/ 29 November 2010

Irish case casts doubt on EU bank’s stress test

As Lord Turner, the chairperson of the United Kingdom’s Financial Services Authority, defended his approach to overseeing the £140-billion in exposure of United Kingdom (UK) banks to the battered Irish economy, doubts were raised about whether the Europe-wide “stress tests” of more than 90 banks published in July had been thorough enough.

The results of the tests, overseen by the Committee of European Banking Supervisors (CEBS), were intended to demonstrate to investors that banks did not need to raise more capital. Two of the Irish banks, Allied Irish Banks and Bank of Ireland, that are now waiting for bailouts from the European Union and International Monetary Fund (IMF), were given a clean bill of health.

Robert Talbut, the chief investment officer of Royal London Asset Management, said: “Experience shows the stress tests were not as stressed as they should have been.”

Share prices of banks across Europe have been under pressure as the terms of the Irish bailout are hammered out because of the exposure many banks have to the country and the fear of default.

The CEBS tests were conducted after the €110-billion bailout of Greece. The Greek debt crisis prompted a so-called “sovereign risk shock” to be added to the worse-case scenarios based on an “adverse scenario” of a double-dip recession.

Ian Gordon, an analyst at Exane BNP Paribas, said the tests provided a valuable snapshot of each bank’s position at the time. They were required to publish their holdings of government debt, for instance, allowing analysts to conclude that UK banks’ exposure to Ireland was largely through companies rather than sovereign debt.

Nick Parsons, at National Australia Bank raised concerns about the test results of AIB and Bank of Ireland. “Ploughing through the 55-page [CEBS] report, we find that under ‘adverse scenarios’ as at end-December 2011 and with an additional sovereign shock, these two institutions were expected to have tier one capital ratios of 6,5% and 7,1% respectively,” Parsons said. A bank is deemed to need fresh capital, and therefore fails the test, if its so-called tier one capital cushion falls below 6%. “Events in Dublin in the past few days would suggest that these assumptions might have been a tad overoptimistic.

“The problem is that while seven European Union banks were deemed to have failed the stress test; 84 were given a clean bill of health, including the two largest Irish banks. The market now has to figure out whether the benign prognoses for the other 82 are still valid.” — Guardian