The European Banking Authority has published the results of its 2011 stress test of 90 banks in 21 countries in the Euro-area.  While the aim is “to assess the resilience of the banks involved in the exercise against an adverse but plausible scenario,” it is not as if there will be at least some skepticism here over this.  The EBA allowed specific capital increases during the first four months of 2011, and as a result more banks passed this round of stress tests than would have at the end of December-2010.

There is one primary concern here, above and beyond whether the criteria is tough enough: this only takes us through the end of April, and the biggest blow-ups in Europe and the biggest fears have all been since then.

We also note that this incentivized the banks to bolster their books rather than these banks getting a review as-is.  Slimming up the PIIGS before the beauty contest.  The EBA has also issued its first formal recommendation stating that national supervisory authorities should require banks whose Core Tier 1 Ratio threshold falls below the 5% level to promptly remedy their capital shortfall.  One key admission is that the EBA noted: “this is not sufficient to address all potential vulnerabilities at this point.”

At the end of 2010, there were 20 banks which would have fallen under the 5% Core Tier 1 Ratio threshold over the two-year horizon of the exercise and the overall shortfall would have come to 26.8 billion euros in total. The banks raised about 50 billion Euros in the first four months of this year.

As of the end of April, 8 of these banks fall under the 5% Core Tier 1 Ratio threshold over the two-year time horizon, but that is stated as an overall Core Tier 1 shortfall of 2.5 billion euros.  The breakdown is 5 failed in Spain, 2 in Greece, and 1 in Portugal.

It was also noted that 16 of these banks displayed a Core Tier 1 Ratio threshold of between 5% and 6%.  Of those which “barely passed” those were 2 in Germany, 2 in Greece, 2 in Portugal, and 7 in Spain.  All of the Dutch, French, UK, and Italian banks passed.

An additional recommendation is that the EBA believes that national supervisory authorities should request that all banks whose Core Tier 1 threshold is above but close to 5%, and which have sizable exposures to sovereigns under stress, to take specific steps to strengthen their capital position.  Recommended actions should include restrictions on dividends, deleveraging, issuance of fresh capital, or conversion of lower-quality instruments into Core Tier 1 capital.  We have one question… Recommend?  That should be demand, particularly with what we have seen in May, June, and July.  Progress reports will be given by the EBA in February and July 2012.

While EBA noted, “The 2011 EU-wide stress test provides an unprecedented level of transparency on banks’ exposures and capital composition to allow investors, analysts and other market participants” we do wonder if these can really be taken that seriously.  Actually, “wonder” is being very generous with the use of terms.

The full aggregate report is here.  Unfortunately, if you look at Page 6 of the Methodological Note you can see that the assumptions of the credit ratings are likely to change and some have already changed.  Go back to our WHO IS REALLY ‘AAA’ RATED piece from earlier in the year and you can see how rapidly this has changed even from then with the outlook warnings in the United States.

JON C. OGG

Thank you for reading! Have some feedback for us?
Contact the 24/7 Wall St. editorial team.