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Big results are in today about the health of Europe’s banks.The European Banking Authority will present details about the solvency of 90 banks across 27 nations after performing a series of stress tests.
Since last year, the EBA has imposed far more stringent regulations and required the banks to disclose far more information than ever before.
But what do these tests really mean, and what can you expect?
- 90 banks will be tested, from 21 countries. That's 65% of the EU banking sector.
- Test how banks would handle an extremely adverse scenario: (1) EU economy contracts by 0.5%, (2) EU equity markets fall 15%, and (3) Big trading losses are incurred while the EU manages its sovereign debt.
HUGE disclosures from the banks. They'll be forced to publish:
- Profitability estimates for 2011 and 2012
- Details about the volume and maturity of sovereign debt holdings
- Capital levels
Trader's expect that 10-15 banks will fail the tests, and that others will narrowly skirt the 5% core (Tier 1) capital to risk-weighted assets requirement. That's about 1 in 6 banks tested. Reuters reports that no large bank is likely to fail. However, many more banks may pass by only a slim margin.
Failures will likely come from:
- Spain: 6 banks (5 savings banks -- or 'cajas' -- and a mid-sized bank)
- Germany: Bank Helaba was suspended from the test because it didn't comply with capital requirements (it would have failed under the new more stringent policies). Landesbanks -- run partially by local governments -- are vulnerable because they can use alternative sources of capital as a substitute for reserves.
Banks that do not meet the 5% required capital ratio will be required to raise the necessary capital by January 15, 2012, or six months from the publication of results.
If they are unable to do that, the EBA expects national governments to step in with 'backstop mechanisms' to fill the void. However, an EU document released last week argued that 'there is no guarantee that the market has been convinced of their willingness and/or ability to intervene.'
New testing requirements, mainly with the capital ratio requirement.
- Banks are not allowed to count alternative sources of capital as Tier 1 reserves, giving them a ratio under the 5% requirement. Spanish Finance Minister Elena Salgado and 2 Spanish banks are particularly annoyed about this.
- German banks have attacked the tests for disclosing too much bank information. They argue that releasing detailed information could increase investor jitters and encourage 'targeted speculation' against certain banks. Perhaps they have something to conceal?
PRO: Stress tests will give a far more detailed picture of banks' health than last year. The results will include 3,000 data points this time compared to about 100 last year, when Ireland's major banks were given a clean bill of health just 4 months before they completely collapsed.
European leaders are also hopint that the results and subsequent scrutiny will convince banks of the need to recapitalize, particularly since some kind of sovereign default seems so close at hand.
CON: Poor results -- or at least signs that banks will not be able to weather sovereign default as well investors thought -- could fan the flame of EU economic collapse.
Investors have been begging banks for greater transparency about their sovereign debt and capital holdings, and now they're about to get it.
If these results are generally positive, they could bolster confidence in the state of the euro zone and stimulate interbank lending.
If they're negative, the financial stability of the EU might be in jeopardy a lot faster. Expect an increase in speculation against weak banks, adding to a credit crunch. The questionable likelihood that governments that are already struggling with enormous sovereign debt burdens will come to the aid of their ailing banks will aggravate preexistent crises.
The results of the stress test largely discount the fact that the EU's financial situation is crumbling.
Sure, Italy's banks can pass the test, but that doesn't pull them back from the brink of the abyss. The head of the Portuguese banking association can talk confidently about Portugal's banks too, but that doesn't mitigate the fact that a full 8% of bank assets are being funded by the lender of last resort.
No doubt about it, poor results make things go down the tube a lot faster.
A healthier overall report may bolster investor confidence in the short run, but this is unlikely to last too long. Simply, economic problems in the EU run too deep. Other factors like stalled growth, political instability, and skyrocketing public debt will not be resovled by a little more bank stability. These problems are pervasive, and are likely to cause trouble for the forseeable future.