EU stress tests: who knows, who cares?
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.