Saturday, July 16, 2011

Thoughts on stress tests for European banks

Eight of the 90 banks failed the stress tests. 16 came close to failing.Not bad?

Well, the main question is that were the tests tough enough. I have an engineering background and I have long worked with mission critical systems (i.e. systems in which a system-wide failure is not an option). The very basic questions with these type of systems are: What happens if X fails? What happens if X and Y fail simultaneously? And so on..

Therefore, a real stress test for European banking system should include atleast a single failure (i.e. default by one eurozone country). An even better test would take into account multiple failures and the resulting financial panic.

The now conducted stress tests simulated what would happen to bank finances during a recession where growth falls more than 4 percentage points below EU forecasts.

That sounds of a bit soft scenario given the number of countries facing serious debt problems. You got the usual suspects from Europe, but also USA with its debt ceiling talks and then there is Japan..

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