Like final-year high school pupils, Europe’s investors, bankers and regulators are on tenterhooks ahead of the release on Friday of the results of stress tests on 91 European banks. The kids have to take the results seriously. The adults, however, are placing too much faith in the outcome of an exercise designed as much to reassure as to illuminate. Take Hypo Real Estate, which it now appears will fail the tests. This is an institution rescued by the German government two years ago and the beneficiary of €7.9bn of fresh capital and more than €100bn of liquidity guarantees from the taxpayer. The stress tests need to do more than confirm that an already failed German bank is a failed German bank.
Which begs the question of what investors should expect from the stress tests. The secrecy and hesitancy of the Committee of European Banking Supervisors have not helped. Most of the banks will pass simply because the bar has been set low. Any bank that would fail to survive a recession three percentage points more severe than the European Commission’s average two-year forecast – the CEBS’s adverse scenario – should not be in business.
The tests could be worthwhile, however, if they allow Europe’s banks to draw a clear line under a terrible period. They will be able to do this only if the tests are rigorous and the results fully transparent and understandable. Ideally, some banks – and not just the HREs of this world – will fail. Those that do fail, probably public sector banks, must launch credible recapitalisation plans backed by their governments. JPMorgan Cazenove estimates total potential capital needs of €40bn.
Last year’s US stress tests boosted confidence in the US banking sector. If the European equivalent can do the same for European banks, rather than telling investors what they already know, it will be worthwhile.
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