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Applying A Basel III Tier 1 Stress Test Threshold Implies E2.6 Trillion Of Assets In 39 Banks Impaired By Equity Undercapitalization

Tyler Durden's picture




 

With the assumptions and conditions for the stress test pulled straight out of CEBS' collective bottom, it is no surprise that a mere 7 banks for a total $246 billion in affected assets end up being defined as undercapitalized. But what happens when instead of using a 6% Tier 1 capital threshold, a Basel III 8% Tier 1 is used? Something log scale worse. As Austrian Der Standart journalist Lukas Sustala points out, and as demonstrated on his chart below, the failure rate goes up exponentially: instead of 7 banks failing, 39 of Europe's biggest banks would be undercapitalized, and the impaired assets would amount to a whopping E2.6 trillion, requiring at least E30 billion in incremental equity capital, on top of the hundreds of billions already infused by European governments. In Lukas' words: "The stress tests were a farce (taking no account of counterparty risk or a sovereign default), but at least they provide some good data points (I currently look into all the sovereign holdings of the individual banks, so there is more to come). 39 banks fail the 8% criteria."

And for those who just can't get enough of peeking at the imaginary numbers behind the farce theater's curtain, here is Goldman's most recent essay in which they attempt to validate why they were so blatantly wrong (i.e., pessimistic) on the Stress Test's outcome last week.

 

 

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Mon, 07/26/2010 - 12:14 | 488671 rubearish10
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And so if it was 10% all banks would be undercapitalized. Geeze, God, WTF! If we were right in our view of the financial world being so screwed up, we'd be at new lows by now! 

Mon, 07/26/2010 - 14:26 | 488874 old_turk
old_turk's picture

Never fear, the regulators are here.

 

http://www.bloomberg.com/news/2010-07-26/basel-committee-reaches-broad-agreement-on-bank-capital-liquidity-rules.html

 

So ... what's fer lunch?

 

Actually no specifics in this story, just that there's been some changes.

Mon, 07/26/2010 - 23:32 | 489707 Squid-puppets a...
Squid-puppets a-go-go's picture

10%? how pissweak have our standards become? How about a purely honest system - test to 100% , no less.

Mon, 07/26/2010 - 12:16 | 488672 Jeff Lebowski
Jeff Lebowski's picture
by No Mas
on Mon, 07/26/2010 - 10:35
#488607

 

ZH must be short everything.  All they do is post justification for their doom and gloom projections.

But the smart money doesn't give a damn about the hole digging, gold sucking losers here.

Just look at the market - up 70 POINTS MOFOs!!!!!   What do I keep telling you morons living in your mother's basement??  BUY YOU FOOLS!!!  But no - another article that basically says "SEEE!!!! I AM RIGHT!!!  THE MARKETS SHOULD BE FALLING!!!  THEY MUST BE MANIPULATED!!!!  WAH!!! WAH!!! MOMMY - MAKE THE MARKETS STOP GOING UP!!  I'M RIGHT DAMMIT!!  I'M ALWAYS RIGHT!!!

Keep posting this crap; I think I'll watch CNBC and make some more MONEY!!!!!

My motto losers:  Life is hard; it's harder when you're stupid!

Mon, 07/26/2010 - 12:28 | 488686 ZackLo
ZackLo's picture

go ahead keep on watching man..keep on watching...your blind as fuck..

Mon, 07/26/2010 - 13:13 | 488755 Jeff Lebowski
Jeff Lebowski's picture

Sometimes I forget that what is obvious sarcasm to me may not be read as such...  It was.  Completely. 

Now, back to catch the Halftime Report on Fast Money.  <-----  SARCASM.

 

Mon, 07/26/2010 - 12:30 | 488687 InconvenientCou...
InconvenientCounterParty's picture

Smart money is "other peoples' money" when there is no way to accurately value assets.

 

Mon, 07/26/2010 - 12:33 | 488692 Canucklehead
Canucklehead's picture

Jeff, there is a lot of truth in what No Mas says.  He has more of a zero-sum-game outlook than I have.  No Mas appears to be a shark and is willing to swim the oceans alone.  By the way you have presented your post, you are looking to "school-up" for safety.

