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Print Edition> Business
UPDATED: August 2, 2010 NO. 31 AUGUST 5, 2010
Crisis Focus: Hidden Risks in Stress Test

The Committee of European Banking Supervisors released better-than-expected stress test results on July 23 for 91 European banks, whose combined assets account for 65 percent of all European banks. About 84 banks passed the stress test and are able to maintain a core capital adequacy ratio of 6 percent. The positive result has pulled together the global stock and currency markets. But Zhang Monan, a researcher at the State Information Center, said the seemingly rallied financial market is unsustainable and that the European banks will encounter prolonged challenges. Zhang expressed her concerns in Securities Times.

Edited excerpts follow:

The European test results are far from convincing as the process of the test is ambiguous and there is little transparency.

First of all, the Basel Accords, the global banking supervision accords, require a minimum capital adequacy ratio of 8 percent. But in the stress test, European banking regulators required only 6 percent, a lot less than the internationally agreed upon level.

The latest figures from the Institute of International Finance said the tested banks' assets totaled 20.2 trillion euros, twice as much as that of the combined assets of the U.S. financial system. It took the U.S. Government 84 days to release its stress test results—the Supervisory Capital Assessment Program (SCAP)—to make sure how much capital needed to be injected to big banks in times of emergency, but Europe completed such a colossal task in just three weeks. The discretion exercised in conducting the test is questionable.

The financial leverage in the eurozone countries has been much higher than that of the United States. Before the 2008 financial crisis, the leverage ratio in the eurozone was 70 percent of GDP, while that of the United States was 40 percent. At the beginning of 2009, the U.S. SCAP showed the biggest 10 American banks had a financing gap of $70 billion. Therefore, it makes people wonder, why do the European countries, whose leverage ratio is much higher than that of the United States, need a capital injection of only 3.5 billion euros ($4.55 billion)?

More noticeably, this European stress test deliberately ignored some imperative factors. The test had indeed included key macroeconomic data such as GDP, unemployment rate and consumer price indexes. But it failed to reveal the proportion of sovereign debts held by banks, and ruled out the possibility of a national bankruptcy.

In 2010, about 560 billion euros of debt owed by European banks will mature, followed by 540 billion in 2011. The European countries must raise 1.6 trillion euros to pay back the debt, and this will deal a heavy blow to the re-financing plans of European banks.

Passing a stress test is not the end of the story. The key to resolving the problem is to find a way to raise funds for a faltering international financial market. The uncertainties stemming from global economic trends, policy readjustments and fiscal restructuring also pose a long-term challenge for European banks.


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