Article by Lorne Marr
Stress Test of E.U. Bank Reserves – Finance – Banking
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In the middle of 2010, the banking corporations throughout the E.U. were made to be tested to show how well their capital portfolio was structured and how much they were relying on capital connected to problematic states (i.e. Portugal, Spain or, most importantly, Greece). Although the test results were positive initially, the experts discovered that the information which bankers disclosed in their CEBS templates was misrepresented at best. The banks’ funding is more exposed to risk than favourable.
Earlier this year in July 2010, a stress test was imposed upon all European banking houses by a regulator called the Committee of European Banking Supervisors to see how ready they were to withstand a potentially impending financial downturn. The examination was aimed at scrutinizing the questioned EU banks’ reserve levels and its source – whether an appropriate level of capital exists and whether it is of an appropriate quality for the examined banks to fall back to. Several countries outside of the EU undertook a similar test on their banks’ capital ratios as well – LSM Insurance brought an article on this earlier this year. The outcome of the E.U. test did reveal that some banks were in a less-than-favourable situation, but the the results in general succeeded in supporting investor trust in the European banking system. And so, the Euro as a currency and other E.U. currencies outside the monetary union were prospering from an unshaken position in the world’s market.
That wasn’t to be for longer than a little while. On September 7th, The Wall Street Journal came with an indepth review of the outcome the test yielded, comparing it with a snapshot of the banks’ financial statements. The Journal found that the tested subjects often “forgot” to specify all the necessary descriptions on their debt, as the numbers couldn’t be entirely reconciled to their official quarterly financial reports. This way, the reliability of the details was thus unfortunately compromised to a great extent. The banks did not plainly lie. Rather, the banks just neglected to categorize properly their holdings as the CEBS guidelines were not written clearly enough either to start with.
Government bonds were in the past put into the risk-free category. However, they may not be as straightforward as before. Greece carries much riskier bonds and as such, they would rightly be placed in a different category. Banks just didn’t make this important fact clear in their reports. Some banks simply did not report significant sections of their capital and claimed that it was because of their volatility and the fact that they were actively traded. This way, they effectively improved their results in an uncontrollable fashion. Since each tested subject “understood” the requirements of the stress test with differences, each tested bank presented its reserve holdings with slight differences, which let the stress test results hardly comparable and thus unusable.
In conclusion, the main shortcoming of the stress testing was the limited extent of extra notes that the banks managed to share with the CEBS. Obviously, the CEBS test requirements were too lax. This is unfortunate for the Euro, which suffered a significant hit as compared to other major currencies and has been trying to recover warily since. The perplexing news is how the CEBS is even now still defending the original rules even in the light of all the newly uncovered facts.
We hope that banking regulators around the globe are going to learn from this appalling situation so that any future rules and tests are well-thought through. Any further problems would significantly harm the credit rating of the affected economy.
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