Don't be a guppy.

Mon, 07/26/2010 - 13:32 | 488793 SignsAndWonders
SignsAndWonders's picture

ZH advice is to not trade the market.  This place is invaluable for finding the underreported news that drives global macro, but if you're looking to trade the news you have to factor in the irrationality of the market accordingly...

Mon, 07/26/2010 - 14:59 | 488873 AccreditedEYE
AccreditedEYE's picture

Has anyone shown this tool the ZH conflicts/full disclosure?!! For No Mas (aka PISSani):

You should assume that at all times we are so totally just talking our book it would shock and awe you like the unexpected, early-morning arrival of a cluster of BGM-109C Tomahawks (were you a believer in the importance of "optics" that is).

If we make a off-hand remark about New Zealand sheep herders it's because we are long New Zealand West Island Cold Kut (NZ-WICK) Wool futures and Kiwi brand Condoms ("For it's pleasure").  If we are joking around about Cliff Asness, it's because we have developed a synthetic short of ARQ.  If we jest about Joe Sixpack, it's because we are trying to hype our cheap-American-beer holdings so we can exit quickly.  Basically, we are telling you about a position we believe in strongly enough to invest in.

God, I love this site. (keeps getting funnier every time I read it (the above excerpt)... LOL!)

 

Mon, 07/26/2010 - 12:25 | 488680 traderjoe
traderjoe's picture

Didn't the banks get Basel III extended for something like 15 years? Not disagreeing with the analysis...

Mon, 07/26/2010 - 12:43 | 488704 Steak
Steak's picture

It is indeed helpful to see how Basel III would affect capital requirements in light of the stress tests, however it is largely an exercize in futility.

Quelle suprise the banks/finance ministers are lobbying hard and are likely to get an easing of proposed regulations:

http://www.bloomberg.com/news/2010-07-12/european-banks-poised-to-win-reprieve-in-basel-on-how-capital-is-defined.html

PS: a hot track i found today http://www.youtube.com/watch?v=gIbtxA3UsVs

Mon, 07/26/2010 - 12:44 | 488705 lpard
lpard's picture

@Jeff: Buy Buy Bye (Gold until its down to 11839

Mon, 07/26/2010 - 12:46 | 488710 Trichy
Trichy's picture

Did they release all sovereign holdings per bank or only trading book, anyone?

 

Mon, 07/26/2010 - 12:47 | 488712 Borat
Borat's picture

Come on Cramer... I know it is you posting under the No Mas avatar. This is not going to increase your ratings.

Mon, 07/26/2010 - 13:11 | 488752 b_thunder
b_thunder's picture

One way to run the stress test is to determine the Tier I ratio, and calculate whcih banks are undercapitalized.  The Tim Geithner's way is to guess what number of banks and amount of undercapitalization needs to be a) somewhat believable and b) clearly "show" that banking system is "better than expected", and then calculate the Tier I ratio that would satisfy the previous requirements.

On the subject of counter-party riska nd sovereign defaults, the stress test was done right:  since not one eurozone sovereign or bank will be allowed to fail, the assumptions of them failign doesn't have to be in this test (the defaults won't be allowed to happen, get it?)

 

Mon, 07/26/2010 - 13:32 | 488792 andyupnorth
andyupnorth's picture

But just because they give a rosie outlook doesn't mean there won't be unintended consequence, right?

Mon, 07/26/2010 - 14:23 | 488870 knukles
knukles's picture

Exactly. 
Determine the desired outcome and manage the numbers accordingly. 

The Stress Tests are akin to sneaking out a smelly fart during Christmas dinner then laughing about the stench whilst playing dumb. 

Mommy!
Timmy's in the bathroom doing it again!

Mon, 07/26/2010 - 14:25 | 488872 Panafrican Funk...
Panafrican Funktron Robot's picture

"not one eurozone sovereign or bank will be allowