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Business

What is the purpose of European bank stress tests?

Text by Sébastian SEIBT

Latest update : 2010-07-23

Europe is set to publish on Friday the results of a stress test taken by 91 European banks. The purpose of the test is to reassure markets of the solidity of the banking sector. A first stress test was performed in 2009.

What is the point of a stress test?

Banks undergo financial simulations that are supposed to test their resistance in circumstances of severe economic instability. The Committee of European Bank Supervisors then uses the test results to evaluate whether a bank needs extra funds. The results published on July 23 are in a way a health report for European banking establishments. The stress tests have been administered at a moment when several European countries, especially in the south, are undergoing a period of financial turbulence. Authorities hope that the results will reassure financial markets quick to speculate on difficulties in the euro zone.

How are these tests administered?

The test were carried out in July. Economists from the Committee of European Bank Supervisors created various scenarios. Based on data given by the banks being tested, the economists made projections. Two initial hypotheses were posed. One was based on projections of normal growth, the other on a bleaker economic picture. In the second scenario, the experts lowered current growth predictions in the euro zone by three points. In both cases, they included the famous problem of sovereign debts. So for Greece, they predicted a decrease of more than 16% in the value of government bonds, while only 0.7% for France.

Which banks are tested?

When the last stress test was carried out in 2009, only 22 banks were involved. This time, the Committee of European Bank Supervisors aimed for more. In total, the European regulator targeted 91 establishments. The list represents 65% of the European banking sector and 50% of the sector in each country concerned. Spain is the country with the most banks tested (27). Germany has 14, while in France, where the banking sector is very concentrated, only four banks were tested.

What were the criticisms levelled against these tests?

The main criticism of European stress tests is that they don’t go far enough. Certain analysts bitterly regret that no hypothesis included a case of a country simply going bankrupt -- a relevant scenario, given what happened with Greece. The markets have also expressed scepticism about the numbers given for the decrease in the value of government bonds. Another independent stress test administered by Citigroup and Moody’s had Greece with a 40% decrease in government bond value. That is a major departure from the 16% posited by the Committee of European Bank Supervisors. These criticisms have pushed some people to conclude that the results released Friday will not be taken seriously by the markets – in which case, the EU will have failed in what it had set out to do.

Date created : 2010-07-23

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