Europe's Bank Tests Lack Stress: The Ticker

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By Jonathan Weil

The new stress tests from the European Banking Authority are out. Last year saw two large Irish banks seek government rescues shortly after they passed their stress tests. Two months ago, it was the French-Belgian lender Dexia SA that took a bailout, after getting a clean bill of health from the banking authority in July. There's reason to view the latest test results with suspicion, too.

Take one example: Credit Agricole SA. The European Banking Authority today said the French lender had no capital shortfall as of Sep. 30. That's hard to believe using conventional metrics, as opposed to the generous benchmarks used by the EBA.

Credit Agricole showed 1.72 trillion euros of tangible assets on its Sept. 30 balance sheet. By comparison, its tangible common equity was 27.4 billion euros. (Tangible common equity is a bare-bones capital measure that excludes intangible assets such as goodwill, as well as preferred stock.)

That works out to a tangible common equity ratio of 1.59 percent, meaning the company has little hard capital available to absorb future losses. By comparison, Dexia's ratio was 1.18 percent as of Dec. 31, only slightly worse.

Using the EBA's starry-eyed math, Credit Agricole showed an 11.4 percent "Tier 1" capital ratio, which the EBA tells us is a good score. The main trick here is in the calculation's denominator, known as "risk-weighted assets."

For stress-test purposes, the EBA said Credit Agricole had 537 billion euros of such assets as of Sept. 30. So, for purposes of assuring the markets that Credit Agricole has plenty of capital, the EBA made almost 1.2 trillion euros of Credit Agricole's assets disappear. (Never mind that the assets' risks remain.) The lower the denominator, the higher the ratio.

Meanwhile, the numerator in the calculation, Tier 1 capital, includes various items that don't qualify for normal financial-reporting purposes. The higher the numerator, the higher the ratio. Isn't it funny how the regulators' ratios always seem to work out that way?

(Jonathan Weil is a Bloomberg View columnist.)

-0- Dec/08/2011 20:56 GMT