Stress Tests for Banks Assume Loss of 23.1% on Greek Debt, 12.3% on Spain
The 91 banks undergoing stress tests were examined on European sovereign debt losses only for the bonds they trade, rather than those they hold to maturity, which may make the tests easier to pass.
Portfolios of sovereign five-year bonds were tested on trading books with banks needing to keep a Tier 1 capital ratio of 6 percent to pass, according to the Committee of European Banking Regulators, which is overseeing the exams. The stress tests assume a loss of 23.1 percent on Greek debt, 12.3 percent on Spanish bonds, 14 percent on Portuguese bonds and 4.7 percent on German state debt.
“The haircuts are applied to the trading book portfolios only, as no default assumption was considered,” according to a confidential European Central Bank document obtained by Bloomberg News dated July 22 and titled “EU Stress Test Exercise: Key Messages on Methodological Issues.”
European Union regulators are examining the strength of banks to determine if they can survive potential losses on sovereign-bond holdings. They are counting on the tests to reassure investors about the health of financial institutions from Germany’s WestLB AG and Bayerische Landesbank to Spanish savings banks as the debt crisis pummels the bonds of Greece, Spain and Portugal.
‘Lenient Treatment’
The “lenient treatment of bank book exposures” is part of a “sugarcoating” of the stress test results, Sony Kapoor, managing director of policy group Re-Define Europe, said before the criteria was released.
Banks and regulators will release the results today starting at 5 p.m. U.K. time. The banks may also publish how much they will need to raise in capital if their Tier 1 ratio, a key measure of financial strength, falls below 6 percent.
U.K. government bonds will be subject to a 10.2 percent haircut, and France 5.9 percent according to the ECB document.
The tests assume the weighted average yield on euro-area five-year government bonds will rise to 4.6 percent in 2011 from 2.7 percent at the end of 2009. The tests also include an increase in the yield on five-year Greek government bonds to as much as 13.9 percent after “interest rate shocks,” the document shows.
“The haircuts on government debt in the trading book increase according to the introduction of sovereign risk, which is modeled as an increase in government bond spreads in line with market developments since the beginning of May 2010,” according to the document.
‘Underestimate Exposure’
The decision “allows banks to basically underestimate their exposure to distressed peripheral debt,” Brown Brothers Harriman, the New York private bank founded almost 200 years ago, said in a note to clients today. “By leaving out stress tests on the banking book, then a true picture of bank balance sheets will clearly not be obtained.”
Banks’ stress test scenarios also include securitized debt products being downgraded four levels by credit ratings companies, a 20 percent fall in the value of European equities in both 2010 and 2011 and tests in 50 other macroeconomic parameters including a fall in European Union gross domestic product of three percent over two years, CEBS said.
European regulators examined the effect on banks’ balance sheets of an increase in short-term interest rates of 125 basis points. Banks’ overall liquidity wasn’t tested because it might clash with studies being carried out by the Basel Committee on Banking Supervision while it decides on the details of new capital requirement rules.
The 54-member Bloomberg Europe Banks and Financial Services Index was little changed at 4:05 p.m. London time. The euro weakened against the dollar, sliding 0.51 percent to $1.2827.
To contact the reporters on this story: Ben Moshinsky in Brussels at bmoshinsky@bloomberg.net;
Rate this Page