Saturday, July 24, 2010

Stress Test For European Banks : Not So Stressful Though

On 23rd July 2010 results of  Stress Test for 91 banks of the European Union were declared. Of these 91 banks only seven banks failed the stress test. And Spanish banks topped the list with maximum number of failures. Five banks from Spain, one bank from Germany and one from Greece comprised the list of seven failed banks.

One year back similar Stress Test was conducted in US for 19 of its banks. Out of 19 US banks, ten banks failed the stress test conducted in May 2009. It was estimated that these banks would require an infusion of $75 billion to be credit worthy in case of another depression. That was stressful. But here when there is concerns of Sovereign Debt Default in European continent there are only seven banks out of 91 tested which failed. Estimated requirement of capital is just $ 4.5 billion to cater for any rude surprises by way of economic downturn. Isn't it wee bit surprising? It only points to a fact that the tests were not conducted rigourously. The rules applied to test the banks have been lenient. That's the only explanation one can offer.

Stress Test is like an X-ray. It tells us where all the banks and banking system have to be repaired in order to be strong enough to withstand an economic tsunami. In times of trouble if the banks fail, then what is left to bank upon for common citizens of a nation? But the European Union passed off this opportunity to find precautionary measures to safeguard itself against another economic downturn. If the doctor doesn't diagnose the patient correctly then how on earth can you prescribe the right medicine? Critics are  already saying that the stress tests on European banks were so easy that even Lindsay Lohan would have passed it.

So what could be the reason that European Union opted for losing credibility for its banks in the eyes of global investors? The tests were intended to reassure investors and help ease pressure in bank funding. This was urgently required since Sovereign debt crisis in many European nations undermined confidence in the banking system. Has the European Union achieved that goal with a Stress Test bereft of stress? I wonder not!! US investors have already lost faith in the European Banks as is evident from investment data available from various Mutual Funds. For the last two years exposure in European Banks has been drastically reducing in portfolios of US Fund Managers. Some have reduced it by as low as 60 to 80%. On top of that, this Stress Test has evoked some very caustic remarks from US Fund Managers.

Charles de Vaulx, a portfolio manager at International Value Advisers LLC said the stress tests would not change the firm's outlook on European Banks. "We find the European banks still under capitalized," de Vaulx said. "The lack of a test for sovereign risk means the test was too soft and not credible." After announcement of stress test results US markets shrugged off the results as a non event, and marched northwards on  expectations of better corporate earnings.