stress tests

How will sovereign bonds will be handled in the euro area’s forthcoming banking health checks? This is a vexed question and markets seize ravenously upon any clues.

Mario Draghi, the European Central Bank’s president, offered a flicker of information on Tuesday in a letter to Sharon Bowles, the chair of the European Parliament’s Economic and Monetary Affairs committee. Sovereign exposures will indeed bit included in the stress test, he said – confirming previous declarations from the ECB.

However, it is “not foreseen” that bonds in the held-to-maturity category of banks’ books will be adjusted to reflect market valuations – otherwise known as marked to market. That will come as a relief to banks that are holding portfolios that have slumped in value, but analysts caution that it is far too soon for lenders to relax. Read more

Markets remain nervous about Ireland after yesterday’s stress test results – despite the fact they appeared thorough and the €24bn recapitalisation they recommend matches expectations. This has prompted Europe’s biggest clearing house LCH.Clearnet to again raise the margin requirement on clearing of Irish debt, back up to 45bp from 35bp. Effectively, this increases the cost of holding Irish bonds and decreases the cost of shorting them.

Should all this post-stress-test stress lead to another downgrade, as seems likely, Dublin will be protected to a large degree by a lifeline from the ECB, which has pre-emptively suspended its collateral requirement for the country. Read more

Irish stress tests reveal a capital shortfall of €24bn, comprising:

  • Allied Irish – €13.3bn
  • Bank of Ireland – €5.2bn
  • Irish Life – €4bn
  • EBS – €1.5bn

Note: Anglo Irish Bank and Irish Nationwide Building Society were not included in the exercise because their loan books are being wound down. Anglo was fully nationalised in January 2009 and Nationwide is “effectively state-owned”. Both have required substantial state aid.

The headline figure of €24bn is better than many expected, particularly since about a fifth of it is for an additional capital “buffer” that goes beyond the 10.5 per cent tier one requirement in the base scenario, and 6 per cent requirement in the adverse scenario. Without this additional requirement, the recapitalisation requirement would be €18.7bn. The Irish central bank seems to have gone for the warts-and-all approach, which bodes well for the reliability of the numbers.

As well as raising new capital, banks will need to sell many of their non-core assets, following a deleveraging plan agreed with the central bank “in order to transition to smaller balance sheets and a more stable funding base”. They will separate assets into core and non-core, gradually selling off the latter. But shareholders, take heart: first, this will not be done in a hurry; second, the losses this will inevitably incur are already factored into the analysis: Read more

No stress tests for ages, then they all come along at once.

Some banks are set to raise their dividends imminently in the US, once the Fed gives them the green light ahead of detailed stress test results released in secret next month. Another practice put on hold in 2009 – share buybacks – will also be back on the menu for some of the 19 large banks. Only those groups that wanted to increase dividends or share buy-backs, or repay government capital, received a call from the Fed on Friday. Those receiving good news will no doubt act swiftly: any of these activities will presumably be seen as a public badge of honour, in the absence of results publication.

Europe, meanwhile, does intend to publish results. Arguably the target audience for Europe’s stress tests is investors and markets rather than the banks themselves. This might give the unfortunate impression that policymakers are aiming for the appearance of a healthy banking sector rather than the real thing. Read more

Irish banks may need more than the €10bn set aside for them in the bail-out, the Irish finance minister has said.

Michael Noonan said in Brussels today that recapitalising Irish banks could not take place till stress tests were completed, but that he would be “surprised” if €10bn were enough. The Irish Independent claimed over the weekend that “a further injection of between €15bn and €25bn could now be needed”. Mr Noonan told reporters he expected the size of the shortfall to be revealed by stress tests, whose results are due to be published by the end of March. Read more

The tests on 88 EU lenders holding 65 per cent of the bloc’s total assets over the coming months are structured to determine how well banks would hold up in a severe economic crisis. Criteria for banks’ passing or failing the test are due to be set next month.

The documents, seen by Reuters, show that the adverse scenarios include: Read more

Holdings of sovereign debt will be included in European stress tests, which will include country-specific adverse scenarios designed by the ECB. There was some doubt whether sovereign debt would be included after Cebs, the EBA’s predecessor, was reported in November saying it wasn’t “clear that a repeat of the sovereign risk sensitivity analysis will be necessary in 2011″. How times change.

Collaboration on methodology will begin tomorrow (Friday) between the EBA and individual countries’ supervisory bodies. Scenarios plus the sample of banks will be published March 18. Broad principles of stress test methodology are expected in April. Several months will be needed to complete the tests, which will be published in June. (Note: new US stress tests, which are due for completion this month, will not be published.) And what will happen should a bank fail? Read more

European stress tests will be held in the first half of this year and published in the summer, the European Banking Association* has announced. They will be accompanied by a review of liquidity funding risks:

The EBA will, as part of its regular cycle of risk assessments, initiate a separate thematic review of liquidity funding risks across the EU banking sector in the first quarter of 2011. The EBA will use this internal review to inform supervisory authorities about areas of vulnerability in relation to liquidity risk.

It looks as though the liquidity assessment will remain private, though the stress tests will be published. We’ve asked the EBA for confirmation and will update you.

No mention of the sovereign holdings part being scrapped; perhaps, in light of current shenanigans in Europe, the EBA felt they might be needed. Read more

To add to the prevailing sense of deja vu, regulators in both the US and Europe are this week discussing new banking stress tests. There is a significant difference with the new tests, however: they are to be part of regular, ongoing scenario analyses, and the results in the US, at least, will remain private. The first round of stress tests were public and aimed at reassurance.

