EU BANK STRESS TESTS

The much talked about test, the EU test of banks' ability to withstand financial shocks, is being highly criticized as too easy after only 7 out of 91 failed. European Union policymakers and regulators voiced relief at results but some market analysts and many media commentators derided the whole exercise in which all listed banks passed as lacking in credibility. There was skepticism about EU regulators' conclusion that banks need only a total of 3.5 billion Euros ($4.5 billion) in extra capital.

Only five small Spanish banks, Germany's state-rescued Hypo Real Estate and Greece's Atebank failed outright. More than a dozen others scraped through with just over the required 6 percent of Tier 1 capital in the most stressful scenario and are likely to come under market scrutiny. However, the wealth of data disclosed by banks representing 65 percent of assets, and the commitment of banks, regulators and governments to follow-up action may well outweigh doubts about the stringency of the tests.

In a first market reaction in New York after the survey, the cost of insuring the debt of large European banks fell further and the euro rose against the dollar despite worries about the tests' credibility. Better-than-expected economic data and business confidence surveys suggesting the euro zone will avoid a double-dip recession despite fiscal austerity measures are also helping revive investor confidence in Europe.

HAGGLING
Given the haggling among EU governments and regulators about the stress tests right up to the last moment, the degree of transparency was greater than had been expected a few weeks ago. In the end, most banks -- except Deutsche -- issued a detailed breakdown of their exposure to the sovereign debt of EU countries, enabling investors to run their own risk simulations to gauge counterparty’s solidity.

The experts say that the results should help reopen the interbank lending market, which partially froze at the height of the euro zone debt crisis in May and has remained tight due to fears that banks have been hiding big exposures.

TRANSPARENCY
Spain, which spearheaded the drive for transparency, tested a larger part of its banking system and disclosed more data than any other country, hoping to clear away lingering market suspicion of its smaller banks' solvency. However economist Nicolas Veron of the Bruegel think-tank said Madrid had underplayed the re-capitalization needs of the cajas, regional savings banks, although its bank resolution fund is well on the way to meeting those needs.

Veron said follow-up actions by governments and regulators should include pressing weaker banks to recapitalise, if necessary with state help and facilitating cross-border takeovers of weaker banks. Even before the results were published, National Bank of Greece, Slovenia's NLB and Civica in Spain announced plans to raise capital.

Italy said it would reopen an offer of government-backed bonds to support its banks, although none failed. Monte dei Paschi di Siena squeaked through with 6.2 percent of Tier 1 capital under the most stressful scenario, and UBI Banca with 6.8 percent. Veron said the success of the exercise would depend partly on whether European regulators adopt a more cooperative approach after the stress tests than they did before them.

Much like the critics, I also seriously doubt that we should be celebrating due to the good result. What I doubt is the credibility of the test. There are four reasons why.

National standards
One, there aren't any common standards. European banks are all regulated on a national basis. The judgments applied to a Portuguese bank may be quite different to a Swedish one. Europe-wide stress tests don't make any sense unless there is a single European regulator applying the same standard to each.

Two, what's being tested exactly? There are all sorts of scenarios you can think of where the banks come through OK. A mild recession in Germany, for example. The oil price surging back to $100 a barrel? But what the markets are really nervous about is that Greece defaults, or Spain comes under attack, and that it brings down some really big banks. Unless you test the ability to withstand that kind of extreme event, it's just eyewash.

Dodgy loans
Third, who says the horrors are hidden inside the big banks? If you know you have lots of bad loans, and you are about to be stress-tested, maybe you could offload them to a friendly hedge fund for a few weeks. You might be able to, or you might not. The point is, a speculator can always spread rumors that you have parked all the stuff somewhere else - and then the stress tests will have achieved precisely nothing.

Finally, and most importantly, why to have it so openly, announcing everything and in the process giving the banks a head start to manipulate the accounts? If you are going to have stress tests, get them done behind the scenes, and then announce the results when you inform the public of the decision to have the tests.

EU leaders think this is a crisis caused by financial markets. They imagine a basically sound system is being undermined by a bunch of badly behaved traders and hedge fund managers. And they think, naively, that if they just get enough information out there, everyone will see that the euro is in good shape, and stop worrying about it.

It isn't true. The real issue is that Greece is probably bust, will default sooner or later, and will inflict huge losses on the banking system when it does.

Stress tests won't change that harsh reality.