by Simon Nixon
Wall Street Journal
July 16, 2011
If the European banking system was looking for a cathartic moment, this wasn't it.
Just eight out of 91 banks failed this year's stress tests, one more than last year, with a combined capital shortfall of just €2.5 billion ($3.54 billion). They comprised five Spanish savings bank, two Greek banks and one Austrian. One German bank also would have failed but withdrew from the process. Some of the failures made it immediately clear they saw no need to raise fresh capital, further undermining the credibility of the exercise.
The key problem, as last year, was that the exams didn't adequately test for the one risk that most worries the markets: sovereign defaults. Write-downs on government debt held on banking books weren't based on market prices but a complex formula based on credit ratings. As result, Greek government debt, which trades at just 50 cents on the euro, was written down by only 15%. Nor was there any allowance for effects such as rising bank-funding costs, whose impact could be greater than the initial capital hit.
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