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As concerns over European banks rippled through the credit markets earlier this year, the EU sought to minimize panic by performing "stress tests" on 91 banks, aimed at clarifying a murky situation.
The tests' stated objective was to "provide policy information for assessing the resilience of the EU banking system to possible adverse economic developments and to assess the ability of banks in the exercise to absorb possible shocks on credit and market risks, including sovereign risks." The key phrase in that statement is "including sovereign risks," because that's really what the markets were most concerned about.
If Greece defaults on its debt, what will happen to a specific bank that holds a significant amount of Greek debt? If Spanish unemployment remains stubbornly high and the government has to refinance its debt, what will happen to Spanish banks with federal debt on the books?
New information released
From the moment the rosy results were revealed (only seven of the 91 banks failed the stress tests), much criticism has been voiced. Now, according to The Wall Street Journal, there's even more reason to feel dubious about conclusions drawn from the tests. Apparently, many banks didn't provide full disclosure about the amount of their government debt holdings -- the exact information that investors truly wanted. Certain banks, such as Barclays (NYSE: BCS ) and Credit Agricole, reduced the amount of debt that they reported, apparently without disclosing that fact.
In addition, the amount of Greek, Portuguese, and Spanish debt that was reported by the tests, as opposed to the amount held on record by the Bank for International Settlements, illustrates a large divergence. This doesn't bode well for any of the EU banks, even the ones that seem to be in great shape, such as Banco Santander (NYSE: STD ) . Already today, banks from the most indebted countries are taking a pretty heavy beating. Both the National Bank of Greece (NYSE: NBG ) and Bank of Ireland (NYSE: IRE ) were down more than 6%, and Allied Irish Banks (NYSE: AIB ) and Banco Bilbao Vizcaya (NYSE: BBVA ) were down more than 3%, at midday.
Don't press the panic button just yet
Even though European banks are sure to head a bit lower (especially as the markets digest the new information), I wouldn't throw in the towel just yet. Yes, the stress tests, in retrospect, now seem like a mere formality. However, some of these banks have very respectable Tier 1 capital ratios, and many are using this time to expand market share and make savvy purchases. So I wouldn't write them all off quite yet.
Check out this recent article on why you should be looking into Banco Santander.