Bloomberg News

Stress Test Near-Failures Face Scrutiny, Morgan Stanley Says

July 13, 2011

(Updates with disclosure details in seventh paragraph. For more coverage on the stress tests, EXT5 <GO>.)

July 13 (Bloomberg) -- Lenders that scrape through the European stress tests with low marks will be examined “intensely” by investors, according to Morgan Stanley.

The bank expects market participants to “scrutinize intensely those which pass by less than 1 percent,” according to a report by Morgan Stanley analysts led by Huw Van Steenis in London.

The banks will be expected to maintain a core Tier 1 capital ratio of at least 5 percent under the stress-test scenarios to pass according to the criteria published by the European Banking Authority, the agency carrying out the tests.

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.

“Our conclusion from last year’s test was to focus on the cuspy names for capital raising,” said the report, dated July 12. “Nineteen of the 22 listed banks that passed by less than 2.25 percent have since raised capital,” Morgan Stanley said.

Analysts have criticized last year’s exams for not being tough enough. Lenders in the 27-nation region were shown by regulators to need only 3.5 billion euros ($4.9 billion) of new capital, about a 10th of the lowest analyst estimate.

Disclosure

Lenders this year will be made to disclose capital levels, estimates for profitability in 2011 and 2012 as well as the size and maturity of their holdings of sovereign debt, the EBA said this month.

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 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.

The Morgan Stanley analysts said that they “see the stress tests as helpful additional disclosures of bank strength but not as game changers for banks or sovereigns.”

“In contrast to U.S. stress tests, we do not expect a clear coordinated prompt for capital raising to enhance market confidence,” the analysts said in their note.

--Editors: Peter Chapman, Steve Bailey

To contact the reporters on this story: Ben Moshinsky in London at bmoshinsky@bloomberg.net;

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net


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