Concerns Over Latest EU Bank Stress Tests

Key parts of a stress test for European banks designed to raise investor confidence in the sector have been softened by regulators despite widespread derision of a similar exercise last year, which was seen by financial markets as too lax.

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Some of the scenarios under which bank balance sheets will be tested are more benign than the tests that failed to gain investor credibility last year.

The new stress test will model the impact of a 15 percent fall in equity markets on banks – way below the numbers used in the 2010 test, with no discernible toughening of other key parameters.

The European Banking Authority, created in January as the new pan-European regulatory body, is keen to gain credibility and cast off the maligned reputation of the Committee of European Banking Supervisors, its predecessor.

But one senior London-based bank analyst said: “There is nothing in what has emerged to change the market’s views about this process. It was a joke last time. Why is it not going to be a fudge this time?”

The 2010 stress tests, conducted last summer, were criticised at the time for being too easy, and lost credibility when Ireland – whose two biggest banks passed the tests – was forced to seek bail-out money, largely to save those banks.

Handelsblatt, the German newspaper, on Wednesday published leaked data points for the test, later confirmed by people close to the exercise.

The 15 percent projected fall in equity markets compares with a 20 percent scenario used overall last year and a 36 percent slump modelled for banks’ equity holdings that were immediately “available for sale”.

Macroeconomic stresses – modelling for a 0.5 percent shrinkage of eurozone gross domestic product this year and 0.2 percent next year – are also more benign than a year ago, in line with upgrades of economic growth expectations by the European authorities.

Though analysts were broadly sceptical of the toughness of the measures, they did praise the inclusion of one new measure – a 1.25 percentage point increase in banks’ own funding costs in a stress scenario.

Andrea Enria, the new chairman of the EBA, told the Financial Times recently that he was determined to make the exercise more credible, and use it as a trigger for the widespread injection of fresh equity into Europe’s most poorly capitalised banks.

In particular, Mr Enria is keen for there to be not simply a pass-fail mechanism for the tests, with no follow-up action by national regulators.

Those who narrowly pass, as well as those who fail, should be forced to increase their capital ratios, he said.