The recently concluded stress test on 91 European banks were designed to see how financially resilient they are in the face of continuing economic pressure. A bank that fails the test would be required to put away additional capital to secure against possible future losses (a painful process known as recapitalization).
On Friday, the Committee of European Banking Supervisors (CEBS, the ultimate Euro bank watchdog) announced that only 7 of the 91 banks tested had failed their requirements. The initial delight on this low number soon gave way to skepticism about the toughness of the tests. Stress tests by regulators can often serve as a tactic to soothe market fears. During the Depression, a time of rampant bank failures, the government undertook similar stress tests of banks over a period of several weeks and then came out with results that closed down several weak banks. Investors and depositors were convinced that the remaining banks were healthy and faith was restored in the retail banking system. Could the CEBS be up to similar tricks this time?
The major criticism of the stress test is that there was no special test to measure the likelihood of a default by the Greek or Spanish governments. Another criticism relates to the low amount of recapitalization deemed suitable to bring the banking system back to health, a paltry $4.5 Billion.
On the bullish side, investors appear to be reassured by the level of government debt exposure of European banks, which had been a major cause of concern about them. The growth of euro zone banks in the booming markets of Asia is also noted as an offsetting positive to the glum domestic markets. The tests found that in the case of a “double-dip” recession and government debt market turmoil, Tier 1 capital ratio, used as a common measure of banks’ resilience to shocks, would decrease 10.3% in 2009 to 9.2% by the end of 2011. While this makes euro banks look pretty resilient, what is worrying is that the proportion of government support to banks remains relatively high.
Perhaps the most positive impact of the test results is the transparency it has brought to how the regulatory agencies measure the banks’ health, a view that guides policy decisions and ultimately affects the course of the stock and bond markets.
The Euro Stoxx Bank index is up 0.42%, while the Euro is at a 7-week high versus the yen on Monday morning.
Get the stress test results here: http://www.c-ebs.org/EuWideStressTesting.aspx
