Markets stressing out over bank stress tests

The imminent publication of the results of stress tests on 91 European banks this afternoon is putting a damper on trading today.

by Andrew Saunders
Last Updated: 06 Nov 2012
Markets in London and  Europe were reporting very cautious trading this morning ahead of this afternoon’s publication of the European Banking Association’s long-awaited stress tests on the continent’s key banks. Hardly surprising that investors are feeling a bit twitchy about making any big calls, given that the tests are widely expected to ‘fail’ some 10 of the 91 institutions covered, which will lead to them having to go to the markets to raise more capital.

The tests key requirement is that all banks should have a minimum of 5% tier one capital (broadly speaking, that means that banks should hold capital reserves equivalent to at least 5% of their total assets). The purpose of such reserves, of course, being to provide a cash cushion against unexpected losses or bad debts. The banks thought most likely to be named and shamed include three Greek banks (no, really?) and a clutch of Spanish savings banks. Those which do not pass will have to call on investors to recapitalise, a request which will not be made easier by the fact that they will just have failed a stress test…

Critics including ratings agency Standard & Poor's say that the tests are not strict enough, despite their having been toughened up after similar accusations last year. But the question of tier one capital ratios is far from being the only juicy titbit set to be revealed by the tests. There will also be much interest in the disclosure of banks’ sovereign debt holdings, especially their exposure to eurozone debt. For even as the Greek sideshow rumbles on, the debt contagion is spreading to other, much more structurally significant EU economies such as Italy, Portugal and Spain. So those banks holding big chunks of euro debt have good reason to be feeling nervous ahead of this afternoon’s results.

There has also been a lot of kerfuffle over the requirement to publish previously confidential data concerning banks' credit exposures – to other banks, mortgages and corporate borrowers – on a country-by-country basis. Germany’s central credit committee, the ZKA, said earlier in the week that this information could trigger targeted speculation against some banks by distressed debt specialist looking to acquire juicy portfolios on the cheap. Some banks may even decide to ignore the request and withhold this data.

But while it is a dead cert that those distressed debt outfits (which have so far been unexpectedly quiet since the crash of 2008) will be poring over the results in eager search of opportunities, as others have pointed out the whole point of the stress test exercise is transparency. By shining a light into financial communities’ darkest corners, the truth (however grim) will be revealed and we can all deal with it and move on.

That’s the theory at any rate, in practice the results will raise some tricky questions for governments and regulators alike. While they should be good news for the investment prospects of the majority that pass, the ones that fail may come under additional pressure, raising the old dilemma of whether to bail them out or let them collapse. Decisions, decisions…

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