The EBA’s latest “Stress-Free” tests of 51 banks Eurozone have a minuscule overall capital shortfall of 5.6 billion euros.

A ZEW study using more reasonable stress test measures concluded something much different.

According to ZEW, capital shortfalls of publicly listed banks in a market-based stress test totaled 675 billion euros.

Crédit Agricole, BNP Paribas, and Deutsche Bank were the worst of the lot.

German and French Banks Have Massive Capital Shortfalls

Inquiring minds are investigation the ZEW report Stress Scenarios Reveal Capital Shortfalls in EU Banking Sector.

European banks lack sufficient capital to offset the losses expected in the case of another financial crisis. Quite how big losses are depends, however, on the stress level to which banks are subject. A recent study carried out by Sascha Steffen (Centre for European Economic Research (ZEW) and University of Mannheim) together with Viral Acharya (New York University Stern School of Business) and Diane Pierret (University of Lausanne) has considered results from the latest round of stress tests carried out for European banks. The study shows that the measured capital shortfalls differ to the extent of billions according to the stress scenario and the stress test methodology used. In particular, substantial differences are seen for banks in France, the United Kingdom, in Germany, Spain and Italy.

The researchers based their comparison on two benchmark methodologies; the approach taken by the European Banking Authority (EBA) in stress tests conducted in 2014, and the approach used by the US Federal Reserve (Fed) in the stress test conducted in the US banking sector in 2016 (CCAR 2016). Building on assumptions made in the EBA and Fed stress tests, researchers used a third, market-based approach, which assumed a global stock market decline of 40 per cent over six months. As in the EBA stress test conducted in 2016, the study considered 51 European banks, 34 of which are publicly listed.

German and French Banks Have the Largest Capital Shortfalls

Under the EBA methodology, the capital shortfalls of all 51 banks totalled 5.6 billion euros. The CCAR 2016 approach resulted in total capital shortfalls of 123 billion euros for all 51 banks. The banks with the largest capital shortfalls are the Deutsche Bank (19 billion euros), and the French banks, Société Générale (13 billion euros) and BNP Paribas (10 billion euros).

If the 34 publicly listed banks are considered, the differences between measured capital shortfalls are even more stark. Capital shortfalls of the publicly listed banks in the market-based approach totalled 675 billion euros, whilst the Fed stress test revealed shortfalls of 92 billion euros. The banks with the largest capital shortfalls were the French banks, Crédit Agricole (79 billion euros) and BNP Paribas (75 billion euros), and the Deutsche Bank (60 billion euros).

Main Objective: Lie

“The main objective of the recent EBA stress test was to achieve transparency in regard to bank capital adequacy in stress scenarios, not to reveal capital shortfalls that need to be taken care of immediately,” explains Professor Sascha Steffen, head of the ZEW Research Department “International Finance and Financial Management” and co-author of the study.

That’s a bit too polite. The main objective was to lie.

No Credibility

On August 1, ahead of the ZEW report, Guardian writer Larry Elliott wrote EBA’s Stress Tests Reveal Their Own Lack of Credibility.

Stress tests for Europe’s banks are Orwellian doublespeak. They are not designed to show the real state of lenders across the continent, nor do they provide any real insight into how the 51 banks examined in the latest exercise would withstand another crisis. Instead, the stress tests are designed to impart confidence, to explain that things aren’t quite as bad as they appear to be.

Even by this measure they have proved to be a failure. This much was evident from the caning taken by bank shares across Europe on Monday, when investors had the opportunity to pass judgment on the findings of the European Banking Authority, which were published after markets closed for business on Friday night.

There were three things glaringly wrong with the latest examination. The tests did not include banks from two of the most troubled eurozone countries: Greece and Portugal. They did not test for the most likely problem: a prolonged period of negative interest rates following Brexit that would further impair the profitability of European banks. And they did not say whether individual banks had passed or failed.

In order to give the exercise a tinge of credibility, the EBA singled out Italy’s Monte dei Paschi as a bank that would see all its capital wiped out under certain conditions: recession and a sharp increase in interest rates.

The truth is that Monte dei Paschi is the tip of a barely concealed iceberg.

Tip of Iceberg

Tip of Iceberg

Fed-Like Stress Test Shortfalls

  • Deutsche Bank: €19 billion
  • Société Générale: €13 billion
  • BNP Paribas: €10 billion

Market-Based Stress Test Shortfalls

  • Deutsche Bank: €60 billion
  • Crédit Agricole: €79 billion
  • BNP Paribas – €75 billion

Market Caps

The above banks would be wiped out in a realistic stress test scenario. The market acts as if they are insolvent or nearly insolvent already.

Mike “Mish” Shedlock