Bank stress tests need to pass test of confidence


  • Business
  • Wednesday, 28 Jul 2010

IT is with relief that most banks in the European Union (EU) have passed the stress tests except for a handful.

Of course criticisms abound as to how the tests were conducted.

One question that has not been addressed is the majority of banks’ holdings of sovereign debt.

“The evaluations took into account potential losses only on government bonds rather than those they are holding until maturity,’’ said Bloomberg.

Further citing a survey by Morgan Stanley, the wire report explained that lenders hold 10% of their Greek government bonds in their banking books and 10% in their trading books and that they only have to write down the value of their bonds in their banking books only if there is “serious doubt’’ about a state’s ability to repay in full or make interest payments.

Stress tests should not be a one-off thing. Just because the EU banks have passed the first round does not mean that they can sit back and drop their guard.

A major issue is the huge disparity between analysts’ forecasts of the additional capital required with the actual amount of just 3.5 billion euros (US$4.5bil).

The stress tests had found that Germany’s Hypo Real Estate Holding AG, Agricultural Bank of Greece SA and five Spanish savings banks didn’t have adequate reserves to maintain a Tier 1 capital ratio of at least 6% should there be a recession and sovereign-debt crisis.

Earlier, analysts at Goldman Sachs Group Inc had estimated that the banks in Europe would have to raise 38 billion euros and Barclays Capital said they would need about 85 billion euros.

More details should be provided on the depth of the stress tests and outstanding issues being looked at.

The impact of the European debt crisis was not as disastrous as that of the US subprime debt holocaust but the fact that people do question the stress tests points to the need for further clarification and transparency.

Banking secrecy is to be respected but the scenarios and other rigorous testing approaches should be made known so as to dispel any notions that this exercise was, as suggested by some reports, designed to help banks pass the tests.

Stress tests carried out in the United States last year revealed that 10 lenders, including Bank of America Corp and Citigroup Inc, required additional capital of US$74.6bil.

Does that mean that they were more rigorous? One may argue that the US situation was more serious or even suggest that its banks were more lax.

Nevertheless, the vast difference in additional capital required makes people wonder.

One reason offered is that the US stress tests were conducted at the height of the financial crisis while those in Europe were carried out amid improving conditions.

The strengthening of the International Monetary Fund war chest from US$750bil to US$1 trillion may be a major confidence booster especially against sovereign defaults.

Even then, the scenario analyses can be more stringent while capital requirements further tightened in view of ongoing uncertainties. More stop gap measures and “unrealistic assumptions’’ can be put in place in the event of default.

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