Under pressure from investors to provide more transparency, European Union (EU) officials are widening the scope of banking stress tests to include more national and regional banks and to assess sovereign-debt risks when calculating how lenders would perform against shocks to the banking system.
The moves come as investors have been increasing pressure on the EU to provide complete transparency while conducting stress tests on the banks.
EU leaders have already agreed to publish stress test results for 26 banks next month – mainly big, cross-border institutions – to address concerns about the Eurozone's exposure to sovereign debt.
The stress tests will be expanded to include as many as 120 more banks to cover "significant market share" a person familiar with the matter told The Wall Street Journal. "We have to find a balance between the credibility of the exercise and the number of banks we can actually get tested in that time," the person said.
The tests will also be extended in scope to include "sovereign shock."
Two other anonymous sources told The Journal the stress tests would likely include banks that together account for more than 50% of the sector's total assets in any EU country.
The expanded testing is already under way and results will be published in July, along with the results of tests on the initial 26 cross-border banks.
The new tests will include second-tier banks, including state savings banks, such as Germany's state-controlled Landesbanken and Spanish Cajas.
In line with the expansion, two to three banks will be tested in smaller countries, while five to six banks will be tested in larger countries. The banks will be picked according to market share.
Investors recently expressed concern that the stress tests, to be conducted by the Committee of European Banking Supervisors (CEBS) in cooperation with national regulators, would not paint an accurate picture of European banks' health unless they take into account risks tied to the sovereign debt of Greece, Portugal and other European nations.
Investors have raised questions about banks' holdings of sovereign debt after several European governments increased borrowing to fund their operations. European banks had $2.29 trillion at risk in Greece, Italy, Portugal and Spain at the end of 2009, according to the Bank for International Settlements.
Bill Winters, the former co-chief executive officer of JPMorgan Chase & Co.'s (NYSE: JPM) investment bank, told Bloomberg Television on June 25 that the main issue for the stress tests is whether they will include restructuring of sovereign-debt holdings in the results.
"The question everybody's asking is: Are you going to include scenarios that involve the restructuring of Greek or another countries' debt in these stress tests?" Winters said. "If you do include it, we already know the answer: There are real issues. If you don't include it, we're not sure we're going to take that test very seriously."
Marking down the value of Greek bonds, even for the purposes of a test, might imply that regulators perceive a debt default as a possibility, which could further unsettle investors, according to analysts surveyed by Bloomberg News.
Spanish Finance Minister Elena Salgado said that the tests would make clear that her nation's banks are strong. Spain will ask European finance ministers at the July 12-13 meeting to publish the results as soon as possible, she said in an interview.
"At the next Ecofin meeting in two weeks, Spain's request will be for our stress tests to be published immediately, to show that our whole banking system has an excellent solvency position," Salgado said in an interview with Cadena Ser radio in Madrid.
The EU has pledged about $1 trillion to reassure the markets and support the euro, which has fallen 14% against the dollar this year on concerns that Greece's debt crisis is spreading. The extra yield investors demand to hold Greek 10-year bonds over benchmark German bunds has jumped to about 800 basis points, almost five times more than levels seen before the debt contagion problem began.
News & Related Story Links:
- Wall Street Journal:
EU to Add More Banks to Stress Tests
Stress Tests Must Gauge Sovereign Risk, EU Draft Says
- Money Morning:
Dollar Bulls Retreating From Bets Against Euro
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Debt Contagion Category