The idea of undergoing a stress test comes across as a much-needed safeguard to ease investor fears that the European banks with which they do business have sufficient capital to deal with future " stress" scenarios.
But this is why the fact that all but seven banks undergoing the European Union-wide stress test at the end of July passed should have come as great news.
This is not the case, market analysts say. They agreed that the tests did not go far enough. For instance, tests for a potential sovereign default scenario - such as the one unfolding in Greece at the moment - were not included.
Royal Bank of Scotland (RBS) analysts said that early market reactions to the bank stress results were somewhere between lukewarm and outright skeptical.
Before the results came out, UniCredit analysts said that the stress tests had a good chance of being a non-event and that it was widely rumored that even some of the worst positioned banks - e.g., German Landesbanken and Spanish cajas - would get a "pass."
"In our view, it appears to be great ballyhoo, politically orchestrated with respect to the scope of the test and details of the release to make sure that (a) no relevant institution fails the procedure, and (b) investors still believe that the scenarios are vigorous enough to be reliable indicators of the strength of the institutions," UniCredit analysts said.
The problem, according to analysts, is that banking book exposures were stressed by computing the incremental capital required assuming an only four-notch downgrade to the assets, while worst-case trading losses were calculated generally assuming a 60% widening in spreads (or up to 80% for 2006/2007 ABX 'AAA' vintages), explained RBS analysts.
Property market stresses under the adverse scenarios also don't go far enough. The U.K. commercial real estate prices, for instance, were stressed to fall 10% in each of 2010 and 2011, RBS analysts said. However, property derivatives are currently already pricing in a capital decline of around 7% to 8% for U.K. CRE next year.
"Such 'stresses' do not look punishing by any measure; indeed, we'd argue that this degree of stress certainly does not capture a '[Lehman Brothers]-like' fallout," said RBS analysts.
By Nora Colomer-Gaffney