Financial Regulatory Forum

FACTBOX-What analysts say on Europe bank stress test

July 26, 2010

LONDON, July 26 (Reuters) – Seven European banks failed a health check and need to raise their capital by 3.5 billion euros ($4.5 billion), much less than expected, as part of a long awaited industry “stress test”.

The tests, the results of which were released late on Friday, were criticised as too soft, but were applauded for providing greater transparency.

Here’s what top analysts said on the stress tests on Monday:

MORGAN STANLEY:

“If the hurdle rate had been set 2 percent higher, an extra 27 billion euros capital would have been needed, of which about 40 percent in Germany and Italy, despite lower relative stresses.

“From looking at the data, it appears Spain has tried hard to provide appropriately harsh stresses on the loan book, and Ireland too. However, some countries and some types of banks look less harsh (Italy and Germany stand out for us).

“There are many valid question marks about the credibility of the stress tests and thus this represents a missed opportunity as it has not been the ‘circuit breaker’ that people had hoped for, in our view.”

RBS:

“The results of the stress test might reassure investors about the health of large quoted banks, but they are unlikely to restore confidence in the smaller periphery banks: 34 out of the 40 least capitalised banks in the stress test are in the periphery (periphery stands for Italy, Spain, Portugal, Greece and Ireland).”

DEUTSCHE BANK:

“We… see a risk that banks will be pressured to recapitalize to 8 percent rather than 6 percent, and that “near misses” may also end up being expected to raise capital.

“If we apply an 8 percent stated target Tier 1 ratio, then 31 additional banks would fail, and the aggregate shortfall in capital would be 27 billion euros (and this could rise towards 100 billion euros if we were to disallow hybrids). This may be more representative of the long-run outcome, in our opinion.”

“We were disappointed with the stress test in three areas. First, we do not find a 6 percent stated tier 1 ratio target particularly challenging. Second, we have found it difficult to reconcile some banks’ assumptions. Third, we think that trading book shocks have not been sufficiently conservative, even before considering sovereign risk.”

UBS:

“Rather than debating whether CEBS has reached the right answer, the more pertinent point is whether they have asked the right question. We are sure the resolution of the European banks’ 800 billion euros of ECB borrowing will not be solved via the injection of 3.5 billion euros into non-quoted/nationalised banks.

“The assessment of whether the stress test has been successful will come from the credit markets in the days/weeks ahead. We also recall that a key outcome of the US stress tests was that institutions who passed as well as those that failed raised equity.”

GOLDMAN SACHS:

“The stress test provides market participants with sufficient information to locate capital shortfalls against the capital ratio of their choosing. Our analysis suggests scaling the capital hurdle to 7 percent increases capital shortfall from 3.5 billion euros to 11.3 billion euros, and number of banks with a capital shortfall from 7 to 24, for example.”

CREDIT SUISSE

“Although the sovereign stress test disappointed many commentators by only stressing trading books, we find that the additional stress placed on the banking book in the “additional sovereign scenario” actually compensates for this; the aggregate amount of loss in the CEBS sovereign scenario for our coverage universe (about 40 billion euros) is actually very similar to the loss that would be delivered in a more realistic assessment of the entire sovereign book.

“The important catalyst here is not so much the stress tests themselves as the transparency provided, which is impressive, in our opinion.”

SOCIETE GENERALE

“The European Bank stress tests released Friday evening delivered on both toughness and transparency.

“While we find the stress tests to be good news on balance, several headwinds loom. First, European banks still have 197 billion euros of government support. Second, there is still substantial uncertainty surrounding the types of capital needs that will result from Basel 3. Finally, the challenge of taming public finances still lies ahead.”

(Compiled by Kenneth Grierson; Editing by Toby Chopra)

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