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Were EU bank stress tests too weak?

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John Kolesidis/Reuters

(Read caption) A woman walks in front of a branch of ATEbank in Athens July 23. Greek lender ATEbank was one of seven European banks to fail stress tests run by the Committee of European Banking Supervisors. Some worry that the stress tests were not rigorous enough.

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In seeking to re-establish confidence in the European banking system – and in particular to prop up the ‘weakest links’ in southern Europe – the Committee of European Banking Supervisors (CEBS) has now announced the results of its stress tests on 91 banks. Not surprisingly, the number of failures was few – a meagre seven despite the fact that it is well-known that many EU banks are hardly as safe as the proverbial Bank of England.

Market scepticism has focussed on the low hurdles that were set, specifically the 6% Tier 1 capital ratio figure. Of the seven banks that failed, five were Spanish Cajas, whose consolidation seems inevitable. In Germany, Hypo Real failed but its acute financial problems are well-known. Surprisingly, all German Landesbanken passed.

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Critics of the EU stress tests would argue that the CEBD precluded any assumption of sovereign risk default, whilst the percentage of ‘haircuts’ for debt that were factored in generally fell short of current market prices. Compared with last year’s stress tests in the US where 10 of the 19 banks failed, the EU failure rate was undeniably low. In the UK, emergence stress tests were undertaken in 2008, which resulted in massive cask injections by taxpayers into two – RBS and Lloyds – of the four high street banks.

In time, it will become clearer whether these stress tests bring financial – and currency – stability or whether, as appears more likely, the market discounts them. Of course, if one of the banks that had passed the EU’s stress tests were subsequently to fail, the lack of rigour in assuming genuine worst-case scenarios would become very apparent – with potentially serious risks for the Euro.

Remember, too, that many banks passed the 6% Tier 1 capital ratio with little to spare.

Credible results or a potential fix to underpin the Euro?

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