Euro Banks Pass Stress Tests But Investors Still Stressed

Euro bank stress test

After months of living up to their name, the four-month-long European bank stress tests yielded extraordinarily good news: 84 of 91 lenders passed the examination.  But not everyone is convinced that the tests were sufficiently rigorous to allay investor fears.

Dow Jones reports,

Europe’s largest listed banks by assets, including the U.K.’s Royal Bank of Scotland Group PLC (RBS), Barclays PLC (BCS) and HSBC Holdings PLC (HBC), France’s BNP Paribas SA and Credit Agricole SA, Germany’s Deutsche Bank AG (DB) and Spain’s Banco Santander SA (STD), said they had plenty of breathing room in their Tier 1 capital ratios to handle even the worst of the EU’s scenarios, consisting of the economy shrinking–contrary to most economists’ expectations–in the next 18 months, and a sharp rise in short-term interest rates and one-year government bond yields.

However, seven small banks, consisting of Germany’s Hypo Real Estate Holding AG, Greece’s 77% state-owned ATEBank (ATE.AT), nationalized Spanish savings bank CajaSur and four other small Spanish savings banks failed to pass the worst-case scenario.

While five of the seven failing banks were Spanish cajas (unlisted savings banks), the results were especially good for Germany, as Bloomberg‘s Christian Vits and Jana Randow point out.

“The German banking system has shown itself to be robust and proved its resilience even under very pessimistic assumptions,” the Frankfurt-based central bank and BaFin said in a joint press release. German banks’ solvency is “assured” even in a scenario of a “sharp decline in growth and shifts in the yield curve.”

The stress tests assume a cumulative economic slowdown in the euro area of 3.0 percentage points for 2010 and 2011, with German output to drop by as much as 3.3 percentage points this year and next compared to the benchmark scenario, Bundesbank and BaFin said.

Hypo Real Estate Holding AG is the only one of 14 German bank to fail the test, the report said.

“The stress test figures are profound, they are reliable, one shouldn’t again speak badly of them,” BaFin President Jochen Sanio said at a press conference in Frankfurt today.

Not everyone agrees with this optimism.  Alpine Mutual Funds manager Kevin Shacknofsky points out, "The critical thing remains how these tests were put together which we’re still learning."   Several investors quoted in the Dow Jones piece concur, with Gary Jenkins, head of fixed-income research at Evolution Securities, saying "the stress tests will be forgotten within a week as investors turn their focus to earnings season and economic data."

Similar concerns are noted even in Germany.  An unsigned Spiegel analysis notes, "The economic developments used in the test scenarios were hypothetical and not based on real forecasts of the future capital needs of the banks." Additionally, the piece notes Wolfgang Gerke, a banking specialist at the state-government sponsored Bavarian Financial Center in Munich, told public broadcaster ARD he was concerned "that what is being called a stress test here doesn’t even simulate a real stress scenario."

But Alexei Monsarrat, director of the Atlantic Council’s Global Business Program, argues that "this had been badly needed for a long time," noting that the U.S. did this some time ago.   He cautions, though, that Europe must still "face up to its lingering, festering banking issues."

Germany, again, is at the forefront of this:

One of the main reasons German banks performed so robustly is that they have already increased their core capital ratios. During the past two years, they have undertaken considerable efforts to clean up their balance sheets and they have also received fresh infusions of capital from their owners or government institutions. At the start of 2008, the core capital ratio for the entire German banking system was 9 percent to a current level of 10.8 percent.

FT reports that the Swiss aren’t taking any chances, putting their own banks through an exercise they claim was “twice as tough” as the EU scenario.

Despite the dismissals now about rigor, there was plenty of nervousness in the days leading up to today’s announcement.  We’ll soon see how the markets respond to the tests but my guess is that, as with the Greek bailout, this will be seen as a necessary but not sufficient step on the path to regaining confidence in the system.   

James Joyner is managing editor of the Atlantic Council. 

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