Testing times

Last Friday the Committee of European Banking regulators (CEBS) published the long awaited results of its stress tests into the region's leading financial institutions. The tests revealed that seven of the 91 European banks had failed to meet the capital requirements.

Even before the test results were published, many market commentators had concluded that the tests were pointless and unlikely to achieve very much. The whole endeavour was not exactly helped by CEBS' website failing its own stress test and crashing just as the results were published. Who said the Europeans can't do irony?

Many critics have pointed to the low capital ratio required to pass the tests and the fact that all the tests relied on data supplied by the banks and verified by their local regulator. Grave uncertainty has also arisen surrounding the consistency of the methodology - with implementation of the scenarios depending to some degree on the local regulatory authorities. It has also been hard for analysts to ignore the fact that the criteria were not only less onerous than testing already conducted by some regulators, but also than some of the banks' internal worst-case forecasts. So, the 'adverse' scenario is not really all that adverse: it assumes only a slight output contraction and market losses on government debt, but no actual sovereign default scenario.

However, the fact that investors still seemingly mistrust capital adequacy rules and that these tests have been branded by many as neither uniform, transparent nor stressful enough, may ultimately not matter that much. The clearest sign that the tests have set the European banking industry on the path to recovery will be seen in interbank lending and the capital markets – if these do not improve then Europe will have to think again.

SS