Stress tests conducted in July found that most of Europe’s large banks were financially healthy. As Dow Jones reports, some critical factors were not taken into account. The news service writes, “the tests didn’t take full account of what would happen to bank capital if a euro-zone government goes through a major default.” This is a stunning admission because defaults on sovereign paper are the greatest threat to the region’s credit system.
The notion that a new round of stress tests would comfort investors is preposterous. Capital markets experts know that a likely default of Greece is only weeks away. Even a refinancing of its debt would mean many banks probably have to take write-downs. And contagion, to the extent that it is a risk, could cause defaults in Portugal and, much less likely, Italy.
It would not take a series to defaults to wreck the balance sheets of some large European banks though. A catastrophe in Greece could do that on its own.
The best test is whether countries, especially Germany and France, will stand behind their banking systems. That is the only important question, one which neither country’s government will answer. To do so would be an admission that a Greek default is possible at all. Such an assurance would convince capital markets that the stated support of Greece by the German and French governments is hollow, particularly if Greece cannot cut expenses to meet EU and IMF goals.
Bank stress tests are useless because they will come too late. The sentiments of Germany and France about how they will support their banks will not come until their banks are pushed to the brink.
Douglas A. McIntyre
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