Whoops--and so what happens to those European banks who fail their stress test?

06/17/2010 1:40 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Stress-testing European banks and then releasing the results is no cure for the euro debt crisis. Investors will be rightfully suspicious that bank regulators and sovereign governments are trying to sell them a bill of goods by setting up tests that banks are sure to pass. Investors were just as suspicious when the United States conducted its own stress tests and then released very incomplete information on which banks had passed.

But conducting the tests and then not releasing the results is a disaster. Then investors have absolutely no information to restrain their imagination. And are left with the very logical question of “Why won’t they release the results?”

Today, June 17, European Union governments dodged that disaster when, at a meeting in Brussels, they decided to disclose how banks did on stress tests.

The European banking industry had violently opposed releasing the results of the tests but the Spanish central bank, the Bank of Spain, had forced a pro-disclosure decision by saying on June 16 that it would release the results of its stress tests on Spanish banks. Failing to follow Spain’s example would have been undercut confidence in exactly those parts of the European banking system—particularly German regional banks—that most worry investors. Germany had been the leading opponent of releasing the results of the tests. (Under German law banks have to approve any public use of their data so it’s not at all clear to me what Germany plans to release. At a guess, I’d expect it to be less than what is released by other Euro Zone members.)

The results of the stress tests will be published in the second half of July. (Hope the crisis is planning on going to the beach until then.)

I expect that in the case of Spain, currently the focus of worry in the Euro Zone, the country’s big banks will come out fine. They may be required to raise new capital, but as in case of stress tests in the United States I expect that their capital requirements will be within their ability to raise money in the markets. I expect that the case will be very different with at least some of Spain’s 45 unlisted savings banks, the cajas. Some, at least, will be so short on capital that the Bank of Spain will be forced to close them or to broker a merger. That, however, seems to be the course that the Bank of Spain has already chosen so that result wouldn’t come as a huge shock. The Spanish Fund for Orderly Bank Restructuring (FROB in its Spanish acronym) has about $15 billion available to use in supporting mergers among the cajas.

That’s a start but probably not enough.

Which raises an important difference between the U.S. and European stress tests. In the United States the U.S. Treasury promised to provide capital to banks that needed it according to the results of the stress tests if they couldn’t raise it in the capital markets. In Europe it’s not at all clear where banks who need capital but that are shut out of the financial markets could go for capital after the test results are released.

German Chancellor Angela Merkel told reporters in Brussels asking just that question that the European Union has “taken precautions.”

I don’t have the foggiest idea what she’s referring to. The $900 billion financial backup plan put together by Euro Zone leaders recently is focused on riding to the aid of sovereign national governments that can’t raise money at a reasonable cost in the financial markets.

It’s wouldn’t seem to be a solution for troubled individual banks. Would they be able to turn to individual central banks—many themselves under stress—or to the European Central Bank?

I’m glad that European leaders have agreed to release the results of bank stress tests, but I sure wish they’d get ahead of this crisis rather than always slapping together solutions at the last minute that just raise questions that they can’t answer.

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