Stress testing European and UK banks

May 8, 2009 — Mitul Kotecha

The US bank stress tests are finally over and markets are breathing a massive sign of relief. 10 out of the 19 banks tested will have to raise $74.6bn in equity but none of the 19 banks will become insolvent, with additional capital requirements deemed as “manageable”.

It hardly seemed worth getting all stressed up over the stress tests but the results are likely to prompt much debate about the methodology used and will not put to bed the issue of the health of the US financial sector and potential for even more capital raising in the future. This should be the theme of another post but for now I want to discuss what this means for European and UK banks.

The stress tests raise questions about whether the European and UK banking sector should follow the US.  The US administration has used the ratio of tangible common equity to total assets for its stress tests on US banks. This measure has been labeled as old fashioned but one that investors currently prefer. This is also the measure the IMF has used in its recent calculations to work our additional capital requirements for banks globally.

The IMF financial stability report estimated additional credit related writedowns in 2009 and 2010 at $550bn in the US, $750bn in the eurozone, and $200bn in the UK. The IMF estimates that the ratio of tangible common equity to total assets was 3.7% in the US at end 2008 but only 2.5% in the eurozone and 2.1% in the UK. It concludes that the extra capital needed to increase this ratio to 6% would be $500bn in the US, $725bn in the eurozone and $250 billion in the UK.

So will be there similar stress tests in Europe and the UK? The increased transparency that the stress test results have brought about in the US is good news for investors even if no bank was ever going to fail them but they raise a potentially worrying comparison with European and UK  banks which appear to have been far less forthcoming. The figures have been disputed by eurozone and UK officials but assuming the IMF is right the estimates raise some disturbing questions about financial sector health outside the US.

Posted in bank rescue, Economics, Europe, Financial crisis, US, US administration. Tags: , , , , , , . 5 Comments »

Show me the money

May 3, 2009 — Mitul Kotecha

The long awaited results of the US administration’s stress tests for US bank will be announced on May 7th. There have been various rumours and speculation about the details in terms of the extent that banks will require further capital injections and indeed which banks will need such injections. Ahead of the announcement I thought it would be an interesting exercise to look at the potential equity needed in the global financial sector.

Some light on this was shed by the IMF’s recent release of the Global Financial Stability Report in which the fund increased its total estimates of global writedowns to over $4 trillion. The most recent estimates of financial sector writdowns suggest that institutions are only about one-third of the way there.

In other words there is still a considerable amount of writedowns on toxic debt left to be undertaken. The IMF estimated further writedowns in the US in 2009 and 2010 at $550 billion, $750 billion in the eurozone and $200 billion in the UK.

Moreover, they estimate that financial institutions will require $500 billion of additional capital in the US, $725 billion in the eurozone and $250 billion in the UK just to raise the ratio of common equity to total assets (a measure of leverage) to 6%. Even these estimates may prove conservative. After all, the IMF has raised its estimates of total writedowns several times already and will likely do so again. These figures do not even include the need for other financing which when added amounts to around 60% of Bank’s total assets.

The bottom line is that even with all the money that is being provided to financial institutions at present it will be highly unlikely that they will be able to raise sufficient capital if the IMF’s estimates are anything to go by. Consequently balance sheets will contract sharply and deleveraging will continue.  Governments will be forced to provide support for a long time to come and the end result will be either outright nationalisation or alternatively bankruptcy for some institutions that are deemed not too big to fail.  Worryingly the risks are skewed on the downside, especially if the economic recovery is a weak one which I believe is highly likely to be the case.

Posted in bank rescue, Economics, equity markets, Europe, Financial crisis, UK, US, US administration. Tags: , , , , , , . Leave a Comment »
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