European Bank Stress Tests - What a Joke!!

Location Date: 
July 18, 2011

Now that analysts and investment professionals have a chance to review European banking data, this week should provide a better understanding of the structure and exposure of the banking industry to a sovereign debt default. Last Friday, the European Banking Authority ("EBA") identified 8 "fails" out of 91 reviewed banks that represented some 65% of the European banking industry. The findings - a mere € 2.5B needs to be raised by these failing institutions to properly buffer their depositors from grief in a soft downturn. This amount is so insanely low given the current state of affairs that it can only cause grief for investors. S&P suggested €250B was needed - 100x more than the EBA suggests! Given the level of due diligence that will now be conducted by investors, counterparties and ultimately, depositors, this could actually trigger more problems for Europe's financial institutions. 

The market this morning has given its' initial verdict - a big push down in European bank share prices and in the value of the Euro. It has also pushed out bond spreads in Italy and Spain versus Germany yet again to historically wide precedents. This spread widening creates higher funding costs for banks in Italy and Spain, which creates a vicious cycle of both a future earnings drag and further deleveraging. Italy, for example, needs more GDP growth to service its high debt/GDP ratio (120). To create this growth, it needs its banks to lend. Italy's two biggest banks have €55.4B in debt to be refinanced in 2012 - given the current state of affairs this will get done, but at what price? 

Of course the solution to all of this Euro mess is to create a proper Euro-zone bond - a formal tie between the monetary and fiscal policies of Europe. However, given the current crop of politicians and the growing tensions, this seems a long shot at best.

Jim McGovern