ECB Stress Test Results Unlikely to Boost Investor Confidence

October 27th, 2014

The European Banking Authority (EBA) released the initial results of its 2014 stress testing.  In total, 123 financial institutions residing in the European Union (EU) were included in the tests. Out of the 123, two-dozen financial institutions failed to withstand the simulated conditions, resulting in a more than $30 billion shortfall.

Although over three-fourths of the participants passed the stress tests, the European Central Bank (ECB) did not implement all of the rules that financial institutions will face in the upcoming year. The tests included the “fully loaded capital ratio,” a severe recession and a bond market collapse.  The ECB did not, however, test financial institutions with all the EU’s new banking rules fully phased in. Financial institutions were also allowed to include certain financial instruments in their calculations that will eventually be prohibited over the next three years.  According to Bloomberg’s calculations, if the ECB had held financial institutions to the full standards, an additional ten institutions would have failed, bringing the total to 34.

France and Germany’s financial institutions faired well in the stress tests; however, most other countries had a handful of failures.  The comprehensive results of the stress tests are expected to be released this weekend.  These results should provide the market with more insight into the condition and preparedness of EU banks.  The results will likely impact investor attitudes regarding the European stock market, which has seen some significant lows in recent weeks.  Given that nearly one-third of financial institutions would have failed if realistic regulatory conditions were imposed, it does not appear that the final results will boost confidence.