The Committee of European Banking Supervisors (CEBS) released its summary report on the results of the EU-wide stress test exercise, which revealed that just seven out 91 European banks would have insufficient reserves to maintain a Tier 1 capital ratio of at least 6% in the event of a ‘worse case’ scenario, such as a recession and a sovereign debt crisis. Many critics are arguing that the evaluations were too easy.
The CEBS was mandated by the ECOFIN to conduct, in co-operation with the European Central Bank (ECB), the European Commission (EC) and the EU national supervisory authorities, a second EU-wide stress testing exercise. Germany’s Hypo Real Estate Holding, the Agricultural Bank of Greece and five Spanish savings banks have failed the resiliency test. These banks will have to raise €3.5bn in total to boost their capital buffers.
The 91 banks represent 65% of the European market in terms of total assets. The threshold of 6% was used as a benchmark for the purpose of this stress test exercise only. This threshold is not a regulatory minimum – all banks that are supervised in the EU need to have at least a regulatory minimum of 4% Tier 1 capital.
Unsurprisingly, the banking industry welcomed the results of the stress tests as attestation that the majority of banks adequately meet the legal and market requirements in terms of solvency. The British Bankers’ Association (BBA) released a statement which said: “UK banks have already put in the work to rebuild their businesses and put more money aside against future financial problems. It is no surprise to find they have exceeded the standards set out by CEBS to ensure banks across Europe are well placed to weather any future financial problems.”
Yet, many in the industry believe that the stress tests were too easy. Christophe Nijdam, bank analyst at independent equity research firm AlphaValue, said: “The market wanted blood on the wall but it got Spanish ketchup on the carpet instead. Seven institutions pinned down out of 91 European banks resulting in a failure rate of less than 8%. The American tests had a 53% failure rate with 10 out of 19 US banks at the time.”
Gerard Fitzpatrick, global fixed income portfolio manager at Russell Investments, was also critical. “The EU has missed an excellent opportunity to materially boost confidence to the liquidity and capital providers for EU banks by limiting these tests to only ‘worse case’ stress tests, rather than a perceivable ‘worst case’ stress test, where ultimate concerns of bank failure risk would have been addressed,” he said.
“The more rigorous a test is, the more reliable its pass mark is. In the wake of the global financial crisis, capital providers to EU banking want to be assured that all EU banks would be adequately capitalised against a perceivable ‘worst case’ test. Such a test would have considered a severe economic shock akin to the crisis and to also consider a sovereign default,” he added, urging the EU and CEBS to engage with the market to address questions emanating from these tests and to enhance the stress test already done to capture a ‘worst case’ scenario.
However, Leigh Bates, head of financial services practice, SAS, believes that the long-term purpose of stress testing has been overlooked. “While the tests will enable regulators to determine necessary capital ratios, the longer term aim is surely to help ‘future-proof’ the industry. Ultimately, banks need to see for themselves what changes are required in terms of risk management procedure so that they can be confident in their own ability to deal with whatever events the future may hold. All the talk about inconsistency in the assessment at a European level is arguably overlooking the internal issues banks must address individually and which will dictate whether or not a bank will fail,” Bates said.
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