The jury came back on Europe’s bank stress tests and the verdict is the tests lacked credibility. European markets, and banking stocks particularly, dived on Monday—the first day investors could react to the European Banking Authority’s report released after trading on Friday.
The EBA found that just eight of 90 large banks tested would suffer a serious capital shortfall amid two years of adverse economic conditions; another 16 banks would barely pass regulatory muster.
But European markets did not find the report reassuring, and the final stock market tallies draw a sharp line as to which banks are seen as most vulnerable. Lloyd’s Banking Group dropped 7.5% in value Monday, followed closely by Barclays’ 7% fall and Royal Bank of Scotland Group’s 6% fall. The large British banks were nearly matched by Italy’s Banco Popolare and UniCredit, which declined 6.7% and 6.4%, respectively. France’s Societe Generale fell 5.5% and Germany’s Commerzbank declined 4.6%
A common criticism among analysts is that many more banks would have failed the test if the stress scenario were more realistic. The Wall Street Journal notes that the EBA’s worst-case scenario for Portugal is an 11.6% unemployment rate this year, rising to 12.9% next year, even though unemployment in Portugal is already 12.4%.
A financial analyst and blogger points out that the EBA’s adverse scenario envisions a 25% haircut for Greek debt while current credit default swap spreads show the market expects a haircut of 50%. The blogger, known as “Also Sprach Analyst,” reports European bank analysts are using the EBA data to estimate capital shortfalls some 10 times higher than the 2.5 billion euros the EBA predicts.