EU Stress Tests Will Cover 91 Banks, Assume Bond Value Drop

By Ben Moshinsky - Jul 7, 2010


European Union regulators are carrying out stress tests on 91 banks, accounting for 65 percent of the area’s banking industry, to examine whether they can withstand a shrinking economy and a drop in government bond values.

The lenders being tested include 14 from Germany, six from Greece and four from the U.K., the Committee of European Banking Supervisors said in an e-mailed statement. EU banking regulators have told lenders that their planned stress tests may assume a loss of about 17 percent on Greek government debt and 3 percent on Spanish bonds, according to two people briefed on the talks.

“This sounds like the softest option possible,” said Stephen Pope, London-based chief global equity strategist at Cantor Fitzgerald. “If that is the indicator how stringent the stress tests will be, then they aren’t worth too much.”

Regulators are counting on the tests to reassure investors that banks have enough capital to withstand a debt default by a European country. U.S. bank stocks rebounded last year after government analysis of their balance sheets found that 10 lenders needed to raise $74.6 billion of capital.

EU leaders have pledged to disclose the results of the tests, showing how individual banks would hold up to economic and market shocks, by the end of July. CEBS is working with the European Central Bank on the tests.

CEBS’s role is to coordinate national banking authorities and make policy recommendations to the EU on regulation. The London-based regulator is working with the European Central Bank on the tests. An ECB spokeswoman declined to comment.

Sovereign ‘Deterioration’

The adverse scenario being tested “assumes a 3 percentage point deviation of GDP for the EU compared to the European Commission’s forecasts over the two-year time horizon and a “deterioration of sovereign risk” from early-May government bond values, according to the CEBS statement.

The commission has said it expects the EU’s economy to grow by 1 percent this year and 1.7 percent next year.

The results will be disclosed “both on an aggregated and on a bank-by-bank basis, on July 23,” CEBS said. The agency didn’t specify scenarios for so-called haircuts on European sovereign bonds.

Greek Bonds

Credit markets are pricing in losses of about 60 percent on Greek bonds should the government default, more than three times the level said to be assumed by CEBS. Derivatives known as recovery swaps are trading at rates that imply investors would get back about 40 percent in a Greek default or restructuring.

The tests originally covered only big cross-border lenders, later broadening out to include smaller EU banks such as Spain’s savings banks, known as cajas.

German Landesbanken such as Bayerische Landesbank, Landesbank Baden-Wuerttemberg and WestLB AG, and Spanish cajas are undergoing the tests. Landesbanken are owned by regional governments and groups of savings banks.

Billionaire investor George Soros said it would be impossible to judge the state of the European banking industry without including “the smaller banks, notably the cajas in Spain and the Landesbanken in Germany,” in the stress-testing exercise, during a speech in Berlin on June 23.

Banks including Spain’s Banco Santander SA and Bankinter SA, as well as Deutsche Bank AG, Commerzbank AG and HSH Nordbank AG, are also involved in the stress testing.

The U.K. banks being tested are HSBC Holdings Plc, Lloyds Banking Group Plc, Barclays Plc and Royal Bank of Scotland Group Plc. BNP Paribas SA and Societe Generale SA are among the French banks under examination.