Stress tests – what’s the networth?

Hannele Järvelä and Anniina Makkonen (group 7)

Cyprus, Italy, Ireland, Iceland… They’re all came down one by one. According to the Finnish Ministry of Finance Finland has spent over 2,124 million euros on the economic crisis in the EU (December 2011). To stabilize the situation European Banking Authority (EBA) has taken the banks in Europe on strict observation testing their capability to handle the situation, if the economic situation worsens even more.

The tests are supposed to tell how a bank is handling its balance if the economic situation worsens suddenly.  Stress tests are one way to try to calm the financial market and to show the risks.

The effects of such disruptions are estimated using models in which macroeconomic factors and market interest rates are assumed to affect banks and their customers as they have, according to statistical analyses, affected in the near past. These models can also be used to estimate the impact of a possible collapse in asset prices on banks’ capital adequacy.

In the year 2011 results of the 90 banks were published, representing 65 per cent of the total assets of the European banking system, 82 have been found to be adequately capitalised, i.e. with a core tier 1 capital ratio remaining above the 5% threshold under the stress scenario. However, eight banks in the EU failed to meet the threshold in the stress scenario and were given three months period to present plans for remedial actions.

Source: EBA

Source: EBA

What about Finland?

The Finnish financial sector has so far managed to avoid the consequences of the European debt crisis at least satisfactorily. At the end of 2011 credit losses were still moderate. The tests were conducted by national supervisor Financial Supervisory Authority FIN-FSA and the Bank of Finland in compliance with EBA’s detailed guidance.

– Supervisiors seek to safeguard the functioning of financial intermediation, notes Jukka Vesala, Deputy Director General of FIN-FSA.

– The stress tests increase market awareness of banks’ risks and thereby strengthen confidence in the EU financial system,’ notes Vesala.

OP-Pohjola Group was the only Finnish bank that got tested. In addition Nordea Bank Finland of Nordea Group and Sampo Bank of Danske Bank participated in the assessment through their financial groups.

OP-Pohjola has no need to strengthen its capital position. The bank’s core tier 1 capital ratio was significantly higher than the minimum threshold set by EBA. The bank’s sovereign exposures are small and the marking to market of sovereign bonds are held at normal value.

Nordea and Danske Bank group’s capital positions are also assessed as being strong. Neither bank has a need for recapitalization.

Both European and national supervisors own regulations should be adjusted to the size and risks of various supervised entities’ business operations.

– The difficult market situation underlines the importance of supervised entities’ own effective risk management and internal control practices, states Anneli Tuominen, Director General of FIN-FSA.

– A balance must be found between tight, cost-increasing regulatory requirements and promotion of economic growth.

The stress tests have gotten stricter, but some say there are still too many flaws in it.

– The stress tests haven’t influenced the market in any way. The biggest problem in the test was that the “worst case scenario” would be only a 0,5 per cent contraction in the economy, said Political Scientist and a consultant for Financial markets Heikki Koskenkylä for in july 2011.

Research Assistant from Aalto University also reminds that stress tests don’t apply on situations where the markets between banks dry and depositors draw their money from the banks.

– Stress tests measure banks one by one. What happens if the whole banking system collapses? That can not be tested.


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