A report says that the EU bank stress tests used scenarios that were “obsolete” by the time the tests were published.
We don’t have a copy of the report, but the WSJ got one, and it’s a doozy.
The WSJ reports that it was published recently by senior EU finance officials, and that the report proposes the reasons why, after the latest UE bank stress tests revealed in July that European banks were mostly well-capitalised, EU bank stocks plunged.
The report says the reasons are obvious. Short version: the bank stress tests didn’t reveal the obvious stress that EU banks are under as Sovereign debt teeters on the edge of default or restructuring.
So market participants didn’t buy it.
The fact is many EU banks have tens of billions in exposure to Sovereign debt, yet somehow the report’s analysis of the stress tests concluded that they “did not [have] any unsustainable amounts of bonds issued by vulnerable sovereigns in the banks’ banking books, as initially suspected by the markets.”
The long version explains why the report failed to conclude the same as market participants: that EU banks might be in serious trouble if Sovereign debt is put under more pressure.
The big problem was that the tests required banks to make relatively limited provisions for losses on sovereign bonds in the banking book, even though Greek 10-year bonds, for example, were trading at around $0.50 on the euro when the tests were published.
In other words, the stress tests used out-of-date macro economic data that wasn’t relevant in July or now.
The EU finance officials conclude: “The credibility of backstop procedures, private or public, has not been challenged in spite of the unfriendly market conditions.”
One solution proposed is forcing the banks to re-capitalise.
Now many people agree with Christine Lagarde’s analysis from Jackson Hole weeks ago that EU banks need to be capitalised urgently.
Whose capital is another question.
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