The New Catalyst - Banks Stress Test

IMF welcomed the publication of European bank stress tests on Friday, saying it promotes transparency and boosts investor confidence in addition to helping beef up the financial system.

Seven of the 91 European banks examined for their strength to withstand a crisis failed, most of them in Spain. Overall, the European banks were judged to be financially sound. The key is the fact that only 7 failed, and secondly they are just Spanish banks mainly, plus a couple in Germany and Greece.

Governments are already working with the seven weak banks, five in Spain and one each in Germany and Greece, to help them shore up their finances, said the Committee of European Banking Supervisors, which carried out the stress tests. Failing the capital strength tests were German state-owned lender Hypo Real Estate, Greece's ATEBank and five regional savings banks in Spain. Germany's case is a state owned, so just rectifying one state owned bank is a non issue. Greece with just one bank is a delight, considering the mauling the economy took over the past 12 months.

'The publication of the results and the actions that have been announced to address bank capital deficiencies promise to significantly strengthen the European financial system,' Mr Strauss-Kahn said. He said these steps complemented measures already taken, including the establishment of the European Financial Stability Facility and improvements in European Union economic governance and financial supervisory framework.

US Treasury Secretary Timothy Geithner also welcomed the release of the bank test results, saying the EU 'has made a significant effort to increase disclosure on the conditions of individual European financial institutions and enhance market stability.'

Goldman Sachs had earlier expected 10 to fail. A figure higher than 10 would have been a negative catalyst. The Goldman Sachs poll of 376 respondents, including hedge funds and long-only investors, showed European banks were on average expected to raise 37.6 billion euros ($48.4 billion) in extra capital following the tests, Goldman said in a note dated July 22.

Banks domiciled in Spain, Germany and Greece were expected to raise the most fresh capital, and the source of capital was expected to be split between the public and private sector, Goldman said.

As with any kind of stress test, there will be critics that they might be too lenient. While the modest findings cast doubt on the credibility of the bank tests -- released on Friday in a bid to restore investor confidence -- with the European economy apparently improving fast, some analysts said that may not matter.

Five of Spain's smaller regional lenders, known as cajas, failed the test and their recapitalisation will almost complete a state-funded drive to consolidate the country's network of its unlisted savings banks. They need 1.8 billion euros, the Bank of Spain said. The fact that Spain has not triggered massive downgrades like Greece or Hungary, they should be able to raise the capital to avert the problems.

Banks in Germany and Greece were also seen as weak spots and in need of restructuring, but state-owned Hypo Real Estate was the only German lender to flunk and state-controlled ATEbank was the only Greek bank to fail.

The key is that no big banks failed the health check. The Committee of European Bank Supervisors (CEBS), a previously little known group with 25 staff at a small London office that coordinated the process, said its test was more severe than the U.S. process.

Europe tested how 91 banks would cope with another recession and losses on government debt after the Greek crisis hit markets and raised fears the euro zone could unravel.

It aimed to repeat a health check on U.S. banks last year that helped restore investor confidence and underpinned a recovery by bank shares. With latest data showing signs of a strengthening recovery in Europe, banks could find themselves in a healthier position than expected, perhaps explaining the muted market reaction.

The euro fell against the dollar as some investors cast doubt on whether stress tests were tough enough but German government bond futures fell on relief that they threw up no nasty surprises. European bank shares ended up on the week, before the results were announced, and the cost of insuring the debt of most European banks fell afterwards.

Any bank whose Tier 1 capital ratio falls below 6 percent by the end of 2011 failed the test, and would be expected to raise funds to make up the capital shortfall. Of most concern to investors was that government bond losses were only applied to trading books, and not hold to maturity bonds, as the test did not consider there was a risk of any sovereign default.

Banks' holdings of government bonds were subjected to a 23.1 percent loss on their Greek debt, a 12.3 percent loss on Spanish bonds and a 4.7 percent loss on German debt, all based on 5-year bonds and their value at the end of 2009.

The hunt for weak spots in European banking has focused on Spain's regional savings banks, as well as regional German lenders, known as landesbanks. Spain and Germany have set up funds to help weak banks recapitalise and Spain wants more cajas to merge. The Spanish banks to flunk were Banca Civica, Diada, Espiga, Unnim and Cajasur. The worst case scenario included a 28 percent fall in Spanish house prices during 2010-11.

Banks that came close to failing with a Tier 1 ratio of less than 7 percent under the most stressed scenario included Germany's Deutsche Postbank, Greece's Piraeus, Allied Irish Banks, Italy's UBI Banca and Spain's Bankinter.

Last year's U.S. bank test helped draw a line under worries about the sector there and Europe's attempt to match it has faced splits in the 27-nation EU about how to model the test and how much to divulge. European banks have also already raised about 300 billion euros since the start of the crisis, whereas the U.S. tests kick-started the fundraising.


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