Saturday, July 17, 2010

The stress tests of Europe’s banks have been chaotic. But it is too soon to write them off

Subregions of Europe (The World Factbook)

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WHEN America did public stress tests on its banks in 2009 they helped end the panic on Wall Street. The Federal Reserve opened banks’ books, imposed a consistent view about how bad losses might be and forced banks that lacked capital to raise more, with the taxpayer acting as a backstop investor.

Europe will soon follow suit, with the results due on July 23rd. Yet whereas America’s tests were run in military style, Europe’s efforts have been chaotic—more akin to a rowdy negotiation about cod quotas than the recapitalisation of the world’s biggest banking system. With just days to go regulators must redouble their efforts to make the tests work.

Stress tests are certainly needed. Banks and transparency are not always a good combination. When a carmaker admits it has a hole in its balance-sheet, its factories are still there a week later; when a bank does so it usually suffers a devastating run. This is why regulators sometimes like to deal with dud banks in secret. But when there is already a widespread loss of confidence, sunlight is the only treatment left. That happened in Japan in 2002-03, when zombie banks were at last prodded to own up to their bad debts, and in America last year.

Europe has reached a similar point. Some banks have been locked out of international borrowing markets, reflecting worries that they could be brought down by the woes of southern Europe and the suspicion that they are sitting on sour loans from the boom years. The fear of contagion has raised debt costs for other banks. Unless faith is restored, the continent’s banking system, heavily reliant on wholesale borrowing, faces a funding crunch. That would force banks to lean even more heavily on central banks and governments to roll over their debts. It could also bring on a double-dip recession.

The stress tests of Europe’s banks have been chaotic. But it is too soon to write them off

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