Stress tests ‘not a pass or fail exercise’: EU watchdog

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Banks are not out of trouble simply because they pass stress tests, Mervyn King, vice-chair of the joint EU financial watchdog warned yesterday evening (2 May), as some hundred financial institutions are currently being examined for their resilience in harsher economic winds.

Banks which pass stringent tests on their ability to withstand more economic shocks should not be "ignored or forgotten" as tougher economic times lie ahead, the English central bank governor warned at a hearing in the European Parliament yesterday (2 May).

"Stress tests are often presented as a pass or fail exercise and this is not the most helpful representation," continued King, who is also vice-chair of the four-month old European Supervisory Risk Board (ESRB).

King warned the sector had harsher economic times to weather and that the next four years would be just as tough for all banks.

The vice-chair also reminded national authorities that plans to recapitalise banks which have not passed the test must be in place before the results' June release date.

The exercise has been organised by one of three newly appointed watchdogs, the European Banking Authority, which has asked banks to test their balance sheets against a 0.5% contraction in the economy and against a 15% drop in shares.

To assuage fears that the test will not work, the head of the EBA and a second ESRB vice-chair, Andrea Enria, pointed out that supervisors are for the first time about to embark on a peer review of the tests, where for the first time in the EU's history an authority can scrutinise a bank that is not within its jurisdiction.

The last round of tests in 2010 were heavily criticised for not subjecting banks to the pressure of tougher economic scenarios, such as a 50% drop in real estate prices.

Enria, who also spoke at the hearing, said the ESRB would be meeting technical experts this week to analyse results that have started dripping in to the EBA's London headquarters.

Although all institutions tasked with analysing the results – the EBA, the ECB, the ESRB and national authorities – are under strict orders to respect the confidentiality of the process, King admitted that politicians may be seduced by leaking the results to the media, with potentially devastating consequences, the governor continued.

Banks that fail the test will have six months to "take remedial action," Enria warned, adding that the EBA will "seriously ponder using the instruments in our hands" if countries neglect to resolve their banking failures.

In 2009, Brussels pushed for banks in need of state aid to undergo stress tests in order to assess the viability of their restructuring plans (EURACTIV 24/07/09).

The last round of stress tests in summer 2010 were painted as a sham by many observers, whose predictions about the sector were not confirmed in the tests. According to the results, only seven of 91 banks failed the stress tests, meaning that their tier one capital ratio – measuring core capital against total assets – fell below a 6% margin.

Ahead of the tests, sources had predicted that some banks would try to conceal their exposure to sovereign debt as disclosing such information would make markets too jittery (EURACTIV 02/07/10).

To add to the criticism of the scenarios used in the tests, six of the 14 German banks tested did not disclose their exposure to sovereign debt, one of a few key benchmarks in an exercise designed to test banks' resilience to future economic shocks.

  • Early June: Stress test results to be published.

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