European Banks: Pre-Stress Test

The market awaits for the European Bank Supervisors to provide more details about the stress tests. If the market has a better sense of the robustness of the stress tests it might lift some uncertainty among investors.

There are several reasons why investors are anxious. Many of these are listed here, cobbled together from various media reports. This is not meant to be exhaustive, but suggestive of some of the key issues.

1. The credit default swaps for Europe's top banks are about 50% higher than for US top banks.

2. Europe's top 20 banks trade at a discount to book value of a bit more than 10%. The top 20 US banks trade at a modest premium to book value.

3. The IMF projects that by the end of this year, US banks would have written down about 7% of their assets, while euro zone banks would have written down about 3%.

4. The BIS reports that at the end of last year European banks had assets valued at 31.1 trillion euros--some 3.5 times more than US banks. Given that the economies are roughly comparable, it points to significantly greater leverage.

5. In late '08, EU leaders pressed for an accounting change to allowed banks to avoid marking down asset values to the plunged market values unless default was thought likely. Some reports suggest this accounting shift helped "save" billions of euros.

6. It is not immediately clear what happens to a bank that is judged to need for capital. That said, several countries have bank funds that might be able to be drawn upon.