November 18, 2010 / 8:42 AM / 9 years ago

Irish bank woes show stress test flaws

(repeats piece first issued on Nov 17)

* Tests can stress loan books, but miss deposits, sentiment

* Irish woes seen outside realm of stress test

LONDON, Nov 17 (Reuters) - The plight of Ireland’s banks has cast doubt over how far stress tests can uncover skeletons that come to light once confidence ebbs from banks and highlights the pitfalls of a common approach to these health checks.

The EU’s stress test of 91 banks this year were meant to reassure investors that any problems tucked away in the sector would be uncovered and weaker lenders forced to recapitalise.

Only seven failed the test, none from Ireland. [ID:nN25160076]

Yet Ireland agreed on Wednesday to work with a European Union-IMF mission to shore up its shattered banking sector, which could see its lenders recapitalised with tens of billions more euros. [ID:nLDE6AG004]

Banks may have been subjected to stiff tests on how far their losses would spiral as commercial property or residential loans soured, but the tests failed to take into account the impact of deposit outflows and higher funding costs that are now adding to the Irish lenders’ pain.

“Whether the stress tests in Europe were tough enough, there are open questions, but we have not had a property bubble explosion of this magnitude elsewhere,” said Graham Bishop, a former investment banker and now a specialist in EU financial services who has advised the bloc’s institutions. “The Irish numbers were outside the realm of the European stress test.”

A European banking official, who requested anonymity due to the sensitive nature of the topic, said that Ireland’s problem was due to a rapidly deteriorating economy and the decreasing chance of outstanding bank loans being repaid.

For now, Ireland is a one-off due to its unprecedented property market collapse, sky-high public debt and little prospect of economic recovery soon.

“Some question marks inevitably can be asked over these stress tests,” the banking official said.

“But I think all this may be more of a reflection of a severe crisis in Ireland than of the stress tests as they seem to be holding up in other parts of Europe and banks there are not in a similar predicament,” the official added.


Ireland has said its bank bail-out bill could top 50 billion euros but investors fear the final figure could be higher as mortgage losses rise and as austerity measures bite.

Ireland carried out its own stress test in March and the country’s Prime Minister Brian Cowen said on Wednesday that was more rigorous than the one conducted by EU banking supervisors (CEBS) and the European Central Bank in July.

Experts said a stress test is only as good as the data fed into it and that questions have been asked over the big drop in the price of bank assets transferred to Ireland’s “bad bank”, the National Asset Management Agency (NAMA), compared with initial indications.

“The Irish question is a very specific one,” said Bishop. “The key to those banks is all about the value those assets were going to be sold to NAMA. To the extent they were valued at one price in the stress test in July then subsequently sold at a much lower price. The question is who knew what and when,” he added.

Irish lawmakers asked the country’s financial regulator, Matthew Elderfield last month whether he was lied to by banks over the value of transferred assets.

He said he didn’t know if the banks lied to NAMA.[ID:nWLA4688]

Irish regulators said they applied a more adverse scenario than required under the July CEBS test.

That applied 17 percent falls in both commercial and residential property prices this year, followed by a further 8 percent fall in commercial property prices and a further 5 percent fall in residential property prices in 2011.

Neither Bank of Ireland BKIR.I nor Allied Irish Banks ALBK.I needed additional capital after the test, beyond capital requirements under the Irish Prudential Capital Assessment Plan (PCAR) set out in March. But both were close to the minimum pass level set by CEBS.

The stress test process was criticised at the time for lacking severity, but most criticism was leveled at the “haircuts” applied to sovereign debt exposures.

Reporting by Huw Jones and Steve Slater. Editing by Jane Merriman

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