After the Lehman collapse and the government injected hundreds of billions into bank capital, the wise decision was made to study the balance sheets of those banks to estimate losses in the event of another "stressful" event in the credit markets. Although done hurriedly, it was detailed enough and serious enough to restore most of the faith banks had about doing business with each other. Eventually, almost all of the goverment funds were recovered easily.
Soon afterward, the European Union decided to "stress-test" their banks as well. Unfortunately, it was neither detailed enough nor serious enough to restore much faith. Momentum finally built to stress-test again and do it right the second time.
The European stock markets were down this morning, as they awaited release of the latest round of stress-tests on their 90 largest banks. Although the market was not expecting bad news, it was still a pleasant surprise that only 8 banks failed. Nine others barely passed. All of the big banks passed easily. This was especially important in France and Germany, who have been driving the effort to save the Euro by containing the soverign debt issue.
During the first four months this year, European banks have raised 60 billion Euros in new capital. Had they not done so, twenty banks would have failed today. Yet, the eight who failed only need to raise a cumulative 2.5 billion Euros, which should not be a problem.
Five of the failing banks were in Spain, one in Austria, and two (only two) in Greece.
All in all, I'm relieved there were no unpleasant surprises. It may be that the greatest benefit of today's report is that banks now have a great deal more information about other banks, which should reduce their uncertainty about which other banks it is safe to do business with. (This is called counterparty risk.)
To my amusement, one commentator pointed out that over 60 percent of the debt of the Greek government was owned by Greek banks, meaning it is more of a Greek problem that a European problem. What he doesn't understand is that we don't know which Greek banks shifted the risk of credit loss outside Greece by using credit default swaps. Thus, it does remain a European problem, not merely a Greek problem. Maybe, there will be a third stress-test to answer that question. I hope so!
In addition, Italy surprised everyone by addressing their soverign debt problem and passed their first austerity measure today as well. (I wish the U.S. was as responsive!)
If the European markets were to open now, I'm confident they would open strongly higher. Of course, Monday morning is light-years from now . . .
