US Stress Tests Model for EU or a 'Farce?'

On July 23 the world will have the results of Europe’s stress tests of its banking industry.


A spokesperson for European Monetary Affairs Commissioner Olli Rehn told CNBC that he “has so much confidence the results are going to be strong and that the few pockets of vulnerability will be taken care of by national governments.”

Overnight Rehn was quoted by Reuters as saying when countries stress-test their lenders they could turn to an existing €500 billion ($620 billion) European Union back-up scheme as a second line of defense.

But Rehn’s spokesperson told CNBC that he is confident access to EU funding will not be needed.

"We are including the criteria of sovereign debt shock in order to reinforce the credibility of results” Rehn said.

The EC said it will only publish the list of banks tested, the banks' results and the methodology. But it remains unclear whether the results will come with an actual number, showing what kind of recapitalization a bank might need, or only the rating of it.

“It will be very clear for the markets to understand” the Commission told CNBC.

Rehn’s comments are causing a lot of confusion, according to Sir Howard Davies, a director at the London School of Economics and former head of the Financial Services Authority, the soon-to-be disbanded UK financial regulator.

“Rehn’s comments are a very dangerous thing to say and we need clarity," Davies said. "The market will now be looking for vulnerable banks and vulnerable governments as Rehn has indicated both exist.”

“We ought to copy what the American’s did in May 2009," he said. "The (Federal Reserve) got ahead of the curve and made the banks recapitalize. The EU and ECB have done the opposite and it has been poorly handled so far."

The problem in Europe is that there is no central authority, Davies said.

“There is no pan-European solution. Who would own the banks, the European Commission? No.”

Instead Davies said any recapitalization would need to be handled like the UK’s bailout of RBS and HBOS.

“Recapitalization is not like providing liquidity," he said. "You cannot borrow to buy equity.”

US Stress Tests 'Were a Farce'

Kirby Daley, a senior strategist at Newedge Group, agreed that the US process of recapitalization was very important, but dismissed the actual tests.

“The stress tests in the United States were a farce but they worked, they were executed with precision," Daley told CNBC. "But don’t forget that the main thing that happened before the stress test was the change in the Financial Accounting Standards Board accounting rule. So no more mark to market. The banks don’t really have anything to worry about."

"The stress tests were a charade to get investors to pour money back in to recapitalize before times got tough again," Daley said. "They did it during the boom time that was during 2009, money flowed back in, again, it was executed with perfection."

Daley said the methodology will be the key for EU tests.

"I don’t think that it’s going to be taken necessarily that seriously, it depends on the parameters that they put in, but its going to be a much more difficult time to raise capital now than it was in the US in 2009," he said.

"So, I m not sure that this is a terrific exercise to be taking at this time," he said. "Bbut then if they don’t do it the markets are going to be very skeptical as well. Its going to be rough either way."