 Many have been curious to see the results of so called stress tests applied to a selected group of European banks. It is curious to see why such tests were carried out now and not at the time of Lehman demise in 2008 but then it must be the politics of the exercise dictated otherwise. The general opinion was that the tests were nothing more than an expensive PR exercise meant to calm waters with investors who have been inundated with knee-jerk reactions from the finance sector. Less than ten percent failed the test. On the 23rd of July the results of the stress tests on 91 European banks from all EU member states were released by the Committee of European Banking Supervisors.So what is the mix of the 91 banks which were so lucky.
The mix includes 26 major cross-border banking groups in Europe, which are followed by CEBS in its work on regular micro-prudential risk assessment, but also covers 65 other predominantly domestic credit institutions .
Is it surprising that seven of the 91 European banks have failed the test included five Spanish banks - Diada, Espiga, Banca Civica, Unnim and Cajasur- as well as the German bank Hypo Real Estate and Greece’s ATEbank. These five Spanish banks that failed, out of 27 tested, were regional savings banks, which racked up heavy losses following the collapse of the Spanish property market.
One may ask how are the European banks that were chosen to parade on the stress carousel. This was the task of the Committee of European Banking Supervisors (CEBS) that was mandated by the ECOFIN of the European Council to conduct in cooperation with the European Central Bank the European Commission and the EU national supervisory authorities a stress test exercise. The scenarios are designed as “what-if” situations reflecting extreme assumptions, which are therefore not very likely to materialise. The test focused mainly on credit and market risks, including the exposures to European sovereign debt. It’s focus is on capital adequacy; liquidity risks were not directly stress tested. Put simply the design of the test assumes a mild recovery from the severe downturn of 2008-2009, whereas the adverse scenario assumes a “double-dip” recession. The overall objective of the 2010 stress tests was to reassure investors over the health of Europe’s financial sectors and thus to assess banks’ ability to survive future economic shocks on credit and market risks.
The stress test has been conducted on a bank-by-bank basis, using bank’s specific data and supervisory information. The most severe scenario which was tested assumed a “double-dip” recession over the next two years, as well as a sovereign debt shock. The seven mentioned banks which failed in this scenario due to the fact that it was deemed that their tier one capital ratio would fall below 6%, the threshold set for the test. According to a spokesman of the Committee of European Banking Supervisors (CEBS) this threshold should not be interpreted as a regulatory minimum neither as a capital target reflecting the risk profile of the institutions, because banks which are supervised in the EU need to have a regulatory minimum of 4% tier one capital. This implies that failing to meet the 6% threshold do not mean a bank is insolvent. So what happens now?
It is expected that the seven failed cases will be closely monitored by the competent national authorities who are in close contact with the banks in question to assess the implications, in particular any potential need for recapitalisation. Naturally, the banks are expected to propose a plan to address the weaknesses that have been revealed by the stress test. The plan will have to be implemented within an agreed period of time, in agreement with the supervisory authority. Back to Malta it was BOV’s turn to be chosen. BOV’s capital ratio, which is an international indicator of balance sheet strength was found to be well above the 6% threshold, amounting to 9.3 per cent due the bank’s strong capital buffers. Likewise HSBC Malta plc took part in this exercise, but as a part of HSBC Holding plc, its parent institution, and the stress tests were conducted by the authorities in the United Kingdom.
According to the FSA this resilience of British banks is a result of the considerable work that has been undertaken to strengthen UK banks in recent years. However in Britain the mood is sober as it prepares itself a sea change in banks regulation Gone are the days when the FSA ( typically see our own MFSA style ) rules the roost. The government is dismantling the FSA and giving the Bank of England control of macro-prudential regulation and oversight of micro-prudential regulation. It will create a new Financial Policy Committee within the Bank of England. which will return as the top regulator after 10 years of Labour rule. It will create two new regulators. The first, a Prudential Regulation Authority, will be charged with regulating banks and other financial institutions, and will operate under the Bank of England. The reformed system will assure investors that in a crisis, it is the FSA that is supposed to spot that a bank is failing. The Bank of England then decides what to do about it, and the Treasury takes decisions to do with public funds and is the body that nationalises banks if necessary.
The second institution that will be introduced will be a new Consumer Protection and Markets Authority. All the new bodies will be responsible to parliament. The government says the transition to the new system will be completed by 2012. Hector Sants, the current chief executive of the FSA, will oversee the transition and will then head the new prudential regulator. Mr Osborne the British chancellor has also announced that an independent commission will look into the possible break-up of big banks. With the new banking commission looking at the competitiveness of financial institutions, the breaking up big banks will become a possibility. All this is happening in the aftermath of a serious EU-wide stress test exercise. However, the British Bankers’ Association (BBA) came out against the move being a strong lobby in favour of maintaining the status quo. It thus warned that “It is clear that other countries are in favour of universal banks and in the crisis they have been the most stable, with the so-called narrow banks being the ones that failed most. “ The lobby group argues that Britain as a modern economy requires banks of all types and sizes. Breaking banks up here would quickly be felt by individuals and companies who would pay more for their mortgages and finance.” The other side of the channel we find that continental banks have fared relatively well in the stress tests.
In Germany six of 14 banks did not disclosure their exposure to sovereign debt. The Financial Times reported that officials from Germany’s BaFin regulatory authority said the banks were not obliged to fully disclose their exposure under German law. Unsurprisingly it was Hypo Real Estate Holding AG which was rescued by the government following the global financial crisis was the only German bank failing the stress tests. Germany’s biggest bank, Deutsche Bank AG, as well as Commerzbank AG and Deutsche Postbank AG, all passed the test with flying colours . To conclude it was the banks in US who started the credit crunch in 2007 alongside with the sub-prime scandal. Hopefully they are now repentent athat the taxpayers have bailed them out and we shakll see some benefits from a reformed banking cohort who are less profligate and more ready to assist in helping the grass shoots to survive.
Julia Otto
Law and Finance Researcher
PKF Malta
An audit and business advisory firm
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