Friday, 18 June 2010

Stressful stress testing

EU leaders yesterday agreed to publish the results of stress tests, performed by European banks. Spain was forcing the hand of her fellow Euro-zone members by declaring that the results of stress tests performed by Spanish banks would be published irrespective of the EU decisions. The stated goal of conducting stress test and of publishing the results is to increase transparency. Hopefully this will calm down the markets, which are now increasingly doubtful about Spain's public debt.

A stress test is a series of calculations, aimed at simulating losses incurred by a bank under a series of specific assumptions about the economic developments. The purpose is to show whether the bank has sufficient capital to survive if accident strikes. US banks were subject to a stress test in 2009 and some banks were revealed as being undercapitalised. The US government subsequently provided help to those banks under the TARP program.

The direct reason for the EU move is the increasing rumours concerning the health of the Spanish banking sector. Spain is currently undergoing its own savings bank crisis, with most of the 45 regional savings banks having ventured into lending activities that are now killing them. 16 of the savings banks are on the brink of collapse and one, CajaSur was taken over by the central bank.

Markets now fear that a) the commercial banks are in similar dire straits and b) that healthy banks will be forced to take over the unhealthy ones, given that the government finances will not allow a bail-out.

The Spanish government and central bank (who had impeccable credentials before the creation of the Euro) have attacked the issue head-on. They have pushed Spanish banks to bring losses forward instead of hiding them, as it is now allowed under European accounting rules.

This step towards transparency has already brought two consequences: Spanish banks have underperformed their European counterparts, and they are already rumoured to come out on top once the stress tests are performed and presented. Seen on this background, the Spanish government had little to lose by releasing the stress tests.

Not surprisingly, virtually every European banker has taken to the microphone in the past 18 hours. 'Stress tests are a not a bad idea, but please do not publish the results' seems to is the message they convey.
This looks like a living proof how little bankers have learned from the crisis over the past couple of years. They still believe that their businesses are best protected behind a shroud of secrecy, when it is increasingly clear that transparency is the way to create reassurance.

Of course some European banks are badly capitalised. European governments have tried to make bank rescue packages on the cheap and that will show. But the correct way of handling this is not by pretending that the problems do not exist.

Armies of financial analysts are convinced that Spanish banks are carrying tonnes on hidden bad loans on the books. This is a clear sign that the secrecy thinking is deeply entrenched in Europe. It can only be bad for business.

In a past life I worked in an investment firm where we almost never had European financials in the portfolio – for the simple reason that they were not sufficiently transparent. While stress testing for sure has its shortcomings, there are only reasons to cheer the EU for the decision to force the banks' hands. Obfuscation is no solid basis for business.

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