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News : EU Economy Last Updated: Mar 10, 2011 - 7:38 AM

Fears growing that European bank stress tests will repeat last year's sham
By Finfacts Team
Mar 9, 2011 - 6:57 AM

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Fears are growing that the European bank stress tests will repeat last year's sham.

European banks will assume a 0.5% shrinkage of GDP (gross national product) in the Eurozone this year as part of the European Banking Authority’s stress tests, the German newspaper Handelsblatt reported, on Wednesday, citing instructions sent to banks.

Last July, the first set of bank stress tests were published and showed that only 7 European banks failed the health check and were ordered to raise their capital by €3.5bn to meet a 6% core capital threshold.

Some 91 banks in 20 countries were tested and Ireland's two biggest banks, Bank of Ireland and Allied Irish Banks, passed the tests.

Two months later, it was deemed that the Irish banks needed additional capital and today they remain on ECB emergency liquidity respirators.

"Meticulous stress tests would show that many banks still carry massive silent burdens," Prof. Hans-Werner Sinn, Ifo economics research institute president, told the newspaper Frankfurter Allgemeine Sonntagszeitung, according to its edition last Sunday.

Prof. Sinn claimed that EU rules still allow banks to declare many securities at their nominal value, not their lower market value. This included Greek government bonds which currently trade at less than 70% of their nominal value.

Handelsblatt has revealed that some of last year's criteria have been eased.

For example, a 15% projected dip in equity markets compares with a 20% drop used overall last year and a 36% plunge modelled for banks’ equity holdings that were immediately “available for sale.”

The newspaper says the tests will use two scenario. One is based on European Commission projections and for growth and inflation, the other on a worsening of the European sovereign debt crisis.

The latter scenario includes a 0.2% contraction in 2012 as well as a tumble in the property market, the newspaper said. The test will have a negative impact on banks’ books as it focuses on the short-term holding of securities, Handelsblatt said.

The crisis scenario also includes an increase in interest rates for short-term interbank loans of 125 basis points, the newspaper said.

The inclusion of a 1.25 percentage point increase in banks’ own funding costs in a stress scenario, is viewed as a  positive.

Discussing Europe's fresh round of bank stress tests with Gerard Lyons, Chief Economist & Head of Research at Standard Chartered:

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