Out of the 91 European banks subjected to the ‘stress test’ devised by the CEBS (Committee of European Banking Supervisors), only seven failed. This was better than expected, but there have been mixed reactions to the outcome of the tests.
While the greater transparency may reassure investors about the relative health of the larger EU banks, some have criticised the tests for being too soft. The results, announced on 23 July 2010, showed that the seven banks that did fail needed to raise just €3.5 billion – far less than had been expected – and have enabled investors to work out for themselves the losses that banks may incur in the case of sovereign default on debt.
A true test?
However, a number of analysts have questioned whether the tests were stringent enough. It had been widely expected that five to ten banks would fail the test – but that the capital shortfall would be over €30 billion. A leading analyst at Deutsche Bank commented that ‘We were disappointed with the stress test in three areas. First, we do not find a 6 percent stated tier 1 ratio target particularly challenging. Second, we have found it difficult to reconcile some banks' assumptions. Third, we think that trading book shocks have not been sufficiently conservative, even before considering sovereign risk.'[1]
What now?
Despite the criticism, investors appear to have viewed the results of the tests as positive – at least in the short-term. Financial stocks are performing well across Europe and confidence seems to have returned to the sector, lifting European shares to a five-week high on 27 July 2010. Banks that emerged from the tests with the strong tier one capital ratios (ratio of capital to assets) have been performing particularly well, with UK banks Barclays and Lloyds – who breezed through the tests with ease – making gains of around 8% on their share price to head up the FTSE 100 index on 27 July 2010.
The euro also made gains against the dollar and yen in the aftermath of the test, as the troubled currency benefitted from a perception that the eurozone was addressing its debt problems. Last month the euro hit a four-year low against the dollar, but since then has rebounded by almost 10%.
Scepticism surrounding the tests, however, is unlikely to go away, and in the long-term this may weigh heavily on risk appetite. Investors are increasingly looking towards alternative ‘safe-haven’ currencies while the outlook for the eurozone, US and Japanese economies remains uncertain. The Aussie dollar, Canadian dollar and even the Swedish krona have been touted as the investment of choice for the risk-averse. ‘The Canadian dollar is a currency you want to own,’ said David Rosenberg, chief economist and strategist at money management firm Gluskin Sheff in Toronto. ‘Canada has basically been re-rated coming out of the credit crisis as a bastion of stability in an increasingly unstable world.’[2]
Though the European banking sector has fared well over the past few days, it remains to be seen if this will continue in the long-term, particularly following the announcement of rigorous new regulations in the US last week.
Attention is likely now to focus on economic data coming out of the eurozone, and with some fairly important numbers due to be revealed later this week, we may see whether ongoing concerns about the stress tests will carry any significance in the long-term.
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Source: [1] Reuters News (26 July 2010), [2] Reuters News (23 July 2010)
The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.
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