Alternative Stress Tests from OECD and Citi

One of the aspects of the CEBS European stress test exercise that has been commented upon quite widely is their decision to only apply haircuts to sovereign debt held on the trading books of the banks examined. However, most of these bonds are held on the “banking books” on the understanding that they are being held to maturity and the CEBS exercise assumed no sovereign defaults over the time horizon considered, so no haircut was applied to this portion of the bond portfolio.

In reality, the trading book\banking book distinction is arbitrary. In the case of a default or restructuring on these sovereign bonds, the distinction is meaningless. In the case of a bank failing, the distinction also doesn’t mean much: If the assets of the bank need to be sold off to meet liabilities, then bonds originally intended marked as hold to maturity the banking book may still have to sold off at market values.

I’ve come across two interesting alternatives to the CEBS stress tests. The first is this report from the OECD, which takes a macro look at the topic. They calculate that 83% of the exposure to EU sovereigns is held on the banking book and the report gives a good sense of the exposures of banks in different countries to various types of sovereign risk.    

The other alternative comes via the Calculated Risk “Some Investor Guy” series on sovereign debt. The Guy linked to this rapid response piece from Citi, redoing the analysis on a bank by bank basis. Applying the haircut to the banking book as well as the trading book, the number of European banks that fail the test rising from 7 out of 91 to 24 of 91.

38 replies on “Alternative Stress Tests from OECD and Citi”


The world knows this. I take it you are “ad idem” with Brian Lucey that the stress tests are a charade. What is your view on Peter Matthews own stress test of AIB/BOI.

@ Tull

Well whatever about what the world knows or doesn’t, I hadn’t seen either the OECD or Citi documents until the last few days and thought other people might be interested in seeing them. If you don’t want to read them, then you can always get off the blog and back to work.

I’m not sure what the “ad idem with BL” business is about. Clearly, though, these were not the most stressful of stress tests.

I have not seen the Mathews stress test.


the Citi stuff is old hat-it cam out weeks ago. Do you think the stress tests were a charade?


Is much of this focus on the treatment of sovereign debt because it’s easy to understand?

I’m stuck on the PD & LGD stresses applied to loans. I’ve found a table on page 9 of . This shows the PD stress applied. There are very significant differences between countries. I’m not sure what they’re doing on the LGDs. Is the rationale for coming up with these PDs available?

@ Tull

Charade is a strong word and I don’t see why discussion of the issue should be based around a random word you’ve picked. I can see why they did what they did but I’d have preferred to have seen stress scenarios involving writedowns of the bonds on the banking book.

And, as I said, I hadn’t seen the Citi report and figured others may not have either. Maybe I’m wrong about that. Either way, who cares?

I dont think Peter (but he can talk for himself) ever claimed to have stress tested teh banks. Would “financial kabuki theatre” be more acceptable to you?
As Karl,and indeed many others have said, these were not stressful. Now, I know you deem my views …dubious. So lets see what some others say

“”I don’t think the market is so stupid as to think that they were so wrong,” said Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, New Mexico, which oversees $57bn. “The right explanation here is that the testing was not very rigorous.””

“Neil MacKinnon, global macro strategist at investment strategists VTB Capital, described the tests as “political whitewash rather than a genuine attempt to assure the markets that eurozone banks have balance sheets that could really withstand sovereign risk shocks”.”

“Even before the outcomes were announced, officials of various governments expressed optimism about the diagnosis of banks in their countries. Such remarks raised doubts about the credibility of the tests. Suspicions persist about deliberate underestimations of the risk of further declines in real estate prices in areas where financial bubbles have collapsed, such as southern Europe.

The assessments of the government bonds of European countries held by banks were not strict enough, either. Even the bonds issued by countries believed to be at risk of default, such as Greece, were regarded as posing no risk of loss to holders as long as they are held until maturity.” (Asahi Shimbun)

“Shamefully, the purpose of the stress tests is not to ensure that depositors’ money is safe or that taxpayers will not be called on again. The purpose is to reassure banks and their shareholders that they will not be required to provide significant additional capital. The lesson – perhaps the only lesson – of the stress tests is that Europe’s politicians and regulators have not begun to address, far less resolve, the issues posed by the crisis of 2008.” John Kay

and, literally, thousands of others.

Only thing the tests show are that German banks are sitting on a pile of crap that they are trying to keep hidden inside the cupboard. Next time a Berliner asks why they are bailing out nutjobs like Ireland and Greece, they should be directed to their local bank.

Whether you include the banking book or not does not have any huge impact on Irish banks.

