The Dark Side of the European Stress Tests

Unexpectedly good news on the state of European banks--but analysts urge caution

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Regulators announced Friday that seven of Europe's 91 largest banks will have to raise more capital after failing stress tests designed to measure their ability to withstand an unexpected economic catastrophe. The results were better than antcipated--earlier this week, analysts at Goldman Sachs predicted ten banks would fail. But that doesn't mean Europe's banks are out of the woods. The euro already took a dive today on news that the tests were less than rigorous, meaning that the results wouldn't give a good sense of the bank's health. Here's what analysts say is really going on, behind the simpler headlines.

  • Catch-22  Even before the number were released, there was concern over the test's methodology, writes The Atlantic's Derek Thompson. "If too many banks pass, the tests might be seen as a joke," he explains. "If too many fail, the banking system will be seen as a joke."

  • The Real Test  Testing the readiness of banks was not the real mission of regulators, argues Joe Weisenthal of Business Insider. "What's actually being tested," says Weisenthal, "is political and regulatory harmonization." The mere appearance of an orderly, transparent process would qualify as a "huge thumbs up for the notion that European regulators, politicians, and the ECB can work together."

  • Problems In Spain  Five of the seven banks to fail were cajas, small unlisted Spanish savings banks. Christopher Bjork of the Wall Street Journal calls cajas "a consistent worry among investors" due to their inability to raise capital, a byproduct of Spain's "arcane regulation" that "hindered them from issuing voting shares."

  • Questionable Criteria  Jack Ewing and Matthew Saltmarsh of the New York Times argue the better-than-expected numbers could be a by-product of unduly optimistic assumptions on the part of regulators:

Some of the assumptions used by the examiners will certainly draw criticism, particularly the way the tests treated European government debt. Authorities did not consider what would happen if Greece or another country proved unable to repay its bonds--even though many analysts have grave doubts whether Greece can ever make good on debts that currently equal more than an entire year’s economic output.

  • Little Impact On American Markets Investors in the United States "moved guardedly" after hearing the results, reports Kristina Peterson of Dow Jones Newswires. At issue, according to Peterson: the "lingering worry the tests may not be tough enough."

This article is from the archive of our partner The Wire.