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The reliability of the bank stress tests
Date 30/07/2010 16:45  Author webmaster  Hits 2210  Language Global
By Marta Andreasen MEP

I have to confess that I never had great expectations for the result of the famous bank stress tests. It is a no-brainer that if the ECB jumped into this adventure it was because it thought that the outcome of the tests would be such that would inject some energy into the financial markets.

Running the risk of ending up with negative results and provoking a further financial crisis would have constituted evidence of major lack of responsibility, which wouldn´t have suprised some of us but would certainly have put an end to any confidence that people could have in the ECB.

The Swiss financial authority FINMA took advantage of the EU test to run their own stress test on their big banks using a stricter capital ratio of 8% (compared to the EU’s 6%) and were able to declare they passed with flying colours. This just highlights the lack of credibility of the CEBS test. In fact CEBS admits that the purpose of the test was not to determine the capital needs of the banks so what was the point?

The reliability of this type of tests lies very much on the definition of the standards which are applied when establishing the ratios and also on what we are specifically trying to measure. As way of example the definition of equity that has been used to determine the said ratios includes in many cases, some hybrids which are not purely capital or reserves but include elements such as the preference shares which the IASB (International Accounting Standards Board) or the FASB (Financial Accounting Standards Board) would classify more on the liability side than on the equity side.

There is also a lack of clarity on the parameters used for the valuation of the bank´s assets. Take the case of the Spanish banks where a big proportion of its assets is made up of real estate property, the stress test concludes that the banks would be able to put up with a 23% decline in the value of this property, whereas the “real estate bubble” that the country has been immersed in during the last decade may require a much bigger adjustment than that.

Notwithstanding the technicalities I have mentioned above, the opening of the financial markets today may bring a different verdict. However it is always useful to remember that solvency does not mean liquidity and that some of these banks that have obtained a good rating in these stress tests may still have liquidity problems that may threaten their survival.

Source: www.martaandreasen.com
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