Banks in Europe fail stress test
Lahore, Islamabad, Karachi Thursday, December 09, 2010, Muharram 02, 1432
FRANKFURT: In the five months after the U.S. published results of its 2009 bank stress tests, the Standard & Poor's 500 Financials Index rose 25 percent.
The failure of the EU tests to restore confidence in the region's banks was underscored last month when Ireland directed its two biggest lenders, both of which passed the exams, to raise additional capital. Since July 23, when the results were disclosed, the average cost of insuring the senior debt of 110 European banks against default has surged 114 basis points, or 1.14 percentage points, more than 30 times as much as for the 34 largest U.S. banks whose credit-default swaps are tracked. Now, amid a widening European debt crisis, regulators from 27 nations are searching for ways to improve the tests, which will be repeated next year. That won't be easy as long as national leaders and central banks remain unwilling to cede bank oversight to a central authority, said Nicolas Veron, a senior fellow at Bruegel, a Brussels-based economics research group.
"Financial nationalism prevented the tests from being credible or really useful," said Veron, who's also a visiting fellow at the Washington-based Peterson Institute for International Economics. "Nations view the bank tests as a competitive game among countries and not as a way to ensure the common good of European financial stability."
To be more credible, the next bank tests need to take into account the risk of sovereign default --something not all nations may be willing to do, according to Peter Hahn, a former Citigroup Inc. banker who lectures on finance at Cass Business School in London. With European lenders holding 191 billion euros ($255 billion) of Greek, Irish and Portuguese debt, according to Goldman Sachs Group Inc., any restructuring of national debt could force banks to raise more capital. "The concept of European government default and the potential inability to backstop banks are the key issues for the markets," Hahn said in an interview. "Today, very few people have much confidence in their bank. Confidence is in the nation that backs up your bank, not in your bank."
Investors have less confidence in European banks than in their U.S. competitors. The price-to-book ratio of the 50 largest European banks is 0.76, compared with 0.97 for the top 50 U.S. banks, Bloomberg data show. That means the market value of European lenders is on average only 76 percent of the value of their assets, suggesting investors don't believe banks' assets are worth what they say they are. In 2007, the ratios for European and U.S. banks were 2.15 and 2.14.
Using stress tests to calm markets is "an abuse of the technique," said Simon Gleeson, a financial regulatory lawyer at Clifford Chance LLP in London.
"Stress tests are a useful tool if they are used by people who know how to interpret the data well," Gleeson said. "Properly conducted stress tests require a wide variety of scenarios and possible outcomes with no simple answers." The European Central Bank --the regional counterpart of the U.S. Federal Reserve --isn't responsible for bank supervision. Instead, the exams were coordinated by the Committee of European Banking Supervisors, a London-based forum for national regulators that will be renamed the European Banking Authority Jan. 1. -PB News