To be honest, the tests were useful for the information that came out of them but no-body looked at the results and thought European banks were in fine shape.

Another kind of stress test: when will banks pay the government back? We know that most US banks passed this test last year. Those of you who live in the parallel universe that sees ‘concretise’ commonly used might be surprised by the European picture. This from Merrli Lynch today:
“A swathe of European financials are paying back their governments more quickly than expected. In the US, full government repayment saw the market caps of the biggest recipients (JPM, WFC, PNC) mark new highs (we’re still waiting on Citi and BAC!). The difference in Europe is that government repayment is taking place out of the day job i.e. without dilutive equity capital raising. Aegon’s 25% repayment yesterday seems the start of a trend. Likewise early government repayment is central to our upgrade of Danske today: we now think they pay back the Danish government’s DKK 26bn hybrid (one third of market cap) by 2012, not 2014. Similarly with KBC, we think they’ll repay the government by the end of this year, not the 2011-13 we previously thought. …. Government sell downs will of course be the inevitable end game for the Lloyds and RBS, both of which we think double by 2012”
Not many stress fractures there, methinks.

“Likewise early government repayment is central to our upgrade of Danske today: we now think they pay back the Danish government’s DKK 26bn hybrid (one third of market cap) by 2012, not 2014. Similarly with KBC, we think they’ll repay the government by the end of this year, not the 2011-13 we previously thought. ….”
So, we, then, being BofA Merrill Lynch? As in you work for/speak for them?


I neither work or speak for them. I merely quote from them. The commas at the start and end give that away. I merely used an authoritative source-the same firm that appears to have advised the govt against the blanket guarantee.

You quoted from i) a Californian fund manager ii) a currency strategist that has had moved job more often than Robbie Keane iii) a Japanese newspaper and iv) a bloke in the FT.

@ Brian Lucey

“said Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, New Mexico”

Jesus, what the hell is it with you and crazy quotes? I just finished reading ‘House of Cards’ yesterday (at the beach), and Thornburg are not the people you want to be using as your references (note, this is their mortgage arm im referring to, not the AM, but its the same guys)…

I’m pretty sure no one out ther is claiming the CEBS bank stress tests were anywhere near perfect, but the real point of the matter is that you could not have conducted the OECD or Citi stress tests without the information released via them…as such they have been incredibly useful. Indeed, from Citi’s paper…

“CEBS provided a lot of data, in a systematic way, including on banks’ sovereign exposures. And aggregate credit loss assumptions and pre-provision profits look sensible.”

The use of the word “charade” looks sillier by the day.

@ Karl

on the substantive issue of sovereign exposure, Irish banks actually appear to be very lowly exposed, even to Irish government debt! Finally some good news…

@Bond. Eoin Bond.

Nothing wrong with Thornburgs model or the quote. I’ve known those guys since the early 90’s. They were not bottom feeders or MBS stuffers. One of the more responsible players but they got crushed by the tsunami of 3Q 2008. Basically good guys but Garreth was his own worse enemy. When he needed short term liquidity to get over the end of the Q crunch he found he had pissed off just enough people who might have given him terms to kill the company.

As for the stress tests, charade is too mild a word. I prefer the term fraud.

@ Eoin

Yes, I agree that it is a rare piece of good news from the Irish banks. There was a stage last year where a lot of commenters here were going on about Irish banks purchasing sovereign debt as a big factor in keeping the fiscal ship afloat. In fact, the banks annual reports showed very small holdings of Irish sovereign debt and relatively modest increases since 2008.

Agreed also that the CEBS exercise allowed for the OECD and Citi analysis and thus was useful.

I guess I missed charade-gate. But if the point of such a comment was to criticise the unstressful nature of the stress test, then it seems like a reasonable sentiment. Whatever about the specific guys that BL quoted above, the sentiment expressed in them does seem to me to have been pretty widespread.

@ Karl

well i’ve seen a lot of comments along the lines of “they should have been so much better, but they are definitely another step along the way to full transperency”. Like i have said a few times, and as you note, you can’t actually do the above reports without the CEBS one, and im sure many investors now have their own in-house studies based on the CEBS data. Was there a bit of spin to them? Sure, but you can make your own mind up on the data yourself if you want, as the OECD and Citi have done. At worst they were a lost opportunity to clear the decks once and for all (even though no one ever actually expected this to happen, which makes the complaints thereafter somewhat pointless).

