Euro stress tests seen as too benign

The only surprise to come out of the stress tests conducted on 91 European banks, coordinated by the Committee of European Banking Supervisors, is that the results were so benign. This has confirmed the worst fears of many analysts - that the tests were too soft.

The major criticism is that the tests did not allow for a sovereign default. The worst case scenario was a double dip recession in Europe over the 2010/2011 time frame, combined with a '"sovereign shock".

A sovereign shock was defined as a sharp rise in the cost of debt for a sovereign, which would spur multiple defaults in the private sector.

CEBS allowed for losses to be incurred on sovereign bond holdings in the trading portfolios of banks but not on bonds held to maturity. It was argued that this was unnecessary as there will not be a sovereign default! Perhaps they mean there will not be a sovereign default before the end of 2011.

It was assumed that the value of five year Greek bonds would fall by 23.1 per cent, Spanish bonds by 12.3 per cent and German bonds by 4.7 per cent.

CEBS defended the test saying it was more severe than the stress testing undertaken in the US.

Indeed, US Treasury Secretary, Timothy Geithner, said the test was a significant effort to increase disclosure on the condition of individual financial institutions and would improve market stability.