EU bank stress tests increasingly farcical

Guest contributor – Tamara Burnell (Head of Financial Institutions, M&G Credit Analysis team)

Press reports following the meeting of EU finance ministers yesterday suggest that the eagerly anticipated Committee of European Banking Supervisors (CEBS) bank stress tests will be extremely “unstressful”. There’s talk of government bond holdings only being stressed for “market price volatility” if held in the trading books (implying bonds held to maturity will not be stressed), pass thresholds for capital ratios being set at very low levels, and results for multinational groups only published on a consolidated basis initially, giving creditors no insight into the quality of their actual legal entity counterparty. Indeed, comments reported on Bloomberg from the Greek Finance Minister that Greek banks are all expected to pass the stress tests, and from the Irish Finance Minister that AIB and Bank of Ireland should have few problems passing the stress test, highlight how pointless the whole exercise is looking, given those two countries’ banks have very clear and obvious problems.

Without any firm detail of exactly what the stress tests will involve, other than the most recent CEBS press release, it is hard to provide a detailed critique, but one particular concern we have is the absurdity of the Spanish regulators testing the Caja sector on the basis of consolidated legal structures that don’t yet exist and where capital is not going to be fully interchangeable within the groups. Indeed it is hard to see how anyone can be relaxed about the condition of the Spanish banking system when Bank of Spain data shows that Spanish banks increased their borrowings from the ECB by 48%, to €126.3bn during June. Similarly, we’re confused by some of the names that aren’t on the stress test list, with the Credit Mutuel Group in France, Nationwide in the UK, and Banca Popolare de Milano not making the list, perhaps because all have complex ownership structures which would make raising fresh capital extremely difficult. German Landesbanks claiming to be “very relaxed about the stress” is particularly worrying, given the track record of Landesbanks having to admit to chunky losses on virtually every problem asset class. And what wholesale markets really need is some reassurance on the financial strength of the actual counterparties active in wholesale markets, particularly that of the investment bank subsidiaries of both EU and non-EU banking groups, which will not be provided by the stress tests as far as we are aware.

However, most ridiculous of all is that the banks are simultaneously claiming that they are so strong that they will easily pass all possible stress testing scenarios, and yet so weak that they cannot cope with Basel 3 implementation by 2012 or the withdrawal of central bank liquidity facilities. How can the banks claim they are too strong to be concerned about the stress tests, but are too weak to implement painful and much-needed regulatory reforms? Any “clean bill of health” given to the banks in the stress testing exercise will therefore have to be accompanied by a commitment to enforce planned regulatory changes swiftly and comprehensively, if it is to carry any credibility whatsoever.