No Greek Risk In EU Bank Stress Tests

A test is only as useful as what it tests for. The European Banking Authority is about to release stress tests on 91 large banks in the region. What the results will not contain is the exposure of the financial institutions if Greece is thrown into default should the IMF, EU, and private shareholders cannot agree on a rescue package.

“The sovereign debt default problem is the depth charge to the credibility of this exercise,” Bob Penn, financial-services partner at Allen & Overy LLP said according to Bloomberg. “There’s nothing the EBA can do about that because it’s politically unthinkable.” That said, the exercise is barely useful at all.

Stress tests are always limited because those who create them know that they can only collect a very limited amount of data about banks. Large financial firms have remarkably complex balance sheets. Only so many contingencies and scenarios can be put into even the most complex model. But there are some measurements that are critical. And among EU banks it is the amount of sovereign debt holdings. Also critical are any assessments banks have made about the damage a Greek default would have on them. Those measurements and assessments would also have to be extended to Ireland, Portugal and Spain at the very least.

It is amazing that banks, as well as those who have created the tests, would risk the fate of the capital and credit markets because they refuse to disclose data that might reveal weaknesses. Better to know which banks are weak now and fix them, even if it costs their shareholders some considerable amount of  investments and some bank officials their jobs. That happened in the U.S. after the credit crisis. Some CEOs and boards were dismissed because they either did not see or refused to acknowledge balance sheet risks as the mortgage crisis began.

The results of the EU bank stress tests are already known. They will become public shortly, to the extent that the banks and regulators have compromised on what can be revealed and what cannot. The insistence of banks to control a large part of the process makes the results less than useful. Whatever warning signs the data might have provided are already lost even before the reports have been seen by anyone beyond regulators–and the banks.

Douglas A. McIntyre