europe's banks stress test - a non-event

8/9/2019 Europe's Banks Stress Test - A Non-event

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Europe’s banks stress test: not really stressful…

Whilst the ECB was first and foremost to react to the hedge fund collapse of Bear Stearnsand BNP Paribas during August 2007, Europe has been running behind events ever since. Within the EU, the recent June decision to screen the main EU banks risk/capitaladequacy and publish the findings was taken on the back of a unilateral decision by Spainfollowing the seizure of its banking sector in June.

Being behind events does not mean that the exercise is not useful if properly conducted, whilst its main aim was for policymakers to calm down the markets. I am not going toreview at length the criteria used, since the claimed transparency is somewhat tainted withopacity.

Scope of the test

The stress test was conducted on 91 European banks in 27 countries representing 65% of the total assets of the EU banking sector or EUR 28 trillion, which is representativeenough.

It covers 2010 and 2011 and mainly focuses on credit and market risks.

Banks pass the test if their Tier one capital over their risk weighted assets reaches a 6%threshold (the regulatory minimum Tier one capital in Europe is 4%).

Adverse macro-economic scenario

The assumptions concerning GDP growth are no so adverse: a 2% drop in GDP over 18months doe not cry foul, particularly if countries outside Europe see their growth decreasesignificantly (a real possibility in the US a possibility in Asia). However, I can live withthis. As I do with the assumption concerning a 175 basis points hike for 3 months rates and

75 basis points for 10 years by the end of 2011, even if in case of crisis these would mostlikely head north and fast.

Sovereign debt

The haircut applied to sovereign debt is not appropriate: it is not a question of taking off,10% here, 2% there and 4% elsewhere. It is a binary game: a country defaults or not; in



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• Did the study take into account rating downgrades that would require banks tomatch their assets with more capital?

• There is no test taking into account core capital only; banks have used financialengineering to boost their Tier one capital ratios instead of core equity to enhancetheir return on equity. In my opinion core equity is the real parameter to take intoaccount to test bank’s stress conditions.

After a mild reaction on Monday 26th July, banks shares showed strong gains, particularly in the eurozone and this continues today (August 2nd). This has however probably more todo with the Basel Committee on Banking Supervision that moderated several of its

planned rules that would have required more capital and increased costs for banks on the very same Monday. In the meantime, CDS 5 yr spreads across Europe went down between 20 et 50% since June peak . Accounting rules also remain accommodating.

To conclude, the stress tests fulfilled their objective short term to calm markets;longer term, the fundamentals of Greece and several other European countries withstructural budget deficits and subdued growth are not properly addressed. This will come back to the forefront of market concerns in the coming 12 months. Meanwhile, I willclosely follow the progress of the Greek stabilization plan and GDP growth.

Source:

Committee of European Banking Supervisors (CEBS): Aggregate outcome of the 2010 EU wide stress test exercise coordinated by CEBS in cooperation with the ECBhttp://stress-test.c-ebs.org/documents/Summaryreport.pdf

FT: Triple bonus boosts Europe bank shareshttp://www.ft.com/cms/s/0/7f0e9e16-99a7-11df-a852-00144feab49a.html?ftcamp=rss

europe's banks stress test - a non-event

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