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 Monday 01 August 2016

Doubts over European stress tests

 

 

European equities began the week and the new month in positive territory first thing this morning. There was some initial relief following the release late on Friday of the European Banking Authority’s (EBA) Stress Test results. As expected, the tests showed up some concerns and Italian bank Monte dei Paschi was identified as the financial institution most exposed under the various scenarios. Other troubled banks include Allied Irish, Royal Bank of Scotland and Commerzbank, although Deutsche Bank performed better than expected.

But there was plenty of criticism of the test. For a start the EBA decided that it wasn’t going to “pass” or “fail” any bank. Instead it said it was up to investors and regulators to interpret the results themselves.

The stress tests considered a severe economic downturn with growth declining 1.2%, 1.3% and 0.7% over the next three years with lower banking profits and rising interest rates.  But critics point out that it didn’t look at protracted period of zero/negative interest rates – our current situation. If we were to have another crisis like the one in 2008/9 central banks wouldn’t have the same scope to cut rates, unless they were prepared to take them deeper into negative territory – something that would be disastrous for bank profitability. In addition, the stress test completely ignored a major feature of the 2008 crisis – contagion. In other words, how would a failure of one bank affect others in the system? Finally, it excluded Portuguese and Greek banks which will be tested separately and the results will not be made public.

As today’s trading session has progressed, it looks as if investors are coming to doubt the efficacy of the tests. The European banking sector came under pressure again and Deutsche Bank looks like ending the day lower despite better than expected stress test results.  

  

 

Posted by David Morrison

Category: PM Bulletin


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