Oh boy, fireworks after the close in Europe tomorrow--it's stress test time again for Euro banks

07/14/2011 4:33 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Maybe it won’t draw as big an audience as Sunday’s World Cup Final between Japan and the United States, but Friday’s stress test of European banks looks likely to provide plenty of entertainment value.

Already German bank Helaba has refused to participate, protesting a decision by bank regulators not to accept its silent participation hybrid debt as core capital. That decision, Helaba says, assured that the bank would fail the capital test.

Two Spanish banks that are reported to have failed the test have also complained that the regulator, the European Banking Authority, has been too strict. European press reports say that Banco Pastor, CatalunyaCaixa and three other Spanish banks will be among the 15 banks (out of 90) likely to fail.

The results are due to be released on Friday after European financial markets have closed.

The big issue in the stress test, as expected, has turned out to be what counts as equity capital.

European banks have long counted hybrid debt as part of their equity capital; the squawking comes now as regulators, looking at the structures of those hybrid vehicles, rule that some don’t provide the cushion of safety of true equity. Banks have known this was coming and it’s actually surprising that the issue is raising protest now. My guess is that some banks saw going to the capital markets to raise equity replacement capital as too painful and expensive—so they’ve decided on a strategy of deny and hope.

The largest number of banks failing this round of the stress test are likely to come from Spain where the issue is how to treat what Spanish banks called “generic provisions”—cash put aside to cover potential losses. Last time around—in last year’s stress test—bank regulators accepted this as core capital. Not so this year. And that will probably give Spanish savings banks, or cajas, dominance at the top of the list of banks that have to raise more equity capital. In the last go round Spanish cajas accounted for five of the seven banks that failed the stress test.

Banks that fail the stress test will have to raise enough new capital to bring their core Tier 1 ratio above 5% of risk-weighted assets. Raising that capital won’t be a trivial challenge since the cost of equity for troubled banks has climbed—if they haven’t been shut out of the capital markets altogether.

Right now, no big European bank is expected to fail the stress test. Analysts say that’s a sign that even with new tougher standards the test remains significantly weaker than the U.S. stress test that required big banks such as Citigroup and Bank of America to raise additional capital.

 

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