Inside Bank Stress Tests

Inside Bank Stress Tests
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So what is it that the European Banking Authority has been doing?

The EBA has tested about 90 of Europe’s top lenders, on how they would react to severe but plausible economic shocks, like market shifts or sovereign debt problems such as those sweeping the continent.

The figures have been checked by staff and experts for quality and solid methodology.

But the announcement could not have come at a worse time for Europe’s stressed markets.

European Banking Federation spokesperson Florence Ranson said her organisation would rather see this exercise remain a confidential one in the future because of that influence on the markets.

She said it is also important to understand that the current criteria that are applied by the EBA go way way beyond the criteria of stress tests that are normally carried out between a bank and its supervisor.

Indeed, the criteria is tougher than last year. But even the EBA says there is no pass or fail. It says the tests are one part of a bigger picture.

National authorities must now assess the results in the context of the bank’s business model, the quality of its management and assets, and look at any other underlying risk factors. Only then will markets get the correct message.

Ranson stressed that markets and the public must always bear in mind that the stress tests are only one of a range of tools that are at the disposal of a banking supervisor to test the resilience of a bank, so the results must always be taken with a pinch of salt.

Stress tests have become an annual exercise, and these ones came at a difficult time. It remains to be seen whether Europe’s banks can expect the same again next year.

The European Banking Authority’s tests are just that — tests. But with today’s shaky markets, the test scenarios themselves risk becoming a reality.

To get a better picture, euronews spoke to Etienne de Callataÿ, chief economist at Banque Degroof and a graduate of the London School of Economics and the University of Namur. We asked him whether announcing the results right now risked throwing more fuel on the fire.

“Yes, because we know that these tests must be tough to be credible, but at the same time, anyone is capable of imagining an even worse case scenario. When you think that a restructuring of Greece’s debt only causes losses of around 20 percent – at a time when the financial markets are expecting much worse – it makes these tests seem almost nice, not to say patronising,” he said.

Last time the tests were conducted several Irish banks passed with flying colours. But a few weeks later, it was those banks who had the biggest problems. So what went wrong?

“Not all of the factors were taken into account,” de Callataÿ said.

“But today, what is important is sovereign debt. You can’t have an authority that comes up with a scenario that says that only about half of the Greek debt and the Portuguese debt and the Irish debt will be repaid, because that would only reinforce the possibility that this scenario might come true,” he went on.

“So we know they call the scenarios extreme, but they are not really, because that would only encourage them to actually happen. By presenting an extreme scenario, the authority could in fact make one more likely, and that would only cause more panic in the markets,” de Callataÿ concluded.

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