By Emma Charlton

BRUSSELS (MNI) – The ability of Europe’s banks to withstand market
turmoil is in focus this week as investors worry about the solidity of
the bloc’s financial system and about whether tests currently under way
are stringent enough to restore confidence.

In a bid to reassure the markets that the European Union’s
financial system won’t bend under pressure, the bloc is currently
assessing whether its largest banks have sufficient capital buffers to
withstand financial market turmoil or the onset of another recession.

Several policymakers including European Central Bank President
Jean-Claude Trichet, European Commissioner for Economic and Monetary
Affairs, Olli Rehn and European Commissioner for Internal Markets,
Michel Barnier, have argued strongly that disclosing the results would
give a much needed boost to investor confidence in the Eurozone.

Worries about the resilience of the financial system, high debt and
deficits, and the risk of a double-dip recession have pressured the
single currency in recent months, causing it to shed around 12% of its
value against the dollar since the beginning of the year. Last Friday,
however, it hit a six-week high above $1.26 and was holding strong at
above $1.25 on Monday. But that is still lower than the levels above
$1.40 seen at the start of the year.

The EU hasn’t published the results of its stress tests before, but
it is widely expected to follow the U.S., which published results of
stress tests for 19 financial institutions last year under its
Supervisory Capital Assessment Program and decreed that 10 of them
needed more capital.

Facing pressure from markets late last month, the EU agreed to
publish the details of the stress tests and to significantly raise the
number of European banks being tested from 26 to well over 100.

But it’s still unclear exactly what the testing parameters will be
and which details will be published.

The debate over how much detail to release is likely to be intense,
because some EU delegations face national banking sector lobby groups
who argue that publication of stress tests could have an adverse impact
on the very market turbulence it seeks to mollify. In Germany, the
biggest EU country, detailed results cannot be published without the
agreement of the individual banks concerned, which could present a
considerable hurdle.

“The Ecofin which takes place next week (July 13) will make the
decisions for the dates and methodology of the bank stress tests,” a
European Commission spokesperson said on Monday.

At a meeting in Southern France, French finance minister Christine
Largarde told reporters that the results would be published “around July
23.”

Support for the publication of the results is growing. Trichet has
said that making the results public is an “important element” in
restoring market confidence in the Eurozone. He and many other
policymakers have repeatedly stressed that maintaining investor
confidence is the key to the economic recovery.

The stakes are high, with many market participants beginning to
worry — even before the methodology has been released — that the tests
might not be vigorous enough. Fueling these concerns was a report in the
Financial Times today saying that tests would include a scenario of a 3%
haircut on sovereign debt — a far more benign outlook than many market
players think possible.

Critics say the tests are largely a public relations exercise and
won’t price in enough exposure to Eurozone sovereign debt — or a
potential default on Greek or Spanish or Portuguese debt — because it’s
too politically sensitive to do so.

“In our view, a proper stress test would have to go for scenarios
assuming a default on Greek sovereign bonds and a default of other
periphery countries, leading to haircuts for these securities of 50% or
so,” said Jurgen Michels, an analyst at Citigroup in London.

“Without such real stress testing, we doubt that the results of the
stress test would provide much to restore confidence,” Michels added.
Moreover, he said, “it would be important to have facilities in place to
immediately provide sufficient extra capital to banks that do not pass
the stress tests.”

So far, there are no strong signs that governments are preparing to
make such contingency capital available to their national banks. The ECB
has said that it will not do so.

The market is likely to focus on the fine print next week, when EU
finance ministers agree what information they will publish and when.

“The credibility of the stress test will depend on the underlying
assumptions and their transparency,” analysts at Nomura said in a note
to investors. “We hope regulators will publish these in detail. If the
stress scenarios are not painful enough, do not acknowledge the default
risk from some European countries, or if the transparency of the
assumptions used is poor, publishing the stress test could be
counterproductive and raise more questions about solvency.”

If the market judges the stress test too lenient, it could punish
the very securities the EU is trying to protect.

–Brussels: 0032 487 (0) 32 803 665, echarlton@marketnews.com

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