Editorial Board

Stress Assessments at European Banks Also Test Credibility: View

The European bank stress-test results are in, and the good news is that, of 90 lenders reviewed, only eight failed: five in Spain, two in Greece and one in Austria. A ninth bank, Germany’s Landesbank Hessen-Thueringen, probably would have failed but refused to disclose its data. Sixteen others narrowly passed, the European Banking Authority concluded.

The bad news is that banking regulators say the eight test flunkers will need to raise a mere 2.5 billion euros ($3.5 billion) in fresh capital by year-end. How can that be bad news? Because the number lacks credibility. Almost no one believes that’s all it will take to shore up Europe’s troubled institutions, especially if Greece or another of Europe’s fragile economies defaults on its debt, which looks increasingly likely.

By contrast, Standard & Poor’s conducted its own analysis of European banks and concluded in March that they needed as much as 250 billion euros ($350 billion) -- or much, much more than the EU’s figure -- to withstand a sharp increase in yields and a severe economic downturn. The U.S. required nine banks to raise $75 billion in new equity after stress tests were conducted in the spring of 2009.

What most undermines the credibility of this latest attempt to calm Europe’s financial fears -- the third in three years -- is that a sovereign-debt default wasn’t among the worst-case scenarios under consideration, even though credit-default swaps already indicate an 87 percent chance that Greece won’t be able to repay its debts. Instead, European authorities looked at the ability of banks to endure an economic contraction of 0.5 percent -- in other words, a mild recession -- as well as a 15 percent stock-market decline, rising unemployment, a drop in housing prices and .

Step Forward

Even so, the unprecedented publication of bank data is laudable. It represents a much-needed step toward improving transparency in an otherwise opaque financial system that has yet to recover from the 2008 collapse of Lehman Brothers Holdings Inc. As analysts pore over the data in the days ahead, investors will finally be able to get a sense of how much of a capital buffer each bank has, and what profitability estimates look like for each in 2011 and 2012. The size and maturities of sovereign-debt holdings by all 90 banks, spread over 21 countries, have also been laid bare, allowing analysts and investors to run their own tests and identify the laggards.

Even if European leaders are in denial about the level of fresh capital required to stem the contagion, they are at least giving investors the tools to begin to figure it out themselves. Stay tuned -- the stress tests could yet give Europe’s bankers palpitations.

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

    Before it's here, it's on the Bloomberg Terminal.