As regular readers know, the stress tests run by the US did not restore confidence in investing in banks. What restored confidence in investing in the 19 banks that were subject to the stress test was Treasury's pledging the full faith and credit of the US to ensure the solvency of these banks. This only worked because investors perceived the US to have the ability to back up this pledge.
As regular readers know, Europe is still facing a solvency crisis. So the regulators are trying to adopt the US solution: stress tests and a government guarantee.
How did the financial regulators convince the governments to stand ready to bailout any bank that "fails" the stress test? Whatever happened to the idea of shutting down these institutions? If they are not able to "pass" a rigged test, isn't that a sign that they are insolvent?
A Reuter's article reports on the return of bailouts in Europe. Specifically, European countries are going to bailout their banks that fail the current round of stress tests in the event that the banks are unable to raise funds from the capital markets.
And why exactly would anyone want to invest in these banks in the absence of disclosure of their current assets and liability-level data? How is an investor suppose to know if their investment is being made into a viable bank and not to support a bank dependent on extend and pretend that will ultimately collapse?
No matter how it is portrayed, the results of the stress test show these banks to essentially be insolvent.
Like the Spanish Cajas, these banks will be unable to access funds from private investors without disclosing their current assets and liability-level data.
European governments are ready to bail out those banks which cannot raise capital from investors after the EU details on July 15 which lenders have failed its latest, more vigorous stress test.
The European Banking Authority (EBA) announced on Friday the publication date for the results of its check on 91 of the region's top lenders. These will be accompanied by measures to bolster capital for those that failed or nearly failed, in another attempt to reassure investors that European banks can withstand future shocks.
According to a separate European Union draft document seen by Reuters, European countries will support banks that fail the stress tests if those lenders cannot raise capital from investors within six months.
The paper, being prepared for EU finance ministers to approve on Tuesday, is an about-face from promises by G20 policymakers in the wake of the financial crisis that taxpayers would never have to bail out banks again.
An official close to the EBA said all banks that fail must have a plan by September to plug the capital shortfall by the end of this year, as previously agreed by EU finance ministers.
Those just above the pass mark will be more closely scrutinized and must also plan remedial actions but their implementation deadline remains unclear and could be clarified by finance ministers next Tuesday, the official said.
Member states will be obliged to have backstops in place only for banks that actually fail the test, the official added.
European Banking Federation Secretary General Guido Ravoet said some banks may struggle to find enough capital.
"Is the European financial market deep enough to respond to the needs for capital? We are not the only sector looking for capital," Ravoet said.
This latest round of tests has been touted as being more rigorous than previous attempts, in which few banks failed, and finance ministers' officials are drawing up plans for how to deal with the fallout.
The EU document also says lenders that nearly fail the tests will be put on a critical watch list in case they deteriorate.
... According to the draft EU document, capital-raising plans should first be based on "private-sector measures, including ... retained earnings ... raising additional common equity or high-quality hybrid instruments from private investors, assets sales, mergers."
But if the search for private capital leads nowhere, then governments should be ready to step in.
Officials do, however, make provision for "the extreme case" if efforts to rehabilitate a bank fail and it threatens wider stability, recommending "a process of orderly restructuring and resolution."
The number of banks declared by the EBA to have failed will either encourage investors that Europe is now coming clean with its banking problems, or if the tests are deemed too lax again, they will hurt the EU's already battered credibility.