Published: July 23 2010 10:12 Last updated: July 23 2010 19:22
Almost all must have prizes. That was the result on Friday of a secretive, rushed, and rather unconvincing stress test exercise on 91 European banks. It is comforting to know that 84 banks passed the tests, so they should be able to survive a double-dip recession should one materialise in Europe, although it would inflict €566bn of losses in 2010-11. All the big European banking names passed; the seven that did not were either already failed institutions or the weaker banks in Spain and Greece.
The Committee of European Banking Supervisors, which designed the tests, took much for granted. By testing only the banks’ trading books, the CEBS failed to address the European banking sector’s Achilles heel – its exposure to sovereign debt. The regulators assumed that no European sovereign would default, which is either brave or foolhardy in light of the eurozone debt crisis. The most extreme assumption was a 23.1 per cent haircut on Greek debt. If Athens defaults, it will cause more damage than that. The double-dip scenario – deviation of 3 percentage points below the European Union’s forecast – also seems modest.
Relatively painless exercise for banks.The seven failures will need to raise new capital, or are already doing so, to bring their tier one ratio up to 6 per cent or above. But the real question is where the tests leave those banks that passed essentially on a technicality – those with tier one ratios of only a few basis points above 6 per cent. When 19 US banks were stress-tested early last year 10 failed, and were urged to raise $75bn in new capital. European regulators and governments will need to support the banking sector in coming months if, as is entirely possible, private investors decide to keep their money in their pockets.
Uncertainty about the health of Europe’s banking sector has been a significant contributor to recent market volatility. The stress test results are unlikely to change that.
Copyright The Financial Times Limited 2010
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