There is a lot of uncertainty about the stress tests on European banks, the results of which are due to be announced on July 23. The question is whether the tests will be stringent enough to have credibility with investors or will be regarded as a whitewash.
I am not sure the statement issued on Wednesday by the Committee of European Banking Supervisors identifying the banks gives a great indication, but some details in the FT story are reassuring as to the exercise’s seriousness.
The problem with the exercise is that CEBS is setting central guidelines for the tests but they will be carried out by national supervisors that have conflicts of interest. As I noted the other day, regulators will not want to declare banks undercapitalised if their own governments will have to pick up the bill.
Naturally, there is already an intra-European argument over how severe the haircut should be on sovereign debt, with German banks not wanting German debt to be penalised. The FT story contains this marvellous sentence, which speaks for itself:
The haircut on German debt would be negligible, German bankers said.
The difficulty with a small haircut (a markdown from the face value) on sovereign debt averaging 3 per cent is that the result is almost bound to be wrong. If a country does not default, there is no need for a haircut on debt being held for the long-term, as opposed to the trading book.
On the other hand, if a country such as Spain did default, then the knock-on effects on Spanish banks would be so great – not only on sovereign debt holdings but real estate and other assets – that no haircut is going to capture it.
Still, the FT story does indicate that the stress tests for the four Portugese banks, 27 Spanish banks and 6 Greek banks involved will be fairly testing:
Bankers and regulators said the stress scenario on Greek sovereign debt had been set at 17 per cent for banks’ trading books, with additional stresses imposed on the banking book, where investments are held to maturity. “That would increase the stress to 20 per cent to 30 per cent in total,” one banker said. Portuguese sovereign debt would attract an 8 per cent trading book haircut, with 5 per cent for Spain.
The very fact that 27 Spanish banks are being examined is somewhat reassuring. That said, I trust that CEBS will tell us more about the nature of the stress tests when the results are announced – if it does not, we will be forced to guess.
