Private investors, bankers and finance ministers alike will be closely watching Friday’s release of Europe’s bank stress tests.
The European Banking Authority (EBA) pledged a transparent look at the credit vulnerabilities of 91 large banks comprising 65% of the region’s banking assets. A similar report in 2010 drew criticism when the Irish banks that had passed the test later imploded, forcing Ireland to seek emergency EU and IMF bailouts. The EBA said in a statement that it sent additional guidance to banks last month in an effort to “address shortcomings and over-optimism of some banks’ preliminary estimates.”
The tests seek to assess whether the banks could survive adverse conditions such as a worsening economy or an unexpected default such as occurred with Lehman Brothers in 2008 in an “effort to improve transparency, identify vulnerabilities, inform policymakers and ensure appropriate measures are taken to address possible deficiencies,” the EBA says. To that end, the EBA will simultaneously announce corrective measures recommended for institutions deemed at risk.
Concern for the financial health of European banks has intensified this week as bond vigilantes put the screws on Italy. Ten-year-government bond yields on the debt of Europe’s third-largest economy surpassed 6%, the point at which many financial experts believe debt-service costs begin to spiral out of control.
Bloomberg quoted Fitch Ratings as saying the yield jump reflects a “crisis of market confidence in the European policy response to the euro-zone debt crisis rather than deteriorating sovereign credit fundamentals,” and assured investors Italy is “on track” to meeting its budget deficit cutting target for this year.
Despite the reassurance, signs of credit contraction recall the period after Lehman Brothers’ collapse when U.S. banks refused to lend to one another. A report in The Wall Street Journal cited defensive moves by European banks to limit their exposure to contagion by shaky European countries and the banks that own their debt.