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Euro Bank Stress Tests
Questions & Answers
Which banks will undergo stress tests?
The European stress test will conduct tests on 91 of the regions
banks which comprises of around 65% of the European banking sector.
The banks tested will range from Germany's Deutsche Bank to Malta's
Bank of Valletta. They will include seven of Germany's eight
regional landesbanks and all of Spain's 19 cajas, or unlisted
savings banks, will be included. Banks in each EU country will be
tested to give a complete overview of the sector.
How will the stress tests work and what will they
show?
The stress tests will be coordinated by the Committee of European
Banking Supervisors, a London-based umbrella group for financial
supervisors. They will simulate how banks cope with financial
pressures on their loans and other assets in a worsening recession.
The tests will assume a 3 percentage point deviation of the EU's
gross domestic product from the European Commission's forecasts
over a two-year period. It will also assume a "sovereign risk
shock" in which some government bond prices would be marked down
further from the depressed levels of May.
Banks will be tested on how their so-called Tier 1 capital, a key
measure of financial strength, bears up against these assumptions.
The ECB wants to see if the ratio of this capital to assets stays
above a minimum benchmark of 6% of assets in the tests. Although
this is higher than the 4% legal minimum, it is lower than most
bank shareholders are confident with. Deutsche Bank, for example,
now has an 11% benchmark of assets. For Europe's biggest banks, the
results are not expected to reveal serious problems. Since the
global credit crisis of 2007-2009 they have strengthened themselves
against many eventualities and have retained their ability to raise
funds from the private money markets.
There is much more concern about the possibility of serious balance
sheet weaknesses being discovered among smaller, second- and
third-tier banks, such as the landesbanks and the cajas. For
example, many believe the state owners of Germany's landesbanks
have not revealed the full extent of their problems.
However, officials from the ECB and EU governments have insisted
that the stress tests will show the European banking system is
fundamentally healthy.
When will the results of the stress tests be
released?
The outcome of the tests will be published on Friday 23rd July,
with results for some subsidiaries of large banking groups coming
about two weeks later. It is not clear where the results will be
published and whether they will be released in one lot or by
national regulators.
Will the stress tests have a positive influence and
reassure the markets?
A limited number of stress tests were conducted on a small number
of European banks last year, the results of which were not released
for individual institutions, but they failed to reassure the
markets. This time, the tests appear to be focused on transparency,
similar to stress tests of US banks conducted during the global
crisis. Those tests did succeed in improving investor confidence.
Once the test results are out, investors will want to see national
governments are willing and able to act quickly to resolve any
problems that have been uncovered, if banks are unable by
themselves to raise enough capital from the markets. ECB officials
have urged countries to make sure they have emergency financial
safety nets in place to prevent any disorderly failures of banks
that do not meet the 6% capital benchmark in the tests. Given the
complexities and uncertainties in bank balance sheets, it is
possible that the markets will not be entirely reassured until
economies around Europe return to a strong, self-sustained growth.
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