(Bloomberg News) The risks to financial stability from analysts using European Union stress-test data to conduct their own exams on banks "should not be underestimated," according to a confidential document prepared by EU officials.
There is an expectation the European Banking Authority stress-test results will be "challenged by market tests" aiming to address "the perceived weaknesses in the design," according to the draft document obtained by Bloomberg News. That may result in nations with lower-rated sovereign debt struggling to borrow money to fund their banks, according to the document.
"The conditions in EU financial markets and the economy have deteriorated since the stress scenarios were envisaged," Sony Kapoor, managing director of policy group Re-Define Europe, said in a telephone interview today. "While the tests are still robust under current conditions, the safety buffer for further deterioration has shrunk."
This year's exams, which will be published on July 15, will include a review of how lenders would handle a 0.5 percent economic contraction in the euro area in 2011, a 15 percent drop in European equity markets as well as possible trading losses on sovereign debt. The banks will be expected to maintain a Core Tier 1 capital ratio of at least 5 percent under the stress-test scenarios, the EBA has said.
Some countries have "no dedicated and committed resolution fund" to recapitalize banks that fail the test, according to the document. It may prove "increasingly difficult for lower- rated countries under market expectations of sovereign default" to borrow money to fund their banks.
Contagion Risks
The document also warns that banks, national regulators and finance ministries will have to address "contagion effects", which could include liquidity risks, a lack of credibility surrounding recapitalization plans, access to capital market funding and problems with information sharing between supervisors.
Some of the risks highlighted in the document will be discussed at an EU press conference today, according to a person familiar with the situation. A spokeswoman for the EBA, which is conducting the tests, declined to comment.
Finance ministers meeting in Brussels today discussed the possibility compiling a list of banks that almost failed the stress tests as part of the publication of results, three people familiar with the discussions said.
The ministers didn't reach a decision on the proposals, the people, who spoke on the condition of anonymity because the talks were private, said.