Using the word ‘charade’ (it took place on Drivetime i think, you’re more of a Spin FM man i know…) smacks of headline seeking rather than any reasoned analysis. Its either sloppy, ignorant of the facts, or deliberately misleading. You choose. I aint exepcting a(nother) clarification or retraction from the Prof.

@ Eoin

Ok, I guess I’m missing something as to why the charade comment is all the things you claim it is. I can see why someone might think the exercise deliberately understated the risk stemming from sovereign debt and I can see why the C word might be used as a rhetorical flourish to describe this.

@ Karl

“the C word”

it used to mean cancer but now it refers to how some feel about financial stress tests. These are the times we live in i suppose!

Lets put it this way – you dont tend to use rhetorical flourishes all that much, yet can still get your point across. People probably consider you a bit more reasoned and sensible as a result. Nuff said.

“on the substantive issue of sovereign exposure, Irish banks actually appear to be very lowly exposed, even to Irish government debt! Finally some good news…”
The irony of it – the banks whose bailout results in the possibility/probality of soveriegn default are “lowly” exposed – really – good news for who?

@ KW

rather than look at what individual commentators say about the stress tests look at what Mr Market says. Since the methodology for the stress tests was announced in early July (7th I think) the SX7P (European Bank ETF) is up about 7% while CDS spreads on individual names are generally narrower. In the intermim, we have also received more clarity on Basle 3 and some better than expected results from most European banks. In the Irish context, AIb results are horrible and BOI are less horrible.

It does not matter what individual punters say in public. The real money does not talk to Bloomberg anyway. However in the short term the market reaction to the stress tests is probably positive. Deeming them a Charade was giving a big fat hostage to fortune. Your description of them was much more circumspect and considered.

I think KW is much more reasonable and sensible than other commentators. I dont find him boring, but then I kinda like this stuff.
Its funny – meeja is a curious beast; there are actually more people who listened to, say, Gerry Ryan, than to Drivetime (usually). Whats also interesting is that the approach on GR, or Vincenzo, or Kildare FM would be very different.

Its like when I write something on gold (forthcoming, Financial Review), or on the effect of financial integration on emerging markets corporate capital structure (forthcoming, Journal of Banking and Finance) , or the ultrametrics of the eurobond market (in press, Physica A) . They are usually terribly “academic” and to most readers dull and remote. Then there’s here, or the broadsheets, or the tabloids.

I think its called communication – theres a spectrum. No one part is “better” than the other, they all serve different needs and constituencies.

@ AM

What I think Eoin means is that it would be doubly unfortunate if the banks that had to be bailed out subsequently went bust becuase they invested in the debt of a sovereign that ultimtely defaulted because a) it had bailed out said banks & b) continued to pursue an incontinent fiscal policy which equalled an Anglo bail-out on an annual basis.

You are of course entitled to your view on the stress test but some back up for it would be welcome.

I don’t know anything about the stress test – the charade comment was just my (admittedly bad) attempt at punning. Given though that all our banks were supposed to be stress tested and declared sound exactly when they were anything but – I think it behoves us to take all this stress test talk with more than a grain of salt.


Allegedly, if you put an infinite number of monkeys in a room, each with a pen and paper,they will ultimately write Hamlet. If at first you don’t succeed, try and try again.

@bl, so what you are saying is that you dumb down when contributing here or in the Irish independent. Thanks because that explains the absolute you crap you have been coming out with. I actually respect Karl and other contributors on this site. I might not always agree but I always see a well reasoned argument.

@Gavin S
No, thats what you think/wish I said. Clearly, you didnt read what I said. Try it again.

Is not the issue here the fact that the EU, by definition, does not have appropriately empowered institutions such as the US Treasury, SEC and Fed with transparent procedures in place to conduct effective stress tests and to deal with the fall-out?

I think “charade” is excessively dismissive of what, I believe, are genuine efforts to craft appropriate institutional arrangements. Since the EU is governed by treaty and not by a constitution there is bound to be an amount of “politcial fudge”.

And perhaps some of the commentary is slanted by US-based commentators using their own institutional arrangements to assess the EU’s approach – with a bit of crowing from the UK with its seriously limited autonomy in these matters.

@ All on this thread

The discussion on this thread is unusual in that there seems to be near-unanimity about the main conclusions about the CEBS tests and yet the discussion is quite hot and heavy-handed in tone.

In my reading there seem to be two consensus-agreed conclusions:

1. The stress tests were insufficiently stressful to be claimed as “fair” tests of bank sector risk in Europe. Since 95% is a minimal confidence level accepted in this type of test this only means that the CEBS has underestimated some of the risks in the worst 5% outcomes, it does not mean that the sector is likely to collapse. A 99%-type confidence level test (if a numerical confidence level is useful at all) might be more appropriate perhaps. In either case it is the tail outcomes that are being examined not the most likely outcomes.

