European leaders have been eager to show nothing but optimism as Friday's release of stress tests results on euro zone banks looms. Central bank leaders and financial ministers from Portugal to Greece have publicly insisted that their banks are not in trouble, with some even providing a sneak preview of the results, claiming that their country's banks will pass with flying colors.
That, though, say an increasing number of analysts, could ultimately be a problem. Should too many banks pass the stress tests, they say, confidence in the stress tests themselves could be undermined, thus doing little to shore up an anxious European financial sector. "The fact that a number of governments are optimistic is not such good news," Marie Diron, a senior economist with the consulting group Oxford Economics, told SPIEGEL ONLINE. "If all banks pass, then it shows that the tests were not drastic enough."
That, though, say an increasing number of analysts, could ultimately be a problem. Should too many banks pass the stress tests, they say, confidence in the stress tests themselves could be undermined, thus doing little to shore up an anxious European financial sector. "The fact that a number of governments are optimistic is not such good news," Marie Diron, a senior economist with the consulting group Oxford Economics, told SPIEGEL ONLINE. "If all banks pass, then it shows that the tests were not drastic enough."
The fact that several European banks are facing difficulties, said Diron, is well-known. Should that not be reflected in the test results, scheduled to be released as soon as markets close on Friday, she said "I think markets would respond negatively to that. They would treat the tests as insignificant."
'At Best, a Sham'
A report in the Wednesday edition of the German business daily Handelsblattseems to indicate that the fear is not an idle one. Of the 14 German banks to have been tested, only one reportedly failed: the notoriously troubled Hypo Real Estate (HRE). The bank has already been nationalized through €102 billion ($104 billion) in infusions from Berlin's bank bailout fun and is expected to transfer €210 billion worth of toxic debts into a government-backed "bad bank" in the coming months. Prior to the tests, there had been much speculation surrounding the health of Germany's Postbank as well as its numerous, troubled state banks. All of them, according to the Handelsblatt, passed with flying colors.
"The stress tests are, at best, a sham," Bert Flossbach, head of the wealth management firm Flossbach & von Storch, told the newspaper.
"We already knew that HRE was failing," seconded Diron.
German Chancellor Angela Merkel on Wednesday sought to play down the criticism of the stress tests. Speaking at her final press conference before the summer holidays, Merkel said that "when balanced against the situation we find ourselves in, the criteria used in the stress tests are very real." She said it had to be kept in mind that Europe has already established a bailout package for Greece as well as a European fund should additional European countries run into sovereign debt troubles. The tests are being carried out by the Committee for European Banking Supervisors, which includes representatives from all 27 European Union member states, and are supposed to indicate how banks might cope with a variety of stressors, from a sharp economic downturn to a Greek bankruptcy. A total of 91 institutions are being tested, 14 of them in Germany. Euro zone leaders hope that the stress test results will reduce market jitters related to the sovereign debt crises run into by countries like Greece, Spain and others. Inter-bank lending has slowed as institutions have become wary of each other, fearing that a national bankruptcy could bring some highly exposed banks down with it.
Consistent Message
Exactly what criteria are being used has been a matter of some speculation. In particular, some analysts have expressed doubts about the degree to which a Greek default has been tested. It has been widely reported that banks were asked to factor in a 17 percent reduction of their holdings in Greek bonds -- the kind of across-the-board cut referred to in the industry as a haircut. Whether that is severe enough remains a matter for debate. "One of the primary uncertainties is about haircuts," Diron said. "It seems that the assumptions that have been made are not what is currently priced in the market."
Additionally, there is some doubt that European leaders have plans in place to provide additional capitalization to those banks which fail the stress tests. According to a story in the New York Times, Credit Suisse estimates that public-sector banks in Europe, including German state banks, the so-calledLandesbanken, and Spanish savings banks, may need up to €90 billion in extra capital.
Still, much depends on how the results of the stress tests are made public on Friday. Central bankers and regulators across the continent will do their best to ensure that the message is consistent across the euro zone. And that enough information about the tests is made available quickly.
"The ideal outcome," said Diron, "is that a few banks fail, but not too many so it's not too disruptive. Then governments should quickly announce what they plan to do."
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