European banking regulators have published the long-awaited results of their stress tests of the region’s banks, finding that most of them would be able to weather a double dip recession.

On Friday, the Committee of European Banking Supervisors published the results of an EU-wide stress test exercise on a sample of 91 European banks. The test focused mainly on credit and market risks, including their exposures to European sovereign debt, as it tested capital adequacy.

The basic macroeconomic scenario they tested assumes a mild recovery, whereas the adverse scenario assumes a ‘double-dip’ recession.

The regulators found that under the adverse scenario, the aggregate Tier 1 capital ratio would drop from 10.3% in 2009 to 9.2% by the end of 2011. The downward pressure on capital ratios would come mostly from impairment losses (472.8 billion euros over the two-year period) and trading losses (25.9 billion euros). Losses associated with the additional sovereign shock would reach 67.2 billion euros, for total impairment and trading losses of 565.9 billion euros.

The regulators say that seven banks would see their Tier 1 capital ratios fall below 6%, which was used as a benchmark solely for the purpose of this stress test exercise, not as a regulatory minimum.

“The aggregate results suggest a rather strong resilience for the EU banking system as a whole and may appear reassuring for the banks in the exercise, although it should be emphasized that this outcome is partly due to the continued reliance on government support for a number of institutions. However, given the uncertainties over the actual path of the macro-economic recovery, the result should not be seen as a reason for complacency,” they say.

Tests on the lenient side, TD says

While noting most of the European banks subjected to the stress tests passed, TD Economics says that it wasn’t a very high bar to clear.

“Overall, our feeling is that the tests were on the lenient side,” TD says in a research note. “No stress test will ever be able to test for every possible ill. The biggest criticism that can be made of this test is that the market has been concerned about a sovereign default and that is not stressed,” it notes.

Seven banks failed the test, including five of the Spanish cajas/savings banks, Germany’s Hypo Real Estate Holding, and the Agricultural Bank of Greece. But TD says that the fact that “the German Landesbanken that are known to be in difficult straits, and only one Greek bank failed, in spite of these banks being highly exposed to any shocks to Greek sovereign problems, provides a sense that the tests were not terribly difficult.”

It also points out that, “Stresses also depend not just on the binary outcome of sovereign default or not, but also the speed of market stresses, as problems that seem digestible over a two year or two month time frame may not be sustainable if they happen over two weeks.”

“Overall, these stress tests move the market past a major hurdle that it has been looking forward to for some time. But we are left with a bit of a feeling of “Waiting for Godot” as we don’t see much more direction now as to where markets feel they should go as a result of these findings,” it concludes.

However, it adds that as more detail is released, the market will be able to come to its own conclusions about the health of these banks. “For example, there have been some details on individual banks holdings on sovereign debt, and with more details still trickling in, markets will be able to see which banks could be particularly exposed to the sovereign default scenario and accurately price these risks into valuations. This could ultimately be the silver lining in these results, though we don’t yet have enough information to know whether we will like what we find.”

IE