The test showed that there is no winter for the banking system in the Union and that problems exist only in isolated cases. However, the item that interested many the most, the exposure of banks to government debt, especially from the most problematic countries like Greece, Portugal, Spain, or Ireland, was the most poorly executed.
Written by Vanja Figenwald
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The long-awaited stress test for banks, as it is popularly called, which sparked discussions even before it was conducted, concluded last week with exceptionally favorable results, although many are not overly convinced of its quality. Out of a total of 91 European banks tested for financial resilience under deteriorating conditions, only seven did not pass. The results, as a logical consequence of initial disagreements about the rigor of the criteria, were received differently. The Committee of European Banking Supervisors (CEBS), the umbrella European regulatory agency for banks, calculated the ratio of the so-called Tier 1 capital under current conditions, then applied severe conditions (GDP decline and worsening macroeconomic conditions individually calculated for each country, depending on current trends and estimates), and finally added a shock from exposure to government debt (the possibility of losses on government bonds), which was the subject of the most disputes. Simply put, it calculates how many financial shocks an individual bank could withstand relative to its real financial strength. Additionally, the test had to cover 65 percent of the Union’s banking sector and at least 50 percent of the sector in each of the countries.
The List of Shame
Tier 1 capital includes the most basic capital of the bank, known reserves, and common stocks, with the possibility of including preferred stocks in that tier. Regulatory agencies most often use this type of capital as an indicator of bank strength, and the seven unfortunate banks fell below the threshold set at six percent of core capital relative to total assets, identified as the minimum necessary to avoid ‘potential need for recapitalization,’ as defined by CEBS. The list of shame includes the beleaguered Hypo Real Estate, which the German government, in collaboration with other banks, rescued two years ago with 50 billion euros, Greek Atebank, and even five Spanish banks: Banca Civica, Diada, Espiga, Unnim, and Cajasur, which can be called relatively predictable results, considering the state of the Greek and Spanish economies. Another reason for the overwhelming share of Spanish banks on the list of failures stems from the proportionality of the number of tested banks in the country. In Spain, as many as 27 banks (95 percent of the sector) were tested, which is incomparably more than in any other country. For example, the next country by the number of tested banks was Germany with 14. The estimated capital shortfall for all seven banks is around 3.5 billion euros, which, considering the size of the European banking sector, is peanuts, so the results are characterized as successful and the system perceived as safe.
However, a considerable number of experts believe that the bar was set too low to allow as many banks as possible to pass the test. The reason for this decision by CEBS is the desire of their principal, the European Commission, to calm financial markets that have been in a state of continuous hysteria since the scandal with Greek public finances broke. Alistair Milne, a senior economist at the Bank of England, believes, for example, that the testing conducted in Greece was extremely lenient. The other scenario, that with severe conditions, is based on a five percent decline in real estate prices this year and a two percent decline next year in that country, and such deliberately low setting of criteria, he rightly concludes, nullifies the intention to calm the markets for the obvious reason – the markets are aware of the low standards set.
From CEBS itself, the results were interpreted as encouraging for the system as a whole, but they noted that one should not lose sight of the fact that many of the tested banks are still supported by state interventions and assistance and that there is therefore no reason for relaxation. According to some interpretations, the test was set up to fail an ideal number of banks. In this way, the criteria are not fundamentally questioned because, after all, some have failed, while on the other hand, the banking system as a whole appears stable. In practice, this means that the weaker banks will have to be recapitalized, allowing all others to pass without taking such measures. Others warn that the results obtained should not be interpreted as some kind of strength table for banks because they were assessed by different criteria, but only as a good indicator of the strength of an individual bank.
