The European Banking Authority (EBA) continues to court controversy with the way it is administering the recent round of bank \u201cstress\u201d tests. The testing process has been in progress since March and is designed to restore confidence in the European banking system awash in questionable sovereign debt.<\/p>\n
As part of the evaluation, the banks have been provided with a formula that will \u201caddress inconsistencies and excessive optimism\u201d when it comes to assessing risk of these sovereign exposures. Based on the risk assumption, the banks can then determine the extent of the \u201chaircut\u201d to which they could face and then determine how much they need in reserves to cover the potential losses.<\/p>\n
What the EBA is not doing, however, is to force the banks to simulate the impact of an actual default<\/em> or debt restructuring<\/em>. If the EBA is hoping to restore confidence with this approach, it leave much to be desired. Especially given the track record of the previous round of stress testing.<\/p>\n Last year\u2019s stress test results were called into question from the very beginning simply because so few banks were deemed at risk. Indeed, the Irish banks were given a clean bill of health just months before the Irish government was forced to provide emergency funding<\/a><\/span> to keep them afloat.<\/p>\n Nevertheless, the EBA claims that owing to the improvements introduced this year, the results will provide a truer picture of the state of the financial system. Still, they are not addressing the greatest fear of all investors \u2013 an out-and-out default by a sovereign nation.<\/p>\n Testing Results Leaked<\/strong><\/p>\n A story carried by several news agencies Tuesday morning quoted an anonymous Eurozone insider as saying that potentially one in six of the ninety-one banks tested will fail the testing process. This means up to fifteen banks are deemed at risk based on the criteria imposed by the EBA.<\/p>\n On the surface this appears to be a dreadful result but according to the EBA source, this is exactly what the banking authority wants as it feels this will prove that the EBA is serious in its assessment.<\/p>\n \u201cIn order to demonstrate that it is credible, the EBA would need to show that the number of bank failures is significant, without being substantial,\u201d the source was quoted as saying. \u201cA number in the teens is about right.\u201d<\/p>\n The process still has the appearance of being manipulated given the nature of the comments, but in light of last year\u2019s fiasco, there could be a degree of method in the madness. Besides, no one is buying the old \u201cthe banks are all right line\u201d line any how, so by finding a significant number as being at risk \u2013 but not too many \u2013 this may actually show investors that authorities are indeed serious this time.<\/p>\n Final results are due in a couple of weeks at which point we\u2019ll see once and for all how the EBA intends to deal with the bank solvency question.<\/p>\n Scott Boyd<\/a><\/span> is a currency analyst and a regular contributor to the OANDA MarketPulse FX blog<\/a><\/span><\/p>\n","protected":false},"excerpt":{"rendered":" A story carried by several news agencies Tuesday morning quoted an anonymous Eurozone insider as saying that potentially one in six of the ninety-one banks tested will fail the testing process. This means up to fifteen banks are deemed at risk based on the criteria imposed by the EBA.<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-22002","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/22002","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/comments?post=22002"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/posts\/22002\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/media?parent=22002"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/categories?post=22002"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/fx\/wp-json\/wp\/v2\/tags?post=22002"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}