Experts give luke-warm response to bank stress tests

15th July 2011, Comments 0 comments

Economists gave a lukewarm response to Friday's results of the EU's stress tests on Europe's battered banks, claiming the examination of particularly weak lenders did not go far enough.

The European Banking Authority, the EU's London-based financial regulator, announced that five Spanish, two Greek and one Austrian bank had failed its tests and needed an extra 2.5 billion euros ($3.55 billion) of additional capital.

One German bank, Helaba, said it had failed according to the EBA's standards but passed on its own calculation.

Investors had expected between 10-15 institutions could flounder amid deep worries over their exposure to the eurozone debt crisis, which has already snared Greece, Ireland and Portugal, and spread this week to Italy and Spain.

"Undoubtedly the stress tests have been useful in singling out a few particularly weak banks," said Marie Diron, senior economic adviser to the Ernst & Young Eurozone Forecast (EEF).

"But the 'adverse' scenario considered by the new EBA in this year's tests still did not include the impact of a formal debt default by a European government -- which is the single greatest risk facing the European banking sector at present."

The European Commission said that banks which failed the tests or came close to failing should begin efforts to recapitalise, even though EU finance ministers had said that government support for them had been agreed in principle.

IHS Global Insight economist Jan Randolph agreed that the tests neglected to assess the one scenario that has haunted global financial markets for months and months -- the possibililty of a sovereign debt default.

"The EBA would argue that the better-than-expected failures reflects the bank capital building since the start of this year and the impact of their own stress tests," he told AFP.

"This may be true but there are many more 'near passes' that would still probably face difficulty if the test had also incorporated a few sovereign defaults -- even of the softest kind.

"But then the job of the EBA is to instil confidence through the tests' credibility and transparency -- not to precipitate a sovereign and banking crisis. It may have succeeded in the former but has not given assurances of the latter," Randolph added.

Kathleen Brooks, research director at trading website, said that the default scenario was a key omission.

"The adverse scenarios that tested for a recession and an equity market drop are nothing compared to the carnage a (sovereign) default could cause," she said.

"The EBA made explicit reference that a deterioration in the sovereign debt crisis (a default) 'might raise significant challenges, both on the valuation of banks holdings of sovereign debt and through sharp changes in investors' risk appetite.'

"So these are test results that come with a caveat -- things could be worse if there is a default. So we still don't know how bad banks would be ravaged if a member state failed to pay its debts."

Analyst David Morrison, at trading firm GFT Global, added that investors would struggle to take the tests seriously.

"We were expecting anything between five and 15 outright failures, so it has come out slightly better than expected," he said.

"But it is still difficult to take these European stress tests seriously and that explains the muted reaction that we've seen so far in the euro.

"Overall, I doubt that this stress test is going to lift sentiment in the slightest."

© 2011 AFP

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