IE
All the most salient facts regarding the stress tests
26 July 2010
Our poll indicates that you don’t rate the European stress tests. 40% of people who’ve responded to date think they were pointless piffle; the remainder think they were too lenient to be meaningful.
The markets may agree. Even though German banks came out surprisingly well, Deutsche’s share price plummeted this morning. As BarCap’s banking analysts point out, with or without a stress test, Europe’s banks still have €1.5trn of debt maturing by 2012, as well as the need to repay over €500bn to central banks.’
Nevertheless, the tests do have a function to play, if only by forcing banks to make public previously unknown information about their risk exposures.
How the big banks fared
(Click to enlarge)
Source: BarCap
A tier one ratio of less than 6% = FAIL. The seven failed banks are mentioned here.
(For information on the benchmark scenario, adverse scenario, and sovereign shock, click here and go to page 3).
Why the stress tests aren’t particularly credible
As various analysts have been busy pointing out this morning, the stress tests, while valuable, aren’t exactly credible. This is because…
1) More banks passed than expected
When the US ran stress tests in May 2009, only 47% of banks passed. BarCap analysts were expecting 75-85% European banks to pass; in the event, 92% did.
2) The loan loss criteria weren’t very demanding
Different countries were able to set different criteria underpinning expected loan losses. In Spain, for example, the assumption was that commercial property prices would decline by a cumulative 55%. In Greece, the assumption was for a 7% decline.
Morgan Stanley analysts point out that Germany and Italy appear to have been particularly lenient. Bernstein analyst Dirk Hoffman Becking points out that in April 2010 the IMF was still expecting Landesbanken and Sparkassen to take $47bn in loan impairments and trading book losses in 2010 alone, but that the stress test comes in with an aggregate impairment for two years of €12bn and a trading loss of just €850m for 2010 and 2011.
3) The stress test only applied to government bond exposures on the trading book, not on the banking book
This is a BIG issue, given Morgan Stanley analysts estimate that 90% of Greek sovereign debt is treated as hold to maturity debt on the banking book. They estimate that losses from an additional sovereign shock would reach €67bn over a two-year period, of which €37bn would be on the banking book.
4) Tier one capital can be manipulated
Banks passed the stress tests if they had a Basel II tier one capital ratio of more than 6% after the various scenarios had been considered. However, Basel tier one capital allows for the inclusion of capital derived from government measures to support banks. This increased the percentage by an average of 1.2% according to Alphaville.
Why the stress tests won’t make much difference
BarCap analysts point out that after the US stress tests, the US banking sector surged 70%. This time, a repeat looks unlikely because….
1) It’s a different climate
The US stress test coincided with an economic recover. Equally, as Morgan Stanley analysts point out, the fiscal policy backdrop was different (expansion not austerity) and quantitative easing was only just beginning.
2) There’s still all that debt to rollover
The stress test won’t make banks’ debt go away. “The stress test does little to improve the structural funding challenges facing European banks,” say BarCap analysts. “We estimate that the industry has maturing term debt totaling €1.5trn by the end of 2012, which – when adding in the c €500bn of central bank liquidity that will need, at some stage, to be refinanced independently – suggests funding challenges remain.”
So which European banks should you be working for?
BarCap analysts think HSBC and BNP Paribas look good. However, Dirk Hoffman- Becking points out that BNP isn’t so healthy when the large sovereign debt portfolio on its banking book is taken into account. He’s much keener on the Swiss banks, and then BarCap, and then SocGen.
Ultimately, however, Hoffman-Becking also points out that a European sovereign debt crisis will blow you out wherever you work. He writes cheerfully:
We do not believe a sovereign default of a major European economy (aka Spain) can be realistically modeled. The implications on liquidity and funding would in all likelihood leave only a very small number of viable banks in that country. Given the funding linkages across the Eurozone, this would lead to a chain reaction into other European banks. In the third step, concerns about an uncontrolled breakdown of the Euro would lead to bank-runs across the Eurozone and a subsequent collapse of the system.
