Here are some some details on the stress tests European officials considered.
1. Tests did not consider a sovereign default.
2. They considered what is called “sovereign shock” which means a fall in bond prices. They only considered the impact of this price fall in trading portfolios, but they did not consider their impact on the banks’ books – in which they keep the long term bonds.
3. The worst case scenario called for only a mild decline in GDP growth by 0.4% next year, and a increase in unemployment from 9.6% to 11%.
4. The price declines considered were from the price levels prior to the crisis, which makes very little sense, as these prices have already declined.
5. The drop in the 5-year Greek bonds considered assumed to yield 13.64%. Yet Greek 5-year bond yields hit 14% at the height of the sovereign crisis in April.
6. The hurdle rate was 6% Tier 1 ratio, while the U.S. stress tests in 2009 required banks to exceed 4% core Tier 1, under stressed conditions.
Comparing the results with those in the U.S., we find that: 10 out of the 19 U.S. lenders were found to have insufficient capital. In Europe, only 7 out of the 91 banks needed additional capital.
These tests still do not answer the question whether the banks could withstand a sovereign default, which fears created the European debt crisis, or a significant downturn.
