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As authorities unveil the eagerly awaited results of stress tests on major European banks Friday, it won't be just the banks under scrutiny but the testers as well.
If almost no bank fails when the results of the tests are unveiled well after European markets close, analysts question whether the tests will be regarded as credible, and whether the public will become even more nervous about the health of the financial sector.
They also question whether the tests probed deep enough and whether the results will provide any sort of meaningful look inside a normally opaque sector, as news leaks out across the European Union that banks in country after country have passed with flying colours.
For markets that have been extremely anxious amid Europe's mounting sovereign debt crisis, the results of the tests, and their credibility, are crucial for rebuilding shaken confidence.
For days, politicians have been trumpeting the health of the banks in their countries, leading to some degree of skepticism.
If the tests back up the politicians' boasts and almost all pass, "we think that will prompt a skeptical response," said Carl Weinberg, chief economist with Valhalla, N.Y.-based High Frequency Economics.
"Traders and investors may even take the view that the authorities are covering up weaknesses among the banks by carefully structuring their stress tests and limiting them," he said in a note to clients of his daily report on the global economy.
Reports that dozens of leading banks, including Bank of Ireland PLC and Allied Irish Banks PLC, have passed drove up European financials in trading on Thursday.
So far, only one of the banks tested, Germany's Hypo Real Estate Holding AG, has been identified in published reports as flunking the capital adequacy test in the event that the economy turns sour or sovereign borrowers are forced to restructure debt. But this deeply troubled lender, which holds billions of euros worth of Greek, Spanish and Italian debt, was taken over by the German government in the wake of the 2008 credit freeze and has said it will remain in the red until 2012.
Germany originally opposed full financial disclosure for each tested bank, citing concerns that markets could misinterpret the results. But France and Spain, which has long insisted that its banking system has weathered the country's housing collapse and ensuing credit and fiscal crisis in fairly good shape, pushed for more transparency. Washington, which persuaded the Europeans to follow its own stress tests on 19 banks last year as a means of restoring confidence in the important interbank lending market, also urged maximum disclosure.
To rebuild market confidence, regulators must provide detailed information on each bank tested and show that the tests have been applied consistently across the 20 countries participating in the process, said Nicolas Véron, a senior fellow at Bruegel, an economic think tank based in Brussels. "We will be looking to see how much cross-border comparability there is in what's published."
Whether operating in deeply troubled Greece, Ireland and Spain, or in much stronger economies like Germany, most banks appear to have surpassed the standards set by regulators, operating through the Committee of European Banking Supervisors, to gauge whether they have the financial capacity to withstand the losses that would flow from another severe recession or sovereign debt crisis.
But the tests only cover 91 banks, which means more than 70 others that depend on the European Central Bank for their funding were not exposed to the same scrutiny.
More banks must be tested and the process of evaluation made more transparent to be effective, the International Monetary Fund said in a report on the euro zone. The IMF warned that "some uncertainty regarding the stringency of the tests is likely to remain."
The U.S. tests "were largely a charade," but they were still more useful for analysts than what's going on in Europe, said Christopher Whalen, a managing director at Institutional Risk Analytics of Torrance, Calif., which assesses bank risks.
At least in the U.S., analysts could ascertain the numbers that were used and verify them to some degree, he said. "But in Europe, we have none of that. There is zero public disclosure in Europe, so there is no basis for comparison."
BRIAN MILNER
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