Over the weekend, I was taking some time to catch up on the European debt problems and I came across something very interesting. Stress tests were put in place in 2010 to test various factors regarding the stability of all the major European banks. Things such as market volatility, commodity prices, interest rates and various other market indicators are taken into account when carrying out these tests. These were meant to pick out the “Problem Child” banks that would fail these tests. When these banks failed different policies were put in place to increase the financial stability of the banks. Then another stress test would take place and banks would again fail. The outcome of these stress tests has been hard to decipher until these past few weeks when news of the troubles that the Franco-Belgium bank Dexia was having came about.
Because of this news I have a problem believing and trusting these stress tests. Dexia came out as one of the healthiest banks in Europe during the stress test this past July. The test was looking at Dexia through 2012 and it was ranked at the 12th healthiest bank. Obviously, this goes against the news that has been coming about. News that Dexia is highly susceptible to Euro-zone debt problems was creating mass panic in Europe. Most European banks did not want to lend or bailout Dexia due to their exposure to Greek and Italian debt. Now this is a problem because Dexia is very large bank in Europe and is also a big lender to US municipalities.
Yesterday, it was announced Belgium was nationalizing Dexia hopefully fixing the problem that had gotten out of hand in the past few weeks. One major finding that came out of this was investors cannot rely on stress test results to feel confident about European banks. Clearly, there are faults in the model and something must be done to fix this if they hope to continue analyzing the financial stability of banks during this tough global economic time.