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European banking: Stress test fails to reassure

Last month, European bank regulators tried to reassure the markets that in a severe recession and collapse in European government bond markets, only seven of the 91 leading European banks they tested would face a shortfall in core tier 1 capital ratios below 6%, amounting in aggregate to just €3.5 billion.

If anyone actually feels reassured by this, Euromoney would appreciate a draw of whatever it is they are smoking.

In May 2009, when the US Federal Reserve announced the results of its stress test of the capacity of the 19 largest US banks to withstand losses resulting from a severe recessions lasting to the end of 2010, it required them to raise $75 billion in additional capital – a demand that gave it a stamp of credibility.

Within minutes of the results being announced, banks were busy raising it. Investors had gone very underweight US bank stocks earlier in 2009 and were now keen to buy back into the sector as bank earnings boomed and the Fed’s quantitative easing made the recession outlined in its own test seem an increasingly unlikely outcome.

Europe’s experience is likely to be different, and not just because of lingering doubts about the tests’ credibility, renewed worries about the economy or Europe’s constipated rights issue process for raising new equity.

Regulators and banks don’t want to spark a rush to the equity markets. They want the largely favourable test results by themselves to re-establish banks’ unfettered access to wholesale debt financing.

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