{"id":460,"date":"2010-07-23T13:18:00","date_gmt":"2010-07-23T17:18:00","guid":{"rendered":"http:\/\/www.intuitiveinvestor.com\/web\/?p=460"},"modified":"2018-08-18T17:36:45","modified_gmt":"2018-08-18T21:36:45","slug":"stress-tests-for-european-banks-completed","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2010\/07\/23\/stress-tests-for-european-banks-completed\/","title":{"rendered":"Stress tests for European banks completed"},"content":{"rendered":"<p><span style=\"font-size: 16px;\">Stock markets started collapsing at the beginning of May after investors suddenly started paying attention to the debt crisis that was plaguing European banks.\u00a0 Specifically those rascally Greeks sent folks into fear paroxysms.\u00a0 As a part of calming investor stomachs the Europeans stated that they would undertake &#8220;stress testing&#8221; of the European banking system.\u00a0 The goal was transparency for the financial markets.\u00a0 Investors were assuming apocalypse because they didn&#8217;t know what really was happening at the individual bank level.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">The results of the European stress testing were announced today.\u00a0 Here is a summary of the major findings.<\/span><\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Of 91 banks scrutinized, only 7 would need to raise additional capital (i.e. equity) in the event of a further recession or in the event of a government bond default.<\/span><\/li>\n<\/ul>\n<p><span style=\"font-size: 16px;\"><strong>Analysis<\/strong>: In case you are not schooled in the rigors and obscurities of bank financing let me briefly explain what all of this means.\u00a0 Banks are not required to keep on hand all of the cash that they receive as deposits.\u00a0 Instead they are allowed to lend out or invest huge portions of that cash.\u00a0 But they are required to leave some cash, reserves,\u00a0on hand in the event that some of their investments don&#8217;t perform as expected.\u00a0 This is similar to the equity:debt relationship of a home.\u00a0 Homeowners are not usually required to plunk down the full purchase price of a house.\u00a0 Instead they put down a portion of the worth of the house as equity while banks finance the rest with mortgage financing.\u00a0 That equity is supposed to protect the banking lender in the event of a decline in the value of the house or a default on the part of the homeowner.\u00a0 Well the same is true for banks and their cash reserves.\u00a0 So these stress tests are trying to answer the question of how much of those reserves (equity) would be wiped out in the event of a decline in the value of the banks investments (including mortgages, investments in bonds, etc.), most likely due to an economic decline.\u00a0 Does this make sense?<\/span><\/p>\n<p><span style=\"font-size: 16px;\">So that only 7 of the 91 major banks in Europe would be in trouble in the event of a big decline in the economy is a good thing.\u00a0 This result is much better than expected.\u00a0 Which brings us to the next piece of disclosure by the Europeans today&#8230;<\/span><\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Those 7 banks that failed the stress test would need to raise 3.5 billion euros in order to get capital up to safe and strong levels.<\/span><\/li>\n<\/ul>\n<p><span style=\"font-size: 16px;\"><strong>Analysis:<\/strong> That 3.5 billion euro figure is <span style=\"text-decoration: underline;\">significantly<\/span> lower than what had been feared.\u00a0 Investors had been throwing around numbers ranging from 30 billion euro up to 90 billion euro (!).\u00a0 How could the analysts have been so wrong?\u00a0 Well, not coincidentally, that brings me to my next point&#8230;<\/span><\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">What exactly were the criteria of the stress tests?\u00a0 No one publicly knows precisely what criteria were used.\u00a0 Some of the criteria are slowly making their way into the media.\u00a0 To me the criteria look a little\u00a0flimsy.\u00a0 For example, the stress tests largely focused on the damage an economic decline or debt crisis would have on the short-term investments of banks.\u00a0 That is, the long-term investments (those with maturities over 5 years, I am guessing) were not considered.<\/span><\/li>\n<\/ul>\n<p><span style=\"font-size: 16px;\"><strong>Analysis:<\/strong> Clearly this is bogus.\u00a0 A bank&#8217;s financial strength can&#8217;t just be evaluated based on the performance of their short-term investments.\u00a0 The economic shock-factors that were modeled &#8211; a declining economy and debt crises &#8211; wouldn&#8217;t exclusively affect short-term investments.\u00a0 Those are big, macro shocks that would affect all investments.\u00a0 Are the Europeans mad?<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Which brings me to my next point&#8230;<\/span><\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Why would the Europeans go through this process of reassurance, only to emasculate its potency?<\/span><\/li>\n<\/ul>\n<p><span style=\"font-size: 16px;\"><strong>Analysis:<\/strong> The Europeans are proving yet again that politics trumps economics.\u00a0 There is the whiff of a compromise in these stress tests.\u00a0 If the tests were overly strident the results might have triggered panic and they would have been the very seeds of destruction that the tests were meant to alleviate.\u00a0 But if the tests were too namby-pamby then they wouldn&#8217;t have credibility.\u00a0 I feel what we have here is something in-between.\u00a0 Unfortunately, these tests are not going to completely erase fears that the European banks are teetering on the edge.\u00a0 I feel that the Europeans have missed an opportunity here to quell fears, increase transparency, and\u00a0for themselves, to actually process reality, not financial fantasy.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">I don&#8217;t want to be overly harsh.\u00a0 The stress tests are net, a good thing.\u00a0 Let&#8217;s hope that the tests allow some breathing room for stressed European banks and an increase of confidence on the part of investors.<\/span><\/p>\n<p><span style=\"font-size: 16px;\"><strong>Importance grade:<\/strong> 10; this was one of the most important pieces of economic news in the last 3-4 months.\u00a0 Unfortunately, the impact has been diluted because of the questions surrounding the stress test criteria.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Jason<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Stock markets started collapsing at the beginning of May after investors suddenly started paying attention to the debt crisis that was plaguing European banks.\u00a0 Specifically those rascally Greeks sent folks into fear paroxysms.\u00a0 As a part of calming investor stomachs the Europeans stated that they would undertake &#8220;stress testing&#8221; of the European banking system.\u00a0 The [&hellip;]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[3],"tags":[],"class_list":["post-460","post","type-post","status-publish","format-standard","hentry","category-the-blog"],"_links":{"self":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/460","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/comments?post=460"}],"version-history":[{"count":0,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/460\/revisions"}],"wp:attachment":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/media?parent=460"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/categories?post=460"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/tags?post=460"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}