COLUMN-EU bank stress tests: what’s the point?

By Guest Contributor
March 4, 2011

Employees of the Deutsche Bank walk in front of the Deutsche Bank headquarters in Frankfurt April 28, 2010. REUTERS/Johannes EiseleBy Keith Mullin, Editor at Large, International Financing Review; the views expressed are his own.

LONDON, March 4 (Reuters) – The European bank stress tests that are just kicking off are a pointless and futile exercise that will cause more harm than good.

I’ve written before in this column about the laws of unintended consequences. There could be some pretty serious ones here because the list of banks that fail the supposedly more rigorous tests will lead to an A and B list of saints and sinners.

I doubt the European Commission contemplated the notion of transforming the bank regulatory apparatus into the role of official stockbroker to the masses. But that’s what it is doing in that banks that fail the tests will in effect become a sell sheet initiated and endorsed by European regulators.

Also, it’s unhelpful and counter-productive in the extreme that the results of the stress tests will be published but not the results of the parallel liquidity tests. Presumably liquidity will be included as an element of stress testing, so what’s the big secret? Why go out of your way to create imperfect information? Such a breakdown of transparency will leave a host of unanswered questions.

Regulators have, once again, failed to take into account the impact of their actions on market forces. There’s little incentive to be a shareholder or bondholder in a bank that is on a well publicised official list of dud banks, particularly those that don’t have an immediate remedy in place or which haven’t been smart enough to strike pre-emptively and pre-announce capital-raising or other remedial measures.

Investors can smell fear. Capital market issuers only do well when they don’t need the money. If you go cap in hand to the market – as up to a dozen banks are expected to do when the stress test results are announced – they need to be prepared for the consequences of difficult market access and loss of pricing power, particularly in an increasingly risk-averse environment. In a world of huge choice, why waste time and incur opportunity cost by investing in a bank that’s deficient, even if the stress tests only offer a point-in-time snapshot?

The European Banking Authority is working overtime to regain some credibility and re-establish its influence after the shambolic attempt last year by its predecessor CEBS backfired and made it a laughing stock. Staking its reputation on phase two of the stress tests is risky, only tempered slightly by the fact that everyone basically already knows which banks are under-capitalised.

More to the point, what exactly is expected to happen to banks that fail other than investors potentially giving them a hammering? Well, Andrea Enria, the EBA’s inaugural chairman, and UK financial services minister Mark Hoban want government backstops.

“We cannot just publish data showing banks having shortfalls of capital and then the day after nobody is providing capital,” Enria told the Reuters Future Face of Finance Summit. Brilliant. But what does it mean? If the clear signal is that governments backstop their dud banks, isn’t someone missing the point? In fact, the more I analyse bank regulatory developments, the more I think it may be me!

I thought the whole point of the new generation of banking regulation and systemic safeguards was that banks that don’t cut it go out of business and that part of the new regulatory process was to ensure an orderly winding-up. Wasn’t that the central assumption of all that righteous stuff about banks no longer being able to privatise gains and socialise losses? Orderly failure is the whole point of The Investment Bank Special Administration Regulations 2011, which came into force on February 8.

Truth be told, there’s far too much contradiction, double-talk, confusion, misconception, politicking and gaming in the bank capital and regulation debate to get a clear picture of where the multiple initiatives are, where they’re headed and whether they’ll ever join up (they won’t). So let events take their course. Time to short some stock.

(Editing by John Manley) ((keith.mullin@thomsonreuters.com))

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