Set aside those unrealistic macroeconomic assumptions in Europe’s stress tests.
Focus instead, on the complete lack of a sovereign bond ‘shock; in the 2010 version. And that’s despite the whole sovereign-bank loop thing, which has worried investors.
The details of the 2011 stress tests haven’t been published yet, so there’s a minute chance administrators may decide to include a default or restructuring scenario. But we’re not betting on it. The stress test scenarios only cover two years — so the EBA probably thinks it doesn’t have to include sovereign shock, given that the eurozone has basically guaranteed there will be no defaults until at least 2013.
Here’s Deutsche Bank’s Marco Stringa:
It appears that regulators fear that assuming a restructuring would contradict the EU’s pledge to prevent a default on any euro-area government debt issued before June 2013. But we think this is missing the point of what a stress test is and its aim for at least two reasons:
- * First, a stress test is not a central case scenario; it is a “what-if-things-go-wrong” exercise. So we think it is fully consistent to argue that the central scenario is for no country to default but assume that there is the tail risk for such an event.
- * Second, in our opinion the fact that the stress test covers only two-years, another unsatisfactory feature, should not be used as an excuse to exclude the sovereign shock, unless the aim is to boost investors’ willingness to lend to banks only in the short term.
Consider an investor who has to decide whether to invest in or lend long-term to European banks and whose main concern is a restructuring in the weakest peripherals. What is her best strategy if the regulators’ answer is not to worry given that there will be no restructuring before mid 2013? At best she could decide to lend with a maturity below three years. But she may realise that there is the risk that (i) banks’ overall debt duration may shorten, as other investors follow the same strategy, (ii) hence there is the risk the banks will face large refinancing needs before mid 2013, (iii) when the ECB full allotment liquidity regime may not be in place any more. Hence, her best strategy would be to lend at a shorter maturity than the average lender. Let’s hope that the above investor is an outlier, otherwise the ensuing process of each investor looking for shortening its maturity with respect to other investors may significantly worsen funding conditions for banks.
Alright. It’s not really stress tests that might shorten funding, it’s the existence of those distortive eurozone bailout policies which does it — but you get the idea.
And in the meantime, we’re left with a(nother) pretty much pointless bank exercise.
Related links:
Running for covereds – but not for long? - FT Alphaville
Back to the future with Europe’s stress tests – FT Alphaville
That European funding problem, charted - FT Alphaville