Whither New Stress Tests for European Banks?

The European Commission is calling for new stress tests for European banks. The reason? Well, it appears that the previous stress tests during the summer failed to spot huge problems at the heart of Ireland’s financial institutions.

Oli Rehn is quoted saying that Ireland’s banking meltdown was a one-off case that would not be repeated elsewhere in Europe. Well, I disagree.

Back in July I noted that stress tests must also include really worst-case scenarios, as in worst-case scenarios. Worst, not best. And all of them. We know that summer stress tests failed to do that. Now we are led to believe that the new stress tests will do the job. That is unlikely.

The problem is analyzed very well by Richard Field. He claims that there is only one way to restore trust and erect a firewall against contagion. Governments must make the statement about which banks are or are not solvent in their system and make the asset-level data available to support it.

The Importance of Bank Stress Tests Results

European banks are mostly endangered today because of the sovereign risk – the risk that an EU Member State might default. The banks have bought lots of government bonds from different EU governments, and now we want to know how much capital they need in order to stay solvent. That is why we need to conduct bank stress tests.

A bank stress test is intended to give an overview of the possible bank performance in case some serious risk materializes. This risk is called a “stress scenario”, and banks calculate if they’ve got the capital reserves to cover losses.

There is news that the results of ongoing tests on European banks will be published on 23 July. Markets need those results in order to get the real snapshot of the EU financial system, and to calculate the risks and perspectives for the EU economy.

But the stress tests results must be useful and transparent if they are to calm the markets. One of the issues is to include all systemically important banks. But the stress tests must also include really worst-case scenarios, as Wolfgang Münchau has argued. Designing stress tests in such a way that the banks will pass them will not convince the markets. Additionally, the stress tests results must be published in full – guaranteeing the transparency of the procedure.

The stress tests are probably the only tool we now have to convince financial markets that EU banks are stable. That is why any improvisation should be avoided.

The Bailout for Greece: Will It Work?

We now have some details on the bailout package for Greece. The program will be managed jointly by the European Commission, the European Central Bank, and the International Monetary Fund. The program will cover a three-year period. The euro area Member States are ready to contribute up to € 30 billion in the first year to cover financing needs. Financial support for the following years will be decided upon the agreement of the joint program. In order to set incentives for Greece to return to market financing, Euro area Members States loans will be granted on non-concessional interest rates. The pricing formula used by the IMF will be used benchmark for setting Euro area Members States bilateral loan conditions with some correction. The initial price of credit will be around 5% p.a. for a three year fixed-rate loan.

But what will be the effect of this program? One thing is certain: it will alleviate current pressures on the eurozone. But at least two commentators (Wolfgang Münchau and The Pragmatic Capitalist) say that this will only kick the can down the road. Wolfgang Münchau is more specific: he believes that Greece will eventually default. He criticizes the EU for not providing a generalised crisis resolution regime.

Greece Makes Strange Moves

Greek Deputy Prime Minister Theodoros Pangalos has criticised Germany’s attitude towards the ongoing Greek debt crisis, adding that Athens had never received adequate war reparations. The German foreign ministry said that a discussion about the past is not helpful at all to solve today’s problems.

Mr. Pangalos also said that the EU suffers from lack of leadership. He added to that Italy was being more inaccurate with its financial statistics.

At the same time Greece demands a debt default guarantee to calm down markets.

I am in disarray. How is Greece expecting to get support and sympathy from its peers when using such language??? The markets will not be calmed by Mr. Pangalos’ statement; that is clear. I wonder whether Kostas Simitis knew better.

Greece: “No Additional Measures Needed”

The Greek finance minister has rebuked claims by the European Commission that the recently approved austerity plan may be inadequate.

Georgios Papaconstantinou said that taking additional action at this point would contravene the EU’s established processes and procedures, and it may send dangerous signals to the markets. Mr. Papaconstantinou further urged other Member States to elaborate on the specific details of how financial support might be provided to Greece.