Europe shores up support for bank stress tests

LONDON Thu Jul 8, 2010 4:03pm BST

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LONDON (Reuters) - European supervisors won tentative support for impending bank stress tests on Thursday, while markets sought more detail about the process before delivering a final verdict.

Regulators are aiming to restore trust among bank investors, in the same way that U.S. stress tests last year helped draw a line under problems there, publishing a list of 91 banks subject to the tests late on Wednesday.

The Committee of European Banking Supervisors (CEBS), tasked with running the tests, said it would test banks' resilience assuming economic growth 3 percent below official EU forecasts.

"The good news is twofold," said Pascal Decque, analyst at Natixis, as the "very wide scope" of the tests, including unlisted banks in Spain and Germany, would give a broad picture of the health of the banking system. "That's good news one."

"Good news two is that it will be published on a bank-by-bank basis as well, and you will have the ability to see each name," he added.

On the "bad news" news front, however, was the lack of detail on exactly how much of a "haircut" each bank would need to take on the sovereign debt they hold, he said.

European bank shares rose roughly in line with overall markets, in a sign the test criteria were not worse than markets had been expecting.

European investors have been shaken by worries about sovereign debt losses, more bad debts and doubts about the health of the unlisted bank sector.

The European test, whose results will be released on July 23, will include losses on some government bonds based on a deterioration of market conditions to worse than the situation observed in May.

The scale of markdowns on sovereign debt is all-important, however.

A markdown of Greek debt would be 16 to 17 percent off the market price, German industry sources said before the CEBS statement, adding there would be no markdown on German bonds.

"Stress should be a worst case scenario and this is not a worst case scenario by any stretch of the imagination ... there's a very real possibility of debt restructurings having to take place for sovereign debt," said Andrew Lim, analyst at Matrix.

"Short term the market is positive on the fact that most of the banks should pass it. But longer term investors will come to the conclusion that the tests weren't onerous enough."

Greek 10-year government bonds traded at a discount of 38 percent at their low, according Tradeweb data. They have since recovered to a 25 percent discount, implying the stress test will apply a haircut of at least 13 percentage points on current market prices.

Based on May lows, Tradeweb data show Portuguese and Irish debt could each take a "haircut" of at least 12 percent from their nominal value and the markdown for Spain could be over 3 percent.

By 1345 GMT the STOXX Europe 600 bank sector index was up 1.8 percent, adding to a near 8 percent rally over the last two days, also helped by positive comments by analysts at Credit Suisse and gains by U.S. peers.

Gainers were led by France's BNP Paribas and Societe Generale, Deutsche Bank and Royal Bank of Scotland, all up over 2.5 percent.

TRANSPARENCY KEY TO SUCCESS

Most of Europe's large banks are on the list to be tested, as well as regional landesbanks and cajas, thought to be among the weakest.

"The purpose of the stress test is to differentiate between the listed and the unlisted banks. That's deliberately the case in Spain, but reluctantly the case in Germany," said Simon Maughan, analyst at MF Global.

"The elephant in the room in European banking is the awful German domestic market. The Germans don't feel the same political and economic pressures as the Spanish to do anything about it, but that's what the stress tests will show," he said.

European regulators appear to have heeded some lessons from the 2009 U.S. stress tests, which were widely regarded as a success in helping restore confidence. CEBS needs to go further in making the process more transparent, analysts said.

U.S. investors took comfort that a line had been drawn under potential exposures to worsening bad debts.

While the American tests reduced fears of more structured credit losses, the key for Europe is to reduce worries about sovereign debt exposures, analysts have said.

Regulators also need to make clear if banks will raise capital privately or if there is a government backstop available for any bank shown to be short of capital.

Under the U.S. test, 10 of the 19 banks tested were found to need to raise $185 billion (122 billion pounds). After asset sales of restructuring the capital need was about $75 billion. The banks were told to raise capital or accept taxpayer help.

The U.S. test process helped a recovery in bank stocks. The KBW bank index rose 30 percent from the start of February -- just before the tests were announced -- to the end of May, after the results came out.

(Additional reporting by Paul Day In Madrid; Editing by Sharon Lindores and Simon Jessop)

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