“Impossible” balancing act to perform with stress tests

July 23, 2010

Tiffany Burk is the European Market Analyst at Travelex Global Business Payments. The opinions expressed are her own.-

Commentators have suggested that the hype surrounding the release of the EU bank stress tests has made it feel more like a PR campaign than a credible financial analysis.

Despite this, EU officials are hopeful that investors’ response will emulate the same positive and confident reaction we saw in the U.S. more than a year ago, after the release of their banking stress tests.

Indeed, while the results are not released until 5pm British time, confidence in a positive outcome is mounting and financial markets are already pricing in good results.

Despite this, there are many who are unsure of the tests’ credibility, an opinion which is clearly reflected in the euro’s fluctuating value.

It dipped in trading this morning as speculation grew that several Spanish banks had failed. Minutes later, it then rebounded, as markets felt the failure of a few banks may bolster the tests overall credibility.

The Committee of European Banking Supervisors (CEBS), the organisation running the tests, certainly has almost an impossible balancing act to perform.

If most of the banks pass the tests, investors may feel they were too moderate, and confidence in their credibility will plummet.

Essentially, investors’ perfect outcome would be an impossible balance of the ‘right’ number of failed banks, in order to verify the tests credibility, but with no resulting impact to the strength of the EU’s financial system.

If the tests show this outcome, there is a chance that they will reassure investors.

Reactive currency movements will be based on the initial glance of results, and if the balance is ‘right’, the euro could surge.

I would expect the euro’s upside to be limited, however, as much of the good news has already been priced into the markets.

As the markets look towards the release this evening, the short-term outlook for the euro and pound remains positive.

Both currencies continue to be supported by better-than-expected macroeconomic data released this week, and their relative strength provides a nice backdrop to the release of the tests.

The real question on many minds is what will happen to the banks who fail the tests. In the U.S., the parameters for a failed test were clear from the outset.

In the EU, next steps are still uncertain. Potentially, this could create further confusion if the CESB does not clarify this after the tests results are published.

What do you think? Post your results on twitter (@Fxpayments)

Picture Credit: A Lloyds bank branch sign is seen near St Paul’s Cathedral in the City of London, July 23, 2010. Regulators have been looking at how banks would withstand another recession in an exercise similar to one in the U.S. last year which helped restore bank sector confidence. Some 91 lenders from 20 countries have faced the so-called stress tests. In Britain HSBC, Royal Bank of Scotland, Lloyds and Barclays, are being examined. REUTERS/Andrew Winning

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