A few weeks ago, in late July 2010, the Committee of European Banking Supervisors ordered a stress test onto the European banks to determine how ready they were to survive another potential financial downturn. This test was supposed to scrutinize the questioned European banks’ reserve levels – whether there is sufficient capital of a sufficient quality for the examined banks to fall back to. Several non-EU countries came with a test on their banks’ reserve ratios too. LSM Insurance reported on that a few weeks ago. The outcome of the test in the E.U. did reveal that a few banks were in an unfavourable situation, but the results in general aided in confirming investor trust in the European Union’s banking system. And so, the Euro and countries not using Euro enjoyed a stabilized position in the world’s foreign exchange market.
That wasn’t to be for longer than four weeks. On September 7th, The Wall Street Journal released a detailed analysis of the outcome the test yielded, compared to a glance at the banks’ official reports. The Wall Street Journal’s findings show that the test subjects in many cases neglected to detail all the necessary clarifications regarding their capital, seeing as the numbers could not be reconciled entirely to the bank corporations’ official statements. The banks did not bluntly lie. Rather, the banks simply neglected to specify the kind of their capital holdings properly as the CEBS guidance was not detailed enough either to start with.
Traditionally, government bonds are believed to be of a very low risk. However, they have gained on importance. Greece carries riskier debentures. As such, they should be recorded in another category. Many banks would not adhere to this important principle when reporting. In addition to that, some banks didn’t count in material bits of their reserves, saying that it was because of their volatility and the fact that they were actively traded. This way, they effectively improved their results in an uncontrollable fashion. As each bank “understood” the requirements of the test differently, each tested bank disclosed its capital holdings with slight differences and that caused the test results to be virtually incomparable.
The main issue with the testing was the limited amount of additional notes that the banks managed to share with the CEBS. One would say that the requirements were too lax to really oblige the banks to reveal any useful pieces of information. The Euro absorbed a significant withdrawal of investor confidence and has been trying to regain its losses cautiously ever since. It is bewildering to see that even now, the regulators are still defending their original questionable rules.
Hopefully, regulators all over the world are going to take something out of the faux pas of their E.U. colleagues so that any new laws and tests are thorough. Any more failures would significantly insult the credit of the economy in question.