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EU Stress Tests Are a Missed Opportunity: Strategist

Monday, 26 Jul 2010 | 3:21 AM ET

European stocks gained on Monday as investors breathed a sigh of relief that the results had not been more negative.

One analyst though tells CNBC.com that governments and regulators have missed a major opportunity that will come back to haunt them.

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"Regulators have missed a good opportunity to get the European banking system back on track," James Ferguson, head of strategy at Arbuthnot Securities, told CNBC.com.

Ferguson believes regulators should have forced the banks to raise money in order to allow them to further restore their balance sheets and thinks they will now be forced to do so in more difficult times.

"Banks need to work through their losses in order to get back to a position where they can begin to lend more money to consumers and businesses," Ferguson said.

"What we will be left with is bad debt and less lending and lower growth," he predicted.

Regulators will end up losing credibility, because most European banks have passed but some are likely to be forced to raise money later, in more difficult conditions, according to Ferguson.

"A tier 1 capital ratio of 6 percent is misleading. The assumptions used in the stress tests show the banking industry will be brought to the edge of the cliff in an economic slowdown. If we get anything worse than those assumptions then we are in trouble," Ferguson, who is negative on the European banking sector, said.

European stress tests assumed a spike of 6 percent in unemployment, economic shrinking of 3 percent on average and a 6 percent rise in market interest rates.

The focus for markets will now return to economic data and corporate earnings, according to Gary Jenkins, head of fixed income research at Evolution Securities.

"The stress tests came in as expected and will be forgotten within a week," Jenkins said. "It is difficult to assume the worst and the European authorities will be wishing they had never bothered doing them in the first place."

Jenkins is negative on economic data for the next 2 years but is more confident about the prospects for corporate earnings and this is why he prefers corporate debt to government debt.

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