortfalls, says Huw van Steenis, a banking analyst at Morgan Stanley. Setting out the design of the AQR earlier rather than later could encourage stronger banks to get ahead of the game by raising needed capital in the markets (see article). But the larger question is whether the AQR will help the weakest lenders to put their troubled past behind them. The answer is cloudier than the ECB would wish. If the review is to quell the doubters it will identify a number of banks that are unviable as they stand. They will need to be "resolved." That might mean recapitalisation, or it might mean splitting lenders into good and bad banks. Either way there will be a burden on taxpayers. Throughout the course of this year the ECB has been pressing the case for a resolution mechanism that would have a European authority at its centre and a common backstop drawing on euro-zone resources. But the German government has opposed this approach and immediately rejected a recent proposal along these lines from the European Commission. When European leaders met in June, the best that the ECB could secure was "the establishment of national backstops." That will be no problem for Germany, whose public finances can cope with any resolution costs for German banks. But it will be a snag for countries like Italy, where the banking sector is in poor health and public debt has reached a giddy 130% of GDP. One way out would be if the European Stability Mechanism (ESM), the euro area's rescue fund, were to recapitalise banks directly. But the amount of money that has been set aside for this purpose is inadequate, at just €60 billion ($80 billion); little Ireland, for example, had to inject a bit more than that into its defunct banks. And in any case the facility is supposed to be made available only when the ECB takes formal charge in late 2014, some months after the review. The lack of a common resolution authority with a euro-zone backstop will overshadow the AQR. The ECB has good reason to be as rigorous as possible because of the reputational risk it faces if banks run into trouble once it is in charge. But the suspicious will wonder whether weak national backstops may circumscribe the ECB's willingness to get tough. Such doubts may undermine the ability of the review to galvanise the banks.