Thursday, October 18, 2012

As predicted, latest round of Spain bank stress tests under-estimated losses

Bloomberg reports that the worst-case scenario in the latest round of Spain bank stress tests appears to be optimistic.

For regular readers, this is not surprising as your humble blogger predicted it.

It was not a tough prediction to make as the history of every bank stress test since the beginning of the current financial crisis has been to try to build confidence by making representations about the true condition of the banks that are shown to be false within 3 months.

Could someone explain to me how the situation is improved when the repeated failure of the stress tests appears to show that the policy makers and financial regulators are incompetent?

Anyhow, regular readers know that the next step will be a more 'rigorous' stress test.  This will be a loan level stress test.  Again, the findings of this stress test will indicate that the Spanish banks face bigger losses than previously estimated (probably in the 150 -200 billion euro range).

Spanish officials will claim that the results are definitive until they are shown to be wrong 3 months later.

As previously discussed, there are market participants who think the losses are in the 400 billion euro range.  This is not unreasonable given a 25% unemployment rate and an economy in recession.

Regular readers know that there is an easy way out of ever having to publicly announce the results of stress tests again.  Require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants can independently assess each bank and determine the losses hidden on and off its balance sheet.  If they want, market participants can even run their own stress tests.

Based on the markets analysis, Spanish banks should be divided into two groups.

Group 1 includes those banks that have the capability of absorbing the losses and rebuilding their book capital through retention of 100% of pre-banker bonus earnings.  These should be allowed to continue in operation.

Group 2 includes those banks that do not have the capability of absorbing the losses and rebuilding their book capital.  These banks should be resolved.

Spain’s banks face more loan losses as the pace of an economic slump risks turning a worst-case scenario dismissed in stress tests into reality. 
Bad loans as a proportion of total lending jumped to a record 10.5 percent in August from a restated 10.1 percent in July as 9.3 billion euros ($12.2 billion) of loans were newly classified as being in default, according to data published by the Bank of Spain on its website today. The ratio has climbed for 17 straight months from 0.72 percent in December 2006, before Spain’s property boom turned to bust. 
Spanish bank stress tests by management consultants Oliver Wyman have factored in an economic contraction totaling 6.5 percent from 2012 to 2014 in an adverse scenario that the government and Bank of Spain said has a probability of about 1 percent. Analysts at Nomura andCitigroup (C) Inc. disagree, saying spending cuts and economic conditions mean the worst-case outcome already looks feasible. 
“You can’t attach a 1 percent probability to a scenario that already looks realistic,” Silvio Peruzzo, a European area economist at Nomura inLondon, said in a telephone interview yesterday. Spain’s gross domestic product will shrink by 6.2 percent from 2012 to 2014, he estimated.... 
Lending in Spain’s banking system fell 1.1 percent in August from July and 5 percent from the same month a year earlier, the Bank of Spain said. 
Deposits dropped 1.1 percent in the month and 8.7 percent from a year ago....
The ongoing run on the banking system shows that nobody believes the results of the stress tests.  So as a means of restoring confidence, stress tests don't work.
Spain commissioned the review as part of terms for its European bailout.
A bailout that is totally unnecessary.

As discussed above, a modern banking system is designed so that countries don't have to bailout their banks.  Specifically, deposit guarantees make the taxpayers silent equity partners of the banks when the bank book capital levels drop to low or negative levels.
Spanish banks’ loan losses will continue to grow because of the deteriorating economic outlook and rising unemployment, said Ebrahim Rahbari, a London-based economist at Citigroup. He predicted a 5.8 percent contraction for Spain’s economy between 2012 and 2014. 
“The adverse scenario of the test looks closer to a forecast of economic performance over the next three years than a stress case,” Rahbari said in a phone interview. “That surely has consequences for loan-loss rates and the one we are most concerned about is household mortgages.”.... 
The default rate for 604 billion euros of Spanish home mortgages stood at 3.2 percent in June, according to the Bank of Spain. Banco Santander Chief Executive Officer Alfredo Saenz said in April that anyone saying mortgage defaults are a problem for Spanish banks was “saying something stupid.”...
I guess I was 'saying something stupid' back then.  However, I have been proven right.  Again.
The bad loans data published today by the Bank of Spain restated the bad loans ratio for July to 10.1 percent from a previously published 9.86 percent. The amount of bad loans was for July was restated to 173.2 billion euros from a previously published 169.3 billion euros.

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