EU stress tests: who knows, who cares?

July 22, 2010

The following is a guest post by Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics. You can also follow him on twitter. The opinions expressed are his own.

Waiting for the results of the EU stress tests, one is reminded of the many times in the past century when the U.S. has rescued the Europeans from their tendency to wage war against one another and go broke in the process. Having now helped to sell the EU banks much of the subprime garbage that sank the likes of Bear Stearns and Lehman Brothers, now the U.S. is offering a solution, namely to mimic the U.S. stress tests of 2009.

The U.S. stress tests, keep in mind, were about restoring confidence, not measuring financial soundness. The assumptions in the U.S. stress tests were soft and virtually all of the banks passed. The U.S. government had already guaranteed the liabilities of most U.S. banks, General Electric and General Motors, and a variety of other formerly non-bank companies. Thus the stress tests are properly seen as an exercise in managing expectations of the bond vigilantes.

The U.S. process was reasonably credible to investors because, despite their many failings, American regulators have a cohesive, if fragmented, approach to gathering data from regulated banks and disclosing same to investors. The data used in the stress tests actually bore some resemblance to public data available on these institutions.

In the EU, on the other hand, there is virtually no transparency on bank financial statements and thus no visibility for investors in terms of making the stress tests credible. There is no SEC in Europe, no EDGAR or FDIC portals on the internet with extensive financial data on banks. There is not even a common template for gathering financial data on European banks or even credit statistics for many EU consumers.

Financial analysts, risk professionals and publishers cannot even obtain basic financial data regarding EU banks without going through enormous trouble and expense. Thus the entire EU stress test process is suspect. And analysts have no way to independently verify either the inputs or the results.

In the U.S., by comparison, data available to regulators makes it possible to benchmark all U.S. banks against the new capital standards and to stress these assumptions. Because of the excellent structured financial data reported quarterly by U.S. banks, and validated and maintained by the FDIC, U.S. regulators may measure and compare the financial compliance of every bank in the U.S. to the post-stress test capital guidelines.

The issue of the availability of bank data in the EU is important for a number of reasons. At present, most EU banks release annual reports and semi-annual updates, but the data is provided as much as six months after the period close and is not in a consistent format that allows for objective comparisons. While EU regulators receive extensive confidential financial information from their constituent banks, none of this data is available to the public, including investors, other banks, and regulators around the world.

So when the world receives the stress test results from the EU authorities, what should we think? The first thing investors should remember is that there is no unified regulator in Europe. The 25 EU member states basically set their own prudential standards and capital rules, and even have their own accounting rules to boot. Unlike in the U.S., where authorities have been regulating banks on a national basis for decades, in the EU such a regime remains a future goal.

More important, remember that in many EU countries, the banks are so large and so few that they have become de facto wards of the state. In the UK, France, Ireland and other EU states, the destruction of private capital by losses from subprime debt and other speculative instruments have left the banks as government sponsored entities.

Regardless of what the stress tests say about a given bank, the real factor driving the willingness of credit markets to do business with a bank in London or Paris is the condition of the government and the probability that the government will support the bank.

Many observers of the EU bank stress tests will miss the irony that there is still no unified bank supervision framework in Europe. The capital markets, however, are unlikely to be impressed by a process that is as flimsy and lacking in independent validation as this hastily concocted exercise in simulated prudential oversight.

The EU needs to move forward from these ersatz stress tests and complete a unified system for monitoring and public disclosure for EU banks. The current state of affairs in terms of public data on EU banks is an embarrassment to every member nation.


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My my, what a well-argued piece. I’m sitting here watching the Euro trade sideways and equities do nothing, waiting for a report at noon EST that, prior to reading the above article, I honestly believed would settle this issue. Now I’m not so sure.

Posted by Gotthardbahn | Report as abusive

forget about reporting standards…they don’t even have the same language!

Posted by takloo | Report as abusive

Thank you Chris. Most helpful to understand the European framework of its various financial ‘sub’ systems versus the States.

I could use this as a soapbox against 1. increasing amounts of Fair Value used in US financial reporting especially permitted to be used by agency at our Financial institutions, especially at the Big Financials and running their non cash, ‘market’ gains thru the income statement to give some sort of gravy train to serve as if management is doing a ‘great-job’ to warrant their way over board pay packages, and keep the dividends and/or engage in stock buybacks largely to support aside from capital adequacy concerns, but agency’s self interests because it now too thinks it’s like an ‘owner’ in a bank.

Now many ‘owners’ today don’t understand these financial institutions, or the financial system, let alone understand in spite of agency abuses via the trading of instruments they do not have the capital nor collateral to trade, let alone to write and trade against the resources of the enterprise, it’s our system and we do have to be on top of it, clean it up and not leave it compromised or able to collude with the European Financials so as to cause global financial problems and avoid or shed any consequences, feel a claw-back only of 2008 remuneration, etc.

I suggest we leave the Europeans to their own devices over there, require them to adequately capitalize to run here, which perhaps would encourage them to pack up their tents and call it a day, and stick to their own knitting at home rather than feel some compulsion to collapse the EU economy with more adds to the EU (while looking for us to give $500B to the IMF), with more commercial abuses in their own societies that we should avoid putting ourselves there and even agency avoiding wasting of the banks’ owners resources in places like the PRC.

That Chris reminded us that again, public companies there and the quality of disclosure about their financial status is significantly different enough with very few Americans skilled enough to parse their prose, fluently speak their languages to understand their commercial meanings, and ah, what and how they go about their business and the way we go about ours should be left be. Our heckling them to run or report or abide in the way ours do, puts us at risk for their self interests on us both there and here.

So they can have their Basel, they can have their reporting, they can have their fair value so that they can goose their earnings with their balance sheet management or what have you. It’s bad for us to adopt that, and here to laud or support it among our own, but it also would disserve us to erode to the manner in the way we’ve let the European reporters even to fail to reconcile with US GAAP if those foreign reporters trade over our exchanges. What did we do for the EU to think we’re their back yard and can feudalize us in their way? We weren’t fools to let the oceans and few shrewd men help us to withdraw from the self interests of Europe’s royalty, it’s cadre of high level agents and its bankers.

Our problem is we let our bankers control us and not suffer any consequences for problems of letting people who conceitedly think they’re expert about the money, when they’re not and they’re costing US voters between $10T to $16T in order for the markets to be flush for our bank players to trade and have higher mark to markets flushed by the voters’ wallet. Since that’s the way in Europe, that our money changers had the power to hijack our economy, pull of their enron and the voters risk that agency will have enriched in this plunder with impunity.

At least in Europe, agency there wasn’t paid anywhere near what it is paid here. Here however, we need to stop letting men at the top who have the insight of clerks while paying them huge amounts of money to slam their companies into the wall, like enron, running in negative cash-flow, and using liquidity mechanisms to given them liquidity when we need to fire many of those senior managers or as Chris has said at other times, bring in the parents. It certainly isn’t what Frank and Dodd passed, nor while Derivatives are trading OTC is the problem solved with the wallets of the voters of all the sovereigns are the final backstop in all ISDA agreements. Until this backstop is removed, there or here, nothing holds managements’ feet to the fire. Nothing unless it’s on their own dime. So if there isn’t bailout on the back end that up to this point has impuned agency in its recklessness when the voters’ wallet has been on the back stop in every or any ISDA agreement, removing this should enable agency to stand on its own 2 feet and their well healed shoes and figure out their own way instead of being about as swift and/or as principled as ah, Andy Fastow. or some other time serving miscreant who slammed their company into the wall and got sent to the ‘bighouse’.

Posted by andreapsoras | Report as abusive