European banking regulators have claimed that the results of stress tests into the financial health of the EU’s biggest banks showed the resilience of the sector, despite the fact that seven institutions failed the tests.

The Committee of European Banking Supervisors (CEBS), made up of national banking regulators, this evening (23 July) published results of stress tests on 91 of the EU’s biggest banks.

Only seven were found not to have sufficient capital to withstand a new financial crisis.

These were Germany’s Hypo Real Estate (HRE), five Spanish savings banks (<!– @page { margin: 0.79in } P { margin-bottom: 0.08in } –Diada, Espiga, Banca Civica, Unnim, Cajasur) and the Agricultural Bank of Greece (ATEbank). They have a collective capital shortfall of €3.5 billion.

Giovanni Carosio, chairman of the CEBS, said the tests proved that the banking sector could handle a “very severe” level of stress.

Vítor Constâncio, the vice president of the European Central Bank (ECB), said that the tests were “a big contribution to financial stability in the EU”. “They show the resilience of the EU banking sector,” he added.

The exercise assessed how European banks would cope with a severe financial shock. The 91 banks account for 65% of the EU banking sector’s total assets.

The CEBS, the ECB and the European Commission emphasised that the seven banks that failed the tests should not be seen by the markets as being at risk of insolvency, as the scenario tested during the exercise was extreme.

Fact File

‘An important step forward’

The European Central Bank (ECB) said that the results of
the stress-test exercise confirmed “the resilience of EU and euro area
banking systems to major economic and financial shocks”, and represented
“an important step forward in supporting the stability” of Europe’s
banking sector.
 

The ECB said that each of the seven banks that failed
Click Here: Cheap FIJI Rugby Jersey
the test should “take the necessary steps to reinforce its capital
position through private sector means and by resorting, if necessary to
facilities set up by member states”.

Guy Verhofstadt, leader of the Alliance of
Liberals and Democrats for Europe group in the European Parliament,
said the
publication of the stress tests was a “vital step to reassuring the
markets of the health and sustainability of the European financial
sector”.

He said it should “lay the foundations for sensible and solid
investment plans over the next few years that can lead EU countries out
of recession”. 

Verhofstadt added that member states had to put in place recapitalisation plans for
banks which failed to show they had the capital to cover their
liabilities.
 

However, they said that the seven should “take the necessary steps to reinforce their capital positions” to reassure the markets that they are safe from insolvency.

They said that the banks would, ideally, do this through private means, but could, if necessary, rely on state support. They added that the banks should make the necessary arrangements in a reasonable timeframe.

Marco Buti, the Commission’s director-general for economic and financial affairs, said that the Commission could quickly approve any requests by national governments to provide state aid to the seven banks that failed.

The tests were based on two scenarios: a ‘benchmark’ scenario and an ‘adverse’ scenario.

The benchmark scenario assumed a mild recovery from the downturn of 2008-09 while the adverse scenario assumed a double-dip recession with economic output shrinking in 2010 and 2011.

The adverse scenario included a drop in growth of the EU’s gross domestic product in 2011-12 of three percentage points compared to current forecasts, and a sharp increase in interest rates.

The scenario also assume a sovereign debt crisis in the eurozone, with banks facing a haircut (or reduction) of an average of 8.5% in the value of government bonds.

To pass the test, a bank’s tier 1 capital ratio (a measure of financial strength) had to stay above 6%. This is higher than the 4% regulatory minimum set by current EU law.

The CEBS said that, under the adverse scenario, the 91 banks’ capital would fall by a cumulative €566 billion in 2010-12. It said that the banks’ aggregate tier 1 capital ratio would fall from 10.3% to 9.2%.

EU leaders agreed in June to publish the results of the stress-test exercise, begun in March, in order to reassure financial markets that banks were not hiding the true state of their losses as a result of the financial crisis. The case for publication was pushed strongly by the Spanish government, as some of its banks, especially the savings banks (cajas) were struggling to borrow money because of market concern about their financial health.

Investors are likely to criticise a decision by the CEBS not to test how banks would be affected if an EU member state defaulted on its debt. The euro fell against the dollar in trading today in response to concerns that the tests would not properly assess the risks posed by banks’ holdings of sovereign debt.

The CEBS said that it had not included a sovereign default in the exercise because recent measures taken by the EU, notably the creation of a €440 billion financial stability facility, had made such a scenario effectively impossible.

“The measures taken in Europe lead to our conviction that, on the basis of those measures, there will be no default,” Constâncio said. He said that it would have been “totally self-contradictory” for the EU to have included a possibility for default in the exercise.

Constâncio also said that markets would be able to make their own assessment of how the banking sector would react to a sovereign default, as banks had agreed to publish details on their holdings of government debt alongside the stress-test results.

The US government carried out a public stress-test exercise last year that is widely regarded as being successful in restoring confidence in the banking sector and aiding the US recovery from the financial crisis. It revealed that ten of the largest US banks needed a combined $74.6bn (€58.06bn) to protect themselves from default in the event of a sudden financial shock.

“I think these stress tests are more extensive, more severe, than have been conducted in [other] developed countries on such a scale,” Constâncio said.

He said that the ECB foresaw a 5% probability of the scenario coming true, whereas the US exercise had been based on a 15% probability.