European Bank Stress Test Results Due Later This Week

With the results of the stress tests to gauge the strength of the European banking system due later this week, criticism over how the tests are being conducted continue to be leveled against authorities. Worse still, the veracity of the tests themselves are now being called into question, challenging the very credibility of the testing process.

EU officials have no one but themselves to blame for this situation. For months now, arguments over how the tests should be conducted, and how the results should be released, have overshadowed the actual intent of the testing process itself. Much of the wrangling has been political in nature as finance ministers from individual EU countries attempt to ensure their own interests remain protected.

Citing fears that publishing results for individual banks could result in the “misinterpretation” of balance-sheet details, German banks have enlisted the aid of the German finance minister to support their argument. For several months, this has been Germany’s position, but in a recent communiqué, the German Finance Minister says that Germany now supports listing individual bank details in the hopes that it will ease speculation shorting the euro.

What is not mentioned however, is the large number of institutions that will remain exempt from testing. A number of Spanish banks known as cajas, as well as several large regional German banks will not be tested. The German institutions, or Landesbanken, are known to have particularly large global market exposures, but because the Landesbanken are not publically-listed like other German banks such as Deutsche Bank, they will be exempt from the testing process.

There is also the question of how to value sovereign debt issued by countries including Greece that for the past six months or so, have been at the center of the credit crisis. One rumor making the rounds, is that nominal values for Greek bonds will receive a 40 percent haircut for valuation purposes, but this only applies to bonds held in trading books and not the actual banking book. In other words, for the purpose of the test, Greek-backed bonds held as assets, will be considered to be of the same quality as German-backed bonds.

Nevertheless, progress appears to have been made with yesterday’s announcement by the Committee of European Banking Supervisors confirming that this coming Friday, at 6 pm CEST, it will publish the results of the testing on its website (www.c-ebs.org). According to Monday’s press release, “a summary of the 91 bank-by-bank results, sorted by country, will be republished on CEBS’s website with links to the websites of the participating national authorities”.

If you recall, it was just a little over a year ago, that the US completed its own bank tests. In the case of the US tests, market confidence rose considerably despite the tests results themselves being less than spectacular – in fact, 10 of the 19 banks included in the testing process “failed” and were told they needed to raise another $75 billion to ensure solvency. In the end, it was the message itself that was most important, and the public’s confidence that the tests were conducted in an open and transparent manner.

Compare this to the European experience where 91 banks are due for testing. The problem here is that already, officials are making public statements that they expect most of these banks to “pass”. This flies in the face of public perception, drawing into question the value of the testing process.

Ultimately, it will be up to the market to pass judgment. True progress was made yesterday when it was announced that bank-by-bank results will be made public and the public will get a sense for debt exposures for each bank. Whether this is sufficient to restore investor confidence in the European banking system itself, remains to be seen.

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