Europe is anticipating positive stress test results for the region’s banks today.  All major banks are expected to pass, with only a few banks with clear problems likely to fail.

How credible are these stress tests?

The market’s positive reaction certainly shows some level of trust in the results – shares of European banks jumped 3% yesterday.  The tests run in the U.S. over a year ago were widely criticized for lofty economic assumptions.  A similar concern exists with the EU’s test scenarios.  Yet, the U.S. tests marked critical turning point in the financial crisis.  The two-month testing process gave investors time to calm down and investors were satisfied with the dollar amounts the banks were required to raise.

There are a few fundamental problems with the EU tests.  Unlike in the U.S., the EU tests are being conducted on publically available data.  This means that the government thinks they are superior model-builders than the private sector.  Another flaw is that the tests were based on data from the end of 2009.  It seems relatively obvious that some banks positions have worsened throughout the last seven months.

Ultimately, the success of the EU bank stress tests will depend on how much detail regulators provide about the basis for their conclusions.  U.S. regulators published the metrics they used to test their banks before they released their results last year.  That isn’t the case this time.  So the raw data may end up being more important than the number of lenders that fail.

The results are set to be released at 6PM Brussels time, or 11AM CST.  This means the European markets will be closed when the results are released, which will give the failing banks time to raise funds before markets re-open on Monday.

I will be posting the results on our blog later today, so make sure to check back. 

Peter Lazaroff, Investment Analyst

www.acrinv.com