Banks are put to the test – or are they?

9th March 2011

But should consumers, investors or taxpayers be worried? Answer, perhaps.

This year, banks will have to demonstrate they can withstand a smaller fall in GDP or in share prices than last, partly because the economic situation is deemed better.

 But as the FT points out, this has made analysts more sceptical about a process they were already sceptical about in the first place.

The new European Banking Authority is determined that its new tests gain in credibility – it has included a new stress test – what happens if a bank's funding costs rise 1.25 per cent.

It also says that home regulators – for the moment, the FSA in the UK – will have to make sure banks address any concerns about their capital position that result from the tests.

This would not just be banks that failed any stress test but also any that came close to failing.

However confidence in the process will take some time to repair.

Last year seven banks, one German, one Greek and five Spanish, failed. 

But Irish bank AIB passed a stress test, then had to have euro 3bn injected by the Irish Government a few months later. This then contributed to Ireland having to seek a humiliating bailout although admittedly it might have happened anyway.

So should you care? Yes certainly, if you are Irish, it might have allowed you to brace yourself for even more bad news.

Also because of the way banks in the UK, Germany and France are exposed to those on the periphery it could affect the investment decisions of those who decide to take a risk on financial stocks.

More broadly and historically, a better testing regime might well have caught the excesses of some of the banks in Britain such as RBS, HBoS and Northern Rock.

If banks are forced to hold more capital, it could mean lower profits, share price and dividends, but it could also mean the share doesn't collapse, as with Northern Rock.

It also shows that regulators are determined not to let banks become vulnerable again, risking a second crisis.

All very good reasons to stress test the banks.

But making anything in the test easier, may not help convince the public.

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