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Europe's stress test ignoring default scenario

Skyline of the banking district in Frankfurt, Germany

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Steve Chiotakis: Today a group of regulators in London will grade more than 90 banks in Europe. Early reports show several Spanish banks have failed the tests, which are meant to restore confidence. But reporter Christopher Werth tells us from London, one important question's been left out.


Christopher Werth: Stress tests are supposed to be a way of getting everything out in the open. Simulations are run to test how banks would do if faced with things like another recession or a jump in unemployment. But Simon Tilford of the Center for European Reform says Europe's stress tests are ignoring one scenario that seems very real:

Simon Tilford: The ability of the banks to cope with a sizable restructuring slash default in Greece and/or other eurozone member states.

He says national defaults remains likely, but that isn't being tested. Peter Hahn is with the Cass Business School in London. He says there are several reasons governments don't want to contemplate a Greek default.

Peter Hahn: If European regulatory authorities suggest the assumption of a sovereign default that creates a greater perception in the marketplace that a sovereign default could occur.

And after setting up a trillion-dollar fund in May to help prevent such defaults from happening, European leaders won't want to be seen betting against their own back stops.

But Tilford warns the tests may do more harm than good if instead of being reassured, markets are simply left with big, unanswered questions.

In London, I'm Christopher Werth for Marketplace.


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Bill Radke: Today regulators in London will give a grade to more than 90 banks in Europe. The so-called 'stress tests' are meant to restore confidence in Europe's financial system. However, early reports show several Spanish banks have failed the tests. Last year the U.S. stress-tested 19 banks and 10 of them came up short. The BBC's Rebecca Singer reports, the American tests are generally considered a success.


Rebecca Singer: There was a lot of uncertainty when 10 U.S. banks were told they needed to raise $75 billion immediately. But Jim O'Neill, chief economist at Goldman Sachs, says it actually helped clear the air and gave the banks some credibility.

Jim O'Neill: The whole recovery of global financial markets coincided with the timing of the stress tests and so particularly with the benefit of hindsight it's now seen as one of the key things that helped bring around the recovery.

Like the U.S. tests, European banks are being examined to see if they'd survive another downturn. But in Europe, there's some concern that the worst case scenario being considered isn't bad enough.

Howard Davies: I think it would be implausible for them to come out and say all 91 are just tickety-boo.

Sir Howard Davies is director of the London School of Economics. He says the banks that fail need to have a backup.

Davies: If there are banks that are short of capital and I suspect there will be a few, that also there is a plan to provide the capital and that's what was successful in the U.S. The markets were actually able to provide new capital for the banks.

The announcement will be made with two hours left of U.S. trading, so it could be an exciting end to the week on Wall Street.

In London, I'm the BBC's Rebecca Singer for Marketplace.

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