Were bank stress tests not stressful enough?

Despite most of them passing the European stress tests, falling bank shares have dragged stock markets down this morning.

by James Taylor
Last Updated: 16 Dec 2014
Here's a ringing endorsement of the methodology of the European stress tests on the continent's biggest banks: despite most of them (including all the UK's 'finest') passing the test with flying colours, their shares have still taken a pounding this morning. The prevailing view seems to be that the stress tests weren't stringent enough, or possibly even asked the wrong question entirely. And with the Eurozone still dithering over what to do about Greece, and how to prevent contagion to Italy and Spain, it's no wonder investors are fretting about doomsday scenarios. Although arguably, things could have been a lot worse...

The stress tests carried out by the European Banking Authority didn't produce particularly scary results: eight banks failed (five Spanish, two Greek, one Austrian) in that they had a capital ratio below 5%, while 20 others only scraped through (5-6%). All the UK banks passed - but that hasn't stopped them being the biggest fallers on the FTSE first thing this morning. And it hasn’t stopped gold soaring to a record $1,600 an ounce, as investors sought out a safe haven.

The problem, it seems, is that markets aren't convinced the stress tests were stressful enough - that the EBA wasn't pessimistic enough about the scenarios the banks could potentially face, particularly in terms of a Greek default. And the latter is still perfectly plausible: Eurozone ministers are meeting on Thursday for their latest summit to discuss what to do next, but it still doesn't sound like they're anywhere near a solution. So it's no wonder the likes of RBS (which has over €1bn of exposure to Greece) saw its share price plunge today.

It's true that the EBA was stuck between a rock and a hard place: if its criteria had been too strict, and loads of the European banks had failed, it probably would have hammered confidence even harder, and persuaded investors that the situation was even worse than it actually was. And SocGen analysts quoted on FT Alphaville argue that even if you factor in some far worse outcomes, Europe's big banks actually look surprisingly resilient.

So no need to panic just yet. But if Greece goes bust, and the problems spread to Italy and Spain too, bank funding levels may be among the least of our worries...


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