Europe's Financial Health Check: Concern of Stress Test Failures on the Rise

The planned stress tests of European banks could be tougher than first thought. According to a German media report, up to 15 percent of the European banks to be examined may fail -- even though the criteria for the tests have been watered down.

The skyline of Frankfurt, home to Germany's top banks. Zoom
AP

The skyline of Frankfurt, home to Germany's top banks.

The pan-European stress tests for banks won't be as easy to pass as previously thought, and 10 to 15 percent of banks assessed may fail them, German business daily Handelsblatt reported on Monday, citing an unnamed management board member of a large German bank.

More than 10 banks in Europe, including one or two in Germany, may fail the tests, the board member said. The results of the stress tests are scheduled to be published on July 23 to help reassure financial markets that Europe's banking system is strong enough to weather the euro debt crisis and the austerity programs launched to overcome it.

The executive told Handelsblatt that the tests needed to be credible in order to boost market confidence. The newspaper also cited unnamed financial sources as saying the tests were "not a show," and that they would simulate real challenges that banks might face. Analysts said one or two of Germany's Landesbanken, publicly-owned regional banks, might be found lacking.

The European tests will be conducted by national banking supervisors and will cover 91 banks. Markets have been increasingly concerned that some banks might be unable to cope with a sharp slowdown in economic growth resulting from the current wave of government spending cuts around Europe.

The tests model the impact on banks of possible economic scenarios. The Committee of European Banking Supervisors (CEBS) said on Wednesday it would test the banks to see how they would hold up if the economy deteriorated and the banks had to write off some of their sovereign debt holdings. The 91 financial institutions to be tested represent 65 percent of Europe's banking sector.

"Passing" would suggest a bank could withstand the stress scenario, while "failing" would imply it needs more capital to preserve core ratios in the scenario.

Are the Tests Too Soft?

The CEBS has not published its full methodology but the details of the methodology released so far have been criticized by analysts and finance experts who say the committee is not testing worst-case scenarios.

The Handelsblatt report came as a surprise after SPIEGEL learned that banks reacted with relief when they were told the details of the planned tests by their respective supervisory authorities last week.

According to SPIEGEL, the 14 German banks being tested have little to fear because the criteria for the tests were watered down in hectic negotiations between the European Central Bank, the European Commission and European banking watchdogs.

In the strictest of three stress scenarios, the impact on banks of an economic slump together with a simultaneous crash in European government bonds is simulated, according to SPIEGEL.

Some Details of Tests Have Leaked out

Banks are told to factor in a 20 percent slump in the value of Greek government bonds, as well as drops of 11 percent for Portuguese bonds, 8.6 percent for Irish bonds, 6.7 percent for Spanish bonds, 4.9 percent for Italian and 2.3 percent for German bonds. But the banks only need to calculate the impact of such losses if they keep the bonds in their short-term trading books, not if they hold them as long-term investments.

Europe agreed to bank stress tests after US President Barack Obama urged fellow G20 leaders to follow Washington's lead and do more to address lingering uncertainty over the balance sheets of their banks. US regulators had published bank stress tests last year and the move had been credited with calming market fears.

Euro zone finance ministers meeting in Brussels on Monday and Tuesday are expected to discuss the policy response countries will take if the tests show problems, an EU source told Reuters last week.

European Central Bank President Jean-Claude Trichet on Friday reiterated the crisis was not over and banks should remain open to accepting help.

In a research note, Credit Suisse said German Landesbanken may have to raise up to €37 billion as a result of the stress tests. Spanish savings banks, which so far have partaken of €11.2 billion from the country's restructuring fund, would also need another €12 billion in a scenario where the economy weakened sharply and discounts were required on sovereign debt, the note said.

cro/With reporting by SPIEGEL Staff

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