The Federal Reserve is expected to start analysing data provided by 19 large banks this week, to work out how their balance sheets would withstand a variety of new shocks. “Only banks that have repaid government bail-outs and can prove a lifted dividend will not compromise their safety will be allowed to return cash to investors,” write Francesco Guerrera and Tom Braithwaite. “The Fed will also decide whether banks are on course to meet more stringent rules on capital requirements, agreed by the international Basel committee last year.” Tests are expected to be completed by March and are expected to be similar in content to those of May 2009. Read more

How did Allied Irish Banks pass the CEBS stress tests, but then require a bail-out from the Irish government? This is the question Labour MEP Alan Kelly is apparently to pose to EU competition commissioner, Joaquín Almunia.

There may be red faces at CEBS, the Committee of European Banking Supervisors, which organised the stress tests and published the results in July. Banks self-reported the numbers, based on a template with some EU-wide and some country-specific assumptions, and CEBS then cross-checked and peer-reviewed the data. Read more

Falling Portuguese and Irish bond prices of late will have been hurting whoever is holding them. But who?

If the stress test result data is anything to go by, German banks are the most exposed of Europe’s larger banks. Caution is required here, as the stress test sample excluded medium and small banks, plus this is trading book data and positions will have changed. Caveats in mind, nine of the 14 German banks to be stress tested had exposure to Irish and Portuguese sovereign debt, totalling €4.1bn.

WestLB, Espirito Santo, Santander and RBS were easily the most exposed to the sovereign debt of both countries combined; each had more than €1bn in exposure, mostly for Portugal. Caixa Geral, Credit Agricole, HSBC and SocGen each had more than $750m.

These data should be seen in context: Read more

Basel attendees have effectively raised the tier one capital ratio from 2 to 7 per cent. The package, popularly known as Basel III, sets a new ratio of 4.5 per cent, but also sets a buffer of 2.5 per cent, setting an effective buffer of 7 per cent. (Banks with capital ratios falling between 4.5 and 7 per cent will face restrictions on paying dividends and discretionary bonuses.) Changes will not be entirely phased in till 2019.

Had the stress tests required 7 per cent, rather than 6 per cent, 17 more European banks would have failed under the adverse scenario with sovereign shock (see column T1_AdvS, below). These are almost exclusively PIIGS banks – except for one Slovenian bank, and two German banks (Norddeutsche and Deutsche Postbank). Read more

Breathe easy: Luxembourg’s banks have performed well in a national stress test. The two larger banks, Dexia and KBC, performed well in Europe-wide stress tests earlier in the year, so you’ll be forgiven for having been quite unconcerned about the small state’s banking sector.

The scenarios were concocted a while back, it seems. Of the four shocks, falling property prices or falling EU GDP have the greatest negative impact on the banks’ capital ratios. The good news is that the ratios remain comfortably above 4 per cent in each case. The bad news is that the shocks are independent, and it is more than plausible that house prices would fall and growth reverse at the same time. After all, we’ve seen that before, quite recently. Read more

If a sovereign default had been factored into the recent stress tests, which banks would have failed and how severe would the contagion have been?

Not too many and not too bad, says the Peterson Institute. They used the sovereign holdings provided by 84 of the 91 banks to model an additional shock: namely, a Greek default. Researchers find bank collapses to be relatively limited – Greek banks collapse, predictably, as do those in Cyprus, but: Read more

*Updated to included the originally missing bank, Sunday 10.21am

The results are in. Complaints have already begun that the stress tests weren’t stringent enough, but with the handy table below, you can fashion your own stress test… just pick your preferred Tier 1 ratio and click the column heading to sort. Read more

Confirmation that PIGS banks are the riskiest of the stress test batch, according to credit default swap data – just as banks from two of these countries reveal capital-raising plans.

Sort the stress test banks on the column headings below to see for yourself. Markit has kindly provided five-year CDS data for as many banks as possible, plus the year-to-date change (in basis points). (Quick reminder: the higher a CDS spread, the greater the cost to insure against default, i.e. the higher the market-perceived risk. A 300bp spread means it would cost $30,000 to insure $1m.) Read more

Stress testing could become an institution in itself. Adair Turner has told reporters he expects authorities to move toward annual stress tests, which would be made public, and behind them tests of specific institutions running on a rolling basis. The head of the FSA also repeated his assertion that British banks would fare well under European stress tests, and that those tests would be sufficiently stringent. His reasoning, though, will not comfort markets.

First, Lord Turner describes the European tests as “adequate” rather than, say, “stringent”. And second, his confidence in British banks is founded upon private scenarios run by the FSA last year, which he describes as “more extreme” than those planned by Cebs, Reuters reports. Read more

July 23: stress test result day, right? Wrong. Consolidated results are now to be released on that date, with individual banks’ results delayed by two weeks. Cue a fortnight of frenzied speculation in the markets, as investors try to work out which banks are at the vulnerable end of anonymous bar charts and scatter plots. Presumably this has been done to allow banks more time to raise equity. But then, after two weeks of volatility, even some banks that have fared well will be needing it!

This decision seems to miss the point that stress tests are all about shoring up market confidence. Even bad results can be taken well by markets if investors believe the scenarios are accurate, transparent and really do consider the worst possible situation. Indeed, equity markets rose after the SCAP results from US stress tests last year. But then US markets could have the ultimate confidence in their banks, because the US government had pledged to bail-out any banks subsequently unable to raise funds through the markets. European banks – at this point – come with no such guarantee.

We’ve got details on purpose and sample, but methodology is thin on the ground. See the table: there are two scenarios and at least five variables, but only one of the ten resulting methods is supplied. Sigh.

The aim of the tests are described in the statement:
1) to assess the banks’ ability to absorb further shocks on credit / market risks, including sovereign risks;
2) to assess current dependence on public support (read: can we exit safely yet?) Read more

The data’s finally out. There are 91 banks. More to follow on methodology.