European stress tests to release unprecedented amount of data, confirms FDR Framework is the solution

According to a Reuters' article, even Andrea Enria, Chairman of the European Banking Authority that is overseeing the stress tests, realizes the need for an unprecedented amount of data to be disclosed on each individual bank.

This is an explicit acknowledgement that implementing the FDR Framework is necessary to restore confidence in the financial markets.

As regular readers know, under this framework, governments are responsible for ensuring that market participants can access all the useful, relevant information.  For their part, market participants are responsible for all gains and losses on their exposures so they have an incentive to analyze this information and use the results of the analysis to set the price and amount of their exposure.

It is only when the data is available that market participants can analyze it.  It is only after the market participants have analyzed the data, regardless of the result of this analysis, that market participants can move forward with confidence to set the price and amount of their exposure.

Where Mr. Enria and your humble blogger differ is the amount of data to disclose.

Under the FDR Framework, the data that should be disclosed to market participants is all the useful, relevant information.  For banks, this is their current asset and liability-level data.

However, this is not what the regulators will release.  They are still searching for a half-way house that allows them to protect their information monopoly.

For example, they will release summary level reports showing each bank's exposure to Greece by amount and maturity.  The problem with summary level reports is that they hide the true data needed to evaluate the risk of the individual underlying positions.

It cannot be said frequently enough that regulators need to stop gambling with the stability of the financial system and give up their information monopoly on the individual underlying positions.  This is the data that market participants need if they are going to be able to accurately assess risk and subsequently adjust both the price and amount of their exposure.

This year's health check of Europe's banks will provide "unprecedented" new insight about the industry that will be useful in a time of market turmoil, the head of the regulator overseeing the test said on Monday, Jul 11 2011. 

"We are still in a very fragile area," Andrea Enria, chairman of the European Banking Authority (EBA), said in regard to current market conditions. 

He said the EBA will for the first time look at confidential data and challenge it, before releasing it for supervisors and investors to assess. 

"We will put an unprecedented amount of data out there," Enria said. 

There had been calls from some countries, including Germany, to limit the amount of data that is disclosed. 

In a letter to the EBA obtained by Reuters, German banking association ZKA (Zentraler Kreditausschuss), which represents the five associations of German banks, warned that "should publication take place in the envisaged form, we fear that it will not help in any way to build confidence or calm the markets -- on the contrary, quite the opposite is likely to occur." 

"Given the tense situation which already exists in money and capital markets, we believe publishing the results with the present level of detail would exacerbate the sovereign debt crisis," it added. 

The warning however seemed to have fallen on deaf ears. 

The templates on how much data would be disclosed had not been changed and the EBA had not replied to the letter, according to sources close to the association. 

The ZKA complained that publication would reveal "deep insight into a bank's business strategy, market positioning and risk profile on a hitherto unprecedented scale." 

It raised concerns that "the possibility cannot be excluded that publication of the stress test results in their present form will spark not only market volatility, but also targeted speculation against individual banks." 

The European Union watchdog is stress testing 91 lenders to see whether they can still stand on their own feet in the face of scenarios such as the economy shrinking for two consecutive years or big falls in house prices. 

The aim is to restore investor confidence in a sector still being propped up by taxpayers in parts and under pressure to contribute to a Greek bailout.