EU Stress Tests on Banks Include a 25% Writedown in Greek Government Bonds

Bloomberg
July 16, 2011

European Union regulators’ stress tests on the region’s banks include a 25 percent writedown on Greek government bonds. The market has already driven down the price of 10-year Greek debt to 52 cents on the euro.

Regulators didn’t include the possibility of a sovereign default in the tests even though credit-default swaps indicate about an 87 percent chance that Greece won’t be able to repay its debts. The tests included a 22.3 percent writedown on Portuguese 10-year securities, while they currently trade at 54 cents per euro.

“Current market expectations regarding sovereign risk are not incorporated in the tests,” Hank Calenti, a bank strategist at Societe Generale (GLE) SA in London, wrote in a note to clients today.

The stress tests show the size and maturities of sovereign bond holdings, the regional split of loans and lenders’ capital strength. To pass, lenders needed to maintain a core Tier 1 capital ratio -- a kind of buffer against losses --of more than 5 percent in certain stressed scenarios. The test applied the 25 percent writedown only to those Greek bonds in each bank’s trading book, not to the bank’s entire holdings of the debt.

Eight of the 91 banks tested failed the examination and were told to raise 2.5 billion euros ($3.5 billion) in fresh capital to strengthen their capital positions, the European Banking Authority said.

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