2. The stress tests were a useful exercise in terms of the extra information that they provided. This extra information release had a positive indirect impact on the sector.

@Paul Hunt
“Is not the issue here the fact that the EU, by definition, does not have appropriately empowered institutions such as the US Treasury, SEC and Fed with transparent procedures in place to conduct effective stress tests and to deal with the fall-out?”
I think you are looking at the US Treasury Fed and SEC through some kind of rose tinted spectacles Paul. If their stress tests were so effective how come they are in even worse crap than we are?


You’re pushing me out of my comfort zone, but I’d hazard a guess that they had a much higher share of really toxic stuff. EU banks were exposed to quite a lot of this stuff, but much of the mess is the result of ‘common or garden’ asset bubbles and fiscal incontinence by some member-states.

I have no brief to laud the US, but, despite the current spasm of partisan polarisation, I do admire the general transparency, FoI and the extent to which government and its agencies are exposed to scrutiny.

I sense the EU is being driven to replicate aspects of these arrangements.

@Gavin s
it’s ok that bl continues to publish crap, he’s just hitting the self destruct button

@KW – “There was a stage last year where a lot of commenters here were going on about Irish banks purchasing sovereign debt as a big factor in keeping the fiscal ship afloat. In fact, the banks annual reports showed very small holdings of Irish sovereign debt and relatively modest increases since 2008.”

I’m certainly one of those commenters and I’m unrepentant.

Identifying who holds the risks associated with bonds is extremely difficult. They don’t necessarily have to show up directly on the books. Bonds are often held in nominee accounts or are bought by funds and following such chains isn’t easy. Though I wouldn’t go as far as suggesting that they’d expose funds under management to irish bonds or institutional placings of new Irish bank stock.

When the credit crunch began, investors concentrated on return OF capital rather than return on capital. However taking numbers from the NTMA website, at YE 2008 82% of bonds were held by international investors. At the end of 2009 this number had grown to 84%. At face value, and bearing in mind it’s to the end of 2009*, this is a strong vote of confidence. And it doesn’t support my contentions. (*There are reasons in 2010, that might make a 3/4yr punt on Irish bonds attractive). It does seem strange that Irish banks have such difficulty accessing interbank markets for short term debt when the sovereign appears so attractive to international markets. Yes, they are different markets, but nevertheless it would be good to see a little transfer of confidence.

I’d expect future stess tests will treat NAMA bounds as Irish debt.

If a sovereign bond is out on repo, who counts as the owner?
(Likewise unrepentant)…

@hoganmahew: Good question. If I remember correctly if a bank uses a sovereign bond as collateral in a repo transaction, the bond remains in the bank’s books.

Example before repo:
Assets: €5bn sovereign bond

Example after repo;
Assets: €5bn sovereign bond
Assets: €5bn cash
Liabilities: €5bn loan
Liabilities: €5bn repo account

This is just my guess. Please correct me if I am wrong

The reason I ask is that Lehmans used ‘repo 105’ transactions to reduce the size of its book at year end. It basically promised to pay over the odds to people to take a load of the dross off so it would not be counted on the balance sheet.

Like you, I had always assumed that repo transactions stayed with the beneficial owner, but the Lehmans case has made me wonder.

Other US banks have since been accused of repo 105-like transactions. Mr. FitzcapitalP effectively did the same thing with his director’s loans.


The asset used in the repo remains on the books. What Lehman’s did was pretend they had done a true sale of the asset by exploiting an accounting rule that meant that if you bought the asset back at 105% of the sale price, the asset could be moved off balance sheet.

@Hoganmahew: Ok I understnad now. It was illegal what Lehman did. It is explained well in this video:

What is Irelands true level of indebtedness?

From an article in the Telegraph (21st August’10)

“The IEA raised its concerns after the latest public finances data from the Office for National Statistics (ONS) this week, which showed that the total debt, excluding bank bail-outs, is £816bn – itself a record high. However, the figures strip out the state’s pension liabilities in a contravention of standard accounting practices.
Mark Littlewood, the IEA’s director-general, said: “The latest official national debt figure is seriously misleading. Looming in the background are pension liabilities. These should be moved to the forefront.”

Indeed, these unfunded contingent liabilities should also be moved to the foreground in Ireland accounts. Last figure I saw was a figure of 108bn back in the comptroller and auditor generals 2008 accounts.

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