Saturday, 24 July 2010

EU stress tests get thumbs down from the market

The results of the EU sponsored stress tests were as expected found wanting because of the numerous politically motivated omissions. As was widely leaked, five Spanish property banks, cajas, one German property bank and a general Greek bank were found to have failed these tests, a total of 7 out of the 91 tested, less than 10%! The negative market reaction comes from a number of omissions.

First on political grounds the possible sovereign default scenario was omitted. Linked to that is the lack of information on which banks are actually holding these Greek bonds. We are none the wiser on this issue now than we were before but it is rightly crucial, in the markets view, in assessing a bank's credit worthiness.

Second much of the sovereign debt held by banks was omitted  if they claim they were holding to maturity. Risible! Why or how long you intend to hold the dodgy bonds is irrelevant. Let AIDS you have got them and can't get rid of them.

Third, how on earth do you value these repossessed properties on bank's books. A problem we have in the  UK with NRock.

Fourth, the tests assume problems will be evenly spread over the EU. Cloud cuckoo land  thinking!

The end result is that the capital needed to recapitalise will have to come from EU governments, not  as happened in the US, from private investors. Investors simply do not see EU banks as a good investment.  The corollary is the EU bank sector will have to shrink creating yet more political problems for the EU especially in countries like Italy where there is over 1000 small regional banks!

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