German banking sector braces for stress test results

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Investors will on Friday probe the results of stress tests carried out on state-owned German banks for signs of any weakness at the core of Europe's biggest economy.

The London-based Committee of European Banking Supervisors is to publish the results of tests on 91 European Union banks which account for 65 percent of the EU banking sector.

Ministers in several European countries and European Central Bank president Jean-Claude Trichet have said most banks should pass the check-up, leading some analysts to wonder if the tests are really tough enough.

The markets want to know that the banks really can survive a fresh financial crisis and analysts say the tests have to show that to be the case. Any sense that the figures have been cooked will hit confidence badly, they add.

Germany has 14 banks on test, the second largest number after 27 in Spain.

Among the 14, at least one, Hypo Real Estate, is tipped to fail.

That would surprise few people however as bailed-out and now state-owned HRE has already said it needs two billion euros (2.6 billion dollars) in fresh funds.

A key yardstick being applied is a bank's Tier 1 ratio, which measures core capital against total assets, such as outstanding loans, to give a measure of a bank's real financial health and ability to resist fresh shocks.

Banks must show they can maintain a minimum Tier 1 ratio of 6.0 percent through next year, even if hit by a severe economic slump or major defaults on loans or government bonds, according to press reports.

Banks in the 16-nation eurozone and in Britain, Denmark, Hungary, Poland and Sweden have been asked to show they can withstand such shocks, which are similar to those that toppled the US investment bank Lehman Brothers in 2008.

In Germany, attention has focused on state-owned banks, with HRE topping the list.

The property lender and municipal-funding specialist was nationalised last year and has already received 7.85 billion euros from the German financial sector stabilisation fund SoFFin, along with 103.5 billion euros in loan guarantees.

At the end of March, HRE had around 39 billion euros in exposure to sovereign debt from weaker eurozone countries such as Greece, Ireland, Italy, Portugal and Spain.

The value of their bonds have all come under pressure as markets wonder whether one or more governments might eventually default on its debt.

Other German banks thought to be at risk are regional Landesbanken like LBBW, Bayern LB, WestLB and HSH Nordbank.

Such banks account for 23-24 percent of all business lending in Germany, the Association of German Public Sector Banks spokesman Stephan Rabe, told AFP.

A 2005 EU decision that abolished favourable conditions for regional banks saw them seek lucrative investments elsewhere, notably in risky US mortgages on which borrowers subsequently defaulted in large numbers to spark the sub-prime crisis.

"The Landesbanken are certainly the weakest link in the German banking industry," Barclays Capital economist Thorsten Polleit told AFP.

But Rabe said they had average equity ratios of "at least eight percent, some are way above ... so we don't expect any negative fallout from these stress tests."

That, some analysts say, could become a problem in itself.

"We should all be bracing ourselves for relief to flow through European financial markets," Credit Agricole strategist Mitul Kotecha commented.

"More likely, questions will be asked about why did so few banks fail and why the tests were not rigorous enough?"

ING strategist Jeroen van den Broek added: "The outcome simply must be realistic; a true classification of the European banking system with necessary capital injections lined up will, in the long term, be beneficial to banking confidence."

Polleit maintained meanwhile that in the final analysis, working out the risk was ultimately the responsibility of investors, not the regulators.

"Risk management includes the role of risk analysis and this has to be done by the investor, not by a government regulator," he said.

© 2010 AFP

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