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Why stress tests were needed

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Why stress tests were needed


The background to the stress tests included catastrophic events like the collapse of Lehman Brothers investment bank in September 2008 which was followed by a near meltdown of global financial markets.

Bad loans from so-called subprime mortgages helped bring down Lehman Brothers.

A year earlier UK lender Northern Rock had had to be bailed out the British government.

As bank customers fretted France’s Nicolas Sarkozy made a pledge. He said: “Whatever happens, the state will guarantee the security and the continuity of the French banking and finance system”.

The financial crisis was followed by the sovereign debt crisis amid fears that European governments – particularly Greece – would not be able to repay the money they’d borrowed.

To reassure the markets, the health of Europe’s banks was tested to see how they might cope with future crises.

The tests covered a total of 91 banks of varying sizes and types in 20 countries including their subsidiaries outside Europe.

They account for 65 percent of the EU’s banking sector in terms of assets.

Individual countries banking supervisors administered the tests coordinated by the Committee of European Banking Supervisors in London.

The first scenario was based on existing forecasts for EU economic growth until the end of next year.

The second imagined a double dip recession hitting Europe and the third added a fall in the value of the sovereign debt of peripheral euro zone countries like Greece, Spain and Portugal.

The tests were an attempt to restore confidence in the region’s banks and follow on from a similar exercise in the United States last year.

Economist Klaus Abberger the Ifo economic think tank explained: “The banking sector is one of the risk factors for future economic development and if we succeed in establishing transparency and implementing measures to support weak banks then this surely is a big step forward.”

The Committee of European Bank Supervisors said its test was more severe than the US health check of its banks.

But some in the financial markets have criticised it as not being rigorous enough.

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