BRUSSELS — The European Union's bank stress tests used out-of-date macroeconomic assumptions that didn't reflect the severe turmoil wracking sovereign debt markets when the tests were completed, according to a confidential document prepared by senior E.U. finance officials that urges regulators to use more timely scenarios in next year's tests.
The stress tests, published in July, found that E.U. banks are mostly well-capitalized. But bank stocks plunged soon after, leading officials to discuss how the reviews can be made more "credible."
"The tests did not manage to restore market confidence," according to the document, which was discussed by finance ministers at last week's meeting in Wroclaw, Poland.
The tests subjected the 90 largest European banks to varying levels of economic stress that could boost losses and deplete bank capital. One way they could be improved, the document says, would be to use a more up-to-date scenario that isn't obsolete by the time the tests are published, "as was the case for instance, for the scenario of a relatively mild sovereign shock in banking books, a scenario which was clearly taken over by events as months passed by."
Banks mainly hold sovereign debt in their "banking books," which is where they park bonds that they plan to hold until they mature. The tests required banks to make relatively limited provisions for losses on sovereign bonds in the banking book, even though Greek 10-year bonds, for example, were trading at around 50 cents on the euro when the tests were published.
Even so, "market tests did not reveal any unsustainable amounts of bonds issued by vulnerable sovereigns in the banks' banking books, as initially suspected by the markets," the document says.
The officials in the document also suggest that fewer banks could be included in the next round of tests. That would allow regulators to focus more closely on the most important banks, an E.U. official said. But that idea is likely to face political objections from governments that want to see more banks included next year, the official said.
The document says that public disputes between the European Banking Authority, the new pan-E.U. regulator, and national regulators should be avoided. Germany's bank regulator criticized the EBA this year for urging German banks to firm up the quality of the capital on their balance sheets, an episode that some observers said undermined the tests.
The key hurdle in the coming months will be for governments to ensure that banks with solvency problems identified by the tests raise new capital, from markets if possible and from governments if necessary, the document says. That means governments must be ready to inject capital into banks, it says.
"The credibility of backstop procedures, private or public, has not been challenged in spite of the unfriendly market conditions," according to the document. "Yet, the full market reactions may show up at a later stage."
