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Monday 5 December 2016

The bank stress tests are missing the point of Europe's massive problems

Published 17/07/2011 | 05:00

WITH the rapidly-worsening Italian and Spanish debt crises threatening to rip the eurozone apart, last Friday's stress test results on the main European banks attracted less attention than they might otherwise have done.

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Which is probably just as well. Having failed just eight of the 90 banks taking part in the exercise, it is clear that the new European Banking Authority funked the challenge of forcing Europe's broken banks to raise more capital.

Normally the results of the latest stress tests carried out on the main European banks by the European Banking Authority (EBA) would have dominated the financial headlines.

But with both Italy and Spain teetering on the brink of insolvency and the eurozone staring into the abyss, Europe's leaders face far more serious problems at next week's emergency summit.

After almost three years of the financial equivalent of "phoney war", this has the smell and feel of the real thing. With Italy (which with total debts of €1.8 trillion is the third most-indebted country on the planet after the United States and Japan) now in deep trouble, yet another fudge simply won't do the trick.

Last week the yields on 10-year Italian bonds soared to a post-euro high of more than 6 per cent. It was a similar story with Spain where the yield on 10-year bonds jumped to 5.85 per cent before falling back to 5.75 per cent later in the week. Those are the sorts of bond yields that Ireland was being forced pay in the run-up to our expulsion from the bond markets and subsequent bailout "request" to the EU and the IMF last November.

The looming insolvency of the third and fourth largest eurozone economies, not the latest set of stress test results, was the real story from the eurozone this week. In any event, the bank stress test results need to be treated with extreme scepticism.

After all, who can forget the results of the July 2010 stress tests, which were carried out by the EBA's predecessor, the Committee of European Banking Supervisors, which handed out a clean bill of health to virtually every bank in the audience -- including both AIB and Bank of Ireland?

Taxpayers will need no reminding that after last year's European stress test results assuring us that all was hunky dory with the Irish banks, our own more rigorous stress test results concluded just eight months later in March 2011 that there was a €24bn hole in their balance sheets.

Did the EBA, mindful of how quickly the results of last year's stress test results were discredited, do any better this time around?

One can only hope so but it might not be a good idea to bet on it. Last week's spat between the EBA and the German central bank, the Bundesbank, over the results of the stress test on German public sector lender Helaba, with the European Banking Authority apparently reckoning that Helaba is under-capitalised and the Bundesbank arguing that everything is just fine, would seem to indicate that old habits die hard.

Helaba eventually flounced out of the stress tests in a huff and wasn't included in last week's results.

Whatever the rights and wrongs of the Helaba affair, it's hard not to be sceptical. Even before the publication of the stress test results analysts were speculating that the EBA was aiming to fail between 10 and 15 banks this year compared with just seven failures out of the 91 banks stress-tested last year.

A modest increase in the number of banks failing would, it was hoped, demonstrate the EBA's "seriousness" without triggering a full-scale eurozone banking crisis. In the event the EBA failed just eight of the 90 banks stress-tested this year.

The fact that the European Banking Authority and the national central banks are still playing such silly games demonstrates that the European stress tests, far from being an objective assessment of each bank's financial strength, are merely a political exercise and should be treated as such.

Meanwhile, out in the real world, as regulators and central banks fiddle, the eurozone burns. For eurozone watchers the big worry had always been that the contagion on the periphery would spread to Spain, whose economy is larger than those of Greece, Portugal and Ireland combined. The fear was that the European Financial Stability Facility, the €750bn bailout fund assembled by the EU and the IMF at the time of the first Greek bailout in May 2010, would be overwhelmed by a Spanish bailout request.

Now the eurozone is facing the nightmare scenario of having both Italy and Spain simultaneously on the rack. The scale of the resources required to address the crisis is now truly enormous, with RBS global strategist Jacques Cailloux estimating that the European Financial Stability Facility (aka the EU/IMF bailout fund) would have to be almost quintupled in size to €3.5 trillion.

Will German chancellor Angela Merkel be willing to put her taxpayers on the hook for the several trillion euro now required to "fix" the euro? Unless she and the other EU leaders come up with a credible policy response next week then the eurozone crisis could well go nuclear, with catastrophic consequences for both the euro and the entire European project.

Sunday Indo Business

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