Jul 15th 2011, 21:21 by A.P.
IMAGINE a patient clutching at his heart, complaining of sharp chest pains. A
doctor arrives, examines him carefully and pronounces him healthy provided he
is not having a cardiac arrest. The same air of unreality infects today s
stress-test results for European banks: most institutions are fine unless there
is a sovereign-debt crisis.
The tests, which were conducted by the European Banking Authority (EBA), found
that eight banks out of 90 tested had failed to pass the threshold of a core
Tier-1 capital ratio of 5% under a stressed scenario. Five were Spanish, two
were Greek and one was Austrian. Another sixteen banks posted ratios of between
5% and 6%, dangerously close to failure.
Despite some claims to the contrary, the tests are not a waste of time. All of
the banks involved in the tests have to disclose lots of information about
their sovereign-debt holdings, which will help analysts to identify the banks
that are most exposed to the unfurling euro-area crisis. They may have helped
encourage some banks to raise capital ahead of time: European institutions
added around 50 billion ($71 billion) of capital between January and April of
this year.
The eight banks that failed to meet the EBA s pass threshold and those that
floated just above it will come under pressure from the markets to raise
equity. The task facing the Spanish banking system has been made clearer, in
particular: five of the eight banks that failed were Spanish, and without the
capital-raising in the first four months of the year, nine out of the 20 banks
that would have failed were Spanish.
Counting the flaws
In at least three respects, however, the tests are badly flawed. The most
obvious is that they gloss over the severity of the sovereign-debt crisis. They
assume that no euro-zone default occurs; to do otherwise would have been to
trample over the official European line on the crisis in Greece and elsewhere.
Haircuts on sovereign-debt holdings are applied only to those in the trading
book; whereas most banks hold government bonds in the banking book, where they
are carried at their original value. Those haircuts are in any case too slight:
they assume a 25% drop in the value of Greek government debt, for example, when
the market is pricing them at closer to a 50% write-down. The EBA did make
banks provision for their banking-book exposures, but they have not exactly
cracked the whip: out of a grand total of 377 billion in provisions across the
90 banks tested, just 11 billion relate to sovereign debt.
The second flaw relates to the way in which the crisis has evolved in just the
past week, with Italy joining Spain in the firing-line. The tests are a useful
indicator of the direct vulnerability of banking systems to shocks. But they
are much less useful, as the EBA itself acknowledges, when it comes to working
out second-order effects of sovereign-debt distress on things like investor
confidence and availability of funding. And both the direct and the
second-order effects of the euro-area crisis get worse when bigger economies
are in the frame. The stress tests can guide policymakers if they want to beef
up the defences of the banking system in case a minnow like Greece topples.
They are much less help with a country like Italy or Spain because the
contagion effects would be so much greater and less predictable.
The final flaw in the tests relates to what comes next. Europe s banks need to
add capital if they are to withstand the effects of a debt restructuring in
Greece, Portugal or Ireland. But that has been the case for well over a year
and yet they have still dragged their heels on recapitalisation. Between the
end of 2009 and the end of the first quarter of this year, American banks added
roughly four percentage points of core Tier-1 equity (see chart). No European
banking system came close to doing the same, and their absolute levels of
capital remain much lower.
These tests may be the catalyst for a wave of capital-raising but there are
clear signs that the EBA will face lots of resistance from national regulators,
many of whom dispute its purist definition of what counts as high-quality
capital. One German bank, Helaba, this week refused the EBA permission to
publish all of its data after the EBA disqualified some of its capital. Helaba
must surely have had the backing of Bafin, the German banking supervisor, in so
doing. The Spanish authorities are also on a clear collision course with the
EBA, which wants banks that failed the tests to put together plans to fill the
shortfall within three months. The Spanish central bank tonight issued a press
release saying that no Spanish bank would be required to add capital as a
result of the tests.
The newly formed EBA has done a better job than its predecessor did with the
2010 stress tests. But the 2011 version still looks doomed to irrelevance: too
soft to reassure the markets, too unenforceable to prompt the recapitalisation
that is needed.