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The EU Bank Reserve Test: The Harsh Truth

By Edited Sep 28, 2015 0 0

In the middle of 2010, the banks of Europe underwent a stress test to present how well their capital holdings were structured and how much they relied on money sourced in higher-risk states. In spite of the findings of the test being positive in the beginning, or so they seemed, it was revealed that the information which the bankers disclosed in their result sheets was misstated at best: the capital of the European banks is of a structure which is indeed subject to more contingent risk than previously the case.

In late July, a stress assessment was imposed on all European banking houses by the Committee of European Banking Supervisors (CEBS) to determine how well prepared they were to live through another potential financial crisis. This test was designed in order to scrutinize the European banks' reserve ratios and its kind. The test should have given an answer as to whether sufficient reserves is available to banks and whether it is of an appropriate quality for the banks to rely on. Several other non-EU countries undertook a similar capital test – LSM Insurance informed about that earlier this year too. The findings of the test in the EU revealed that several banks were in a less-than-favourable position, yet the results in general helped sustain investor confidence in the E.U. banking environment as a whole. And thus, the Euro as a currency and currencies outside the monetary union were prospering from a stable position in the world's currency trade.

However, that wasn't to last for more than a short while. On September 7th 2010, The Wall Street Journal came with a thorough review of the outcome, compared with a snapshot of the quarterly financial reports of the tested banks. The Journal's findings show that the tested subjects failed to disclose all the necessary clarifications on their debt, seeing as the figures could not match entirely the banks' official statutory statements. The banks did not lie. The banks simply neglected to categorize their capital properly since the CEBS guide was not written clearly enough.

Government bonds, in the past automatically beloging to the least risky category, are lately not as clear-cut as before. Greece's near-bankrupt status puts riskier government bonds. As such, they would rightly be recorded differently. Plenty of banks just would not make this important principle clear in their stress test reports. In addition, some banks did not state material parts of their reserves and said that those are highly volatile and actively traded. This way, they effectively improved their results in an uncontrollable fashion. As each tested participant understood the test guidelines with slight differences, each tested subject presented its holdings with slight differences and that let the test results hardly comparable and thus unusable.

In short, the paramount shortcoming of the stress testing was how few extra information, notes the banks managed to include for the regulators. It seems that the CEBS requirements were just too tolerant. This is now to the detriment of the Euro, which experienced a significant shock and has been recovering nervously since. It is very confusing to see that even now, the regulators are still standing behind the original questionable test rules.

Hopefully, regulators universally are going to learn a lesson out of the mistake of their colleagues and will ensure that any new tests and regulations are reliable and thorough. Any more failures will insult the credit of the economy in question.



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