Bank stress tests need grounding in reality

Monday 26th July 2010

Adverse scenarios used to stress test banks need to have a reasonable probability, not an extreme one, says Keith Poore, head of investment strategy at Axa Global Investors.

“Otherwise, mass failure will be the predictable outcome and the tests are worthless (though some may argue these are the same),” Poore says.

He was responding to criticism of the stress test of 91 European banks which resulted in only seven banks failing, five in Spain and one each in Greece and Germany – the German lender Hypo Real Estate Holding AG has already been taken over by the German Government.

The test assumed Europe's GDP would drop 0.2% this year and 0.6% next year and some analysts have criticised that as not being a stressful enough test. They are predicting European stock markets will react negatively, viewing the test as a political whitewash rather than a genuine attempt to reassure investors.

“But then again, the 2009 US stress tests' adverse scenario was for 0.5% GDP growth in 2010 and a 10.3% unemployment rate,” Poore says.

“I can't recall much criticism at the time that the US tests weren't stressful enough – just a collective sigh of relief when 10 of the 19 banks had to raise only US$74.6 billion,” he says.

Bank of America alone had to raise US$33.9 billion.

As a result of the test, European banks will have to raise just 3.5 billion euro (NZ$6.21 billion) in new capital, according to the Committee of European Banking Supervisors (CEBS).

“Analysts were expecting up to 10 times as much, so the market should welcome the news,” Poore says. US-listed European bank stocks did rise on Friday with Bank of Ireland up 3.8% and Banco Santander SA rising 2.6%.

“All eyes will be on European markets on Monday,” he says.

Anxiety about Europe's banks has sprung from the continent's government debt crisis which led to a 110 billion euro international bailout of Greece. Investors are concerned banks are holding government bonds which aren't worth their face value.

“Unless I'm mistaken, unlike the European tests, there was also no haircut applied to US banks' government bond holdings,” Poore says.

Valuation cuts applied to sovereign debt holdings by the CEBS range from 23.1% for Greece to 4.2% for Slovenia.

“Question for discussion: how is that (Slovenia's) less than Germany's?” Poore asks. Germany's cut was 4.7%.

Businesswire.co.nz

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