European banks await test results

Regulators are looking at some 91 banks, including Europe's largest, to see if they can absorb another crisis. The test has some skeptics.

By Charley Blaine Jul 21, 2010 1:04PM
Coming Friday is something investors should pay attention to: stress-test results on 91 European banks.

Reason: Many of the big European banks do a lot of business in the United States and are looking to do more -- if their finances permit.

The list of banks being tested includes the largest multinational banks in Europe: HSBC (HBC) and Barclays (BCS) in Britain, Deutsche Bank (DB) and Commerzbank (CRZBY)  in Germany, and Société Générale (SCGLY) and BNP Paribas (BNPQY) in France.

Deutsche Bank and Société  Générale have big Wall Street presences. Spain's Banco Santander (STD) has been expanding in the United States and Latin America

The goal of the test is to figure out which of the banks are in good operating condition and which would be in trouble in the event of a new crisis without raising new capital.

It's modeled in part on tests conducted last year on 19 big U.S. financial institutions. The test, while very controversial, helped build confidence that the U.S. banking system wasn't about to collapse.

The European test, conducted by the  Committee of European Banking Supervisors, is larger than the U.S. test. The committee includes representatives from all 27 European Union member states.

It will attempt to look at the banks under three scenarios, according to Bloomberg News:

  • Things are roughly as they are now or are likely to be in 2011.
  • The economy is pulling back (an adverse scenario).
  • A serious deterioration in the condition of sovereign debt. Bloomberg says a July 15 draft of a template of the results calls this the "sovereign shock" scenario. The Greek debt crisis caused enormous stress to European banks last spring.
In the last scenario, banks will publish their estimated losses on sovereign debt they hold in their trading book as well as "additional impairment losses on the banking book" that they may suffer after a sovereign debt crisis.

Under accounting rules, banks have to adjust the value of sovereign bonds held in the trading book according to changes in market prices, Konrad Becker, a financial analyst at Merck Finck & Co. in Munich, told Bloomberg.

For government debt held in the banking book, lenders must write down their value only if there is serious doubt about a state’s ability to repay its debt in full or make interest payments, he said.

The sovereign-shock scenario doesn’t assume a European nation will default, a source told Bloomberg. Instead, it will assume that rising government-bond yields will push up borrowing costs, spurring defaults in the private sector that would lead to losses in lenders’ banking books, the source said.

The committee coordinates national banking authorities and makes policy recommendations to the European Union on regulation.

The test is being used to reassure investors about the health of financial institutions from Germany’s WestLB and Bayerische Landesbank to Spanish savings banks as the debt crisis pummels the bonds of Greece, Spain and Portugal.

The test results come with some risks. Der Spiegel, the German weekly magazine, said today that some analysts fear that if too few financial institutions fail, the tests will not be be taken seriously. One report indicates that only a single German bank will fail: Munich's Hypo Real Estate.

The bank has already been nationalized through €102 billion ($130 billion) in infusions from Berlin's bank bailout fund. It's expected to transfer €210 billion worth of toxic debts into a government-backed "bad bank" in the coming months.

There is some doubt that European leaders have plans in place to provide additional capitalization to banks that fail the stress tests.

Credit Suisse estimates that public-sector banks in Europe, including German state banks, the so-called Landesbanken, and Spanish savings banks may need up to €90 billion (roughly $115 billion) in extra capital, The New York Times reported.

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