One of the interesting things upon 1st quick read of the European Banking Authority stress tests is the way it downplays the sovereign debt issue:
The data from the sample of 90 banks (Dec. 2010) shows the aggregate exposure-at-default (EAD) Greek sovereign debt outstanding at EUR98.2 bn. Sixty-seven percent of Greek sovereign debt (and 69% of the much smaller Greek interbank position) is in fact held by domestic banks (about 20% refers to loans which are mostly guaranteed by sovereign). The aggregate EAD exposure is EUR52.7 bn for Ireland (61% held domestically) and EUR43.2 bn (63% held domestically) for Portugal. Importantly, EAD exposures are different from similar exposures reported on a gross basis in the disclosure templates …
Given the distribution of the exposures described above, the direct first-order impact, even under harsh scenarios, would primarily be on the home-banks of countries experiencing the most severe widening of credit spreads. In such cases the capital shortfall should be easily covered with credible back stop mechanisms such as the support packages already issued or being defined for Ireland, Portugal and Greece. In this context these countries have announced capital enhancement measures requiring banks to hold capital to a higher level than that used for the EBAâ€™s EU wide stress test. Additional capital strengthening measures have been, and will be, announced to ensure this.
In other words, most of the Greece, Ireland, and Portugal debt is held by domestic banks which is good news for the other EU banks that might otherwise be feared to be sitting on this stuff and thus should be bad news for the domestic banks of these strained sovereigns — but since they are already under official lending programs, these can be tapped to ensure that the domestic banks (and their lenders) don’t lose money.
Leave aside the concern that Exposure at Default is a technical measure that allows some netting of exposures that might not happen as smoothly in practice as on a balance sheet.Â Think about the claim that since sovereign debt is domestic, losses can be handled as long as there is an official lending program in place.Â Doesn’t that invite attention on countries with lots of domestically held debt, but no program?
We hope to have more when the individual bank results are revealed.Â Note also the filename of the EBA document — it includes a “v6” at the end.Â That’s a lot of meetings!