Sunday, July 17, 2011

In protecting their information monopoly, Eurozone regulators make crisis worse

The Telegraph ran an article on the European Banking Authority and the stress tests that confirms everything your humble blogger has said about regulators gambling with financial market stability by protecting their monopoly on all the useful, relevant information on banks' current asset and liability-level data.
Andrea Enria, chairman of the EBA and other officials of the London-based organisation, fielded questions from analysts angered at what were quickly described as an "inadequate" set of tests. 
Mr Enria is understood to have outlined the difficulties the EBA faced in conducting the stress tests on the 91 European banks that took part. He was asked why just nine banks failed, requiring total new capital of €2.5bn (£2.2bn). 
The EBA was clear in methodology papers it released on Friday that it had faced great difficulties getting different national regulators and banks to provide accurate data. 
Describing the process as "constrained", the EBA admitted that figures given by the banks in some cases "materially" changed after being challenged. "It is clear the EBA is telling us it was unable to perform the type of tests it wanted to and considering the difficulties it faced it didn't do a half bad job," said one market professional. 
The previous two paragraphs need to be re-read as they document financial regulators directly contributing to financial market instability by not making the data available so that the risk of the banks they are supervising could be analyzed.

As a result of the national regulators' efforts, the ability of the market to accurately distinguish between solvent and insolvent banks is compromised.
Criticism of the tests was largely on the loss assumptions it used for banks' sovereign exposures. 
For instance, the EBA required banks only to take a 15pc loss on holdings of Greek government debt, even though the bonds are currently trading in the market at about half their face value. 
"There may be doubts over the credibility of the EBA's ability to conduct a thorough stress test since it appears to have avoided tackling the thorny issue of banks' exposures to sovereign debt," said Syed Kamall, a Conservative MEP and a member of the economic and monetary affairs committee. 
"The exposure of banks to sovereign debt is the giant elephant in the room and ignoring this issue could undermine the credibility of these tests," he added. 
However, the EBA's document makes it clear that it wants national regulators to force the banks to prepare for the eventuality of a severe worsening in the crisis, even a sovereign default. 
"A further deterioration in the sovereign crisis might raise significant challenges, both on the valuation of banks' holdings of sovereign debt and through sharp changes in investors' risk appetite," it said. 
It also warned that "funding pressures" could "further affect market confidence in these banks" if not dealt with quickly. 
This blog has documented these "funding pressures" as the on-going run on the bank for both deposits and inter-bank loans.
... Tomorrow is the first chance for investors to give their view on the tests. Many observers are expecting a volatile trading session as the markets assess the findings of the exercise.

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