Archive for September 12th, 2010

European bank stress tests…..hiding unpleasant details

September 12, 2010

One always feard about veracity of European bank stress tests. Even before they were released, few people said they are not being done properly, it will jut be a coverting act etc. As the results were released, not surprisingly only few banks were found in trouble. THough, some people kept saying the tests are fake, sham etc.

Now, this news is heating up. First WSJ article says that its analysis shows some banks did not give its true exposure to government bonds.

An examination of the banks’ disclosures indicates that some banks didn’t provide as comprehensive a picture of their government-debt holdings as regulators claimed. Some banks excluded certain bonds, and many reduced the sums to account for “short” positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July.

Because of the limited nature of most banks’ disclosures, it is impossible to gauge the number of banks that excluded portions of their sovereign portfolios from their disclosures, or the overall effect of that practice.

But the exposure to government debt of at least some banks, such as Barclays PLC and Crédit Agricole SA, was reduced by a significant amount, according to industry officials and financial filings made by the banks. Adding to the haziness, the stress tests’ reported sovereign-debt levels differed, sometimes widely, from other international tallies and from some banks’ own financial statements.

The findings undermine a primary goal of the stress tests—namely, to reassure investors and bankers world-wide the soundness of Europe’s financial system. “That would certainly be unhelpful to people’s perceptions” of the tests’ credibility, said UBS banking analyst Alastair Ryan. Reducing banks’ reported holdings of government debt “was clearly helpful for the thing [regulators] were trying to achieve: convincing you that there’s not a problem.”

As eurointelligence says reported gap in bank holdings between the BIS and the stress tests is very high.

WSJ Blog points to a paper which says banks only included governemnt debt which was in trading books. They excluded bonds held in banking books which are much larger in size.

The stress tests ignored bonds held in financial institutions’ much larger banking books. The reasoning: Bonds in the banking book are assumed to be held to maturity, so banks don’t have to recognize losses unless the issuer defaults — an outcome the regulators see as unlikely over the stress tests’ two-year horizon, given the European Union’s creation of a 750-billion-euro fund to bail out troubled governments.

The paper, penned by Adrian Blundell-Wignall and Patrick Slovik, provides a useful accounting of just how much the stress tests ignored. The banking books contain more than 1.6 trillion euros in EU government bonds, compared to only 336 billion euros on the trading books, for a grand total of more than 1.9 trillion euros. Using the stress tests’ own worst-case scenario, the authors estimate that banks’ total losses would be 165 billion euros, compared to the stress tests’ estimate of only 26 billion euros.

Those numbers — which might still be understated — aren’t as meaningless as European regulators assume. Just because banks don’t have to recognize drops in the market value of bonds on their banking books, that doesn’t mean they haven’t lost money. Market prices reflect investors’ assessment of the chances that governments will eventually default on the bonds, and that the banks will eventually suffer a loss. Even if those losses come more than two years down the road, they are relevant to the banks’ value today.

As I was reading various sources, the risk spreads have again risen in European countries reacting to these developments.

If true, why would policymakers do this at first place? It would eventually be found out leading to worse problems later on.

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