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19th July 2011

The lesson from the European stress test.
Opinion

Market players, observers and media have struggled to offer conclusions following the European stress test. Before discussing the conclusions first is a summary of the results. The banks that failed were:

Austria : Oesterreichische Volksbanken AG

Greece : Agricultural Bank of Greece (ATE) and EFG Eurobank Ergasias SA

Spain : Banco Grupo Caja3, Banco Pastor SA, Caja de Ahorros del Mediterraneo, CatalunyaCaixa and Unnim.


As discussed previously Landesbank Hessen-Thueringen (Helaba) would have failed except it withdrew from the process. The fact a bank can withdraw from the process appears strange to many. As its shareholders are the state of Hesse and the local savings banks it can be argued that its inclusion or exclusion are of less direct importance. The argument over the inclusion of silent participation or not - could attract EC interest however. The bank argues that as the state has given an explicit guarantee then the bank cannot be other than solid. However this same guarantee could be seen as unfair state aid and draw action from the European Commission Competition Commissioner, as WestLB has done so before. Spain too argues that some of the capital instruments used in Spain should have been included by the EBA.


When it comes to the banks who marginally passed - those with over 5% and under 6% Core Tier 1 capital some bigger names appear - Banco Comercial Portugues, Espirito Santo Financial Group, HSH Nordbank AG and Norddeutsche Landesbank. Both Portuguese banks have plans to boost capital. The Germans' continue to complain over the exclusion of silent participation, fighting a battle already lost in regard to Basel III implementation.


Much has been written about the assumptions in the stress test with regard to a Greek default. Most commentary entirely misses the point, the fact is that other than for Greek banks, and possibly Cypriot banks Greece defaulting would not be a major calamity. Even if there was total default by Greece the effect would be:


End 2010 Greek Sovereign Debt €98.2bn Greek Institutional Debt €17.2bn
Exposure Sovereign Institutional Combined exposure
of banks in % % €bn
Cyprus 7 12 8.9
France 8 5 8.7
Germany 9 10 10.6
GREECE 67 69 77.7

The only argument that can be put forward over the seriousness, in continental terms of a Greek default, is those suggesting a domino effect, that pressure would then move on to the next weakest and the next weakest after in turn. Whilst this is potentially something that will have to be addressed at EU level the effects are so far into the unknown it is not reasonable for the EBA stress test to even begin to model.


So, perhaps the lesson from the European banks stress test is that the designers of it may have been a little cleverer than they have been given credit for. What the EBA may be successfully doing is forcing the increase in capital gross amount and in quality of capital at a pace well ahead of the Basel III timetable and at the fastest pace it is possible to proceed, at without having major countries refuse to participate. Thus helping derisk European banking relating to one of the key risk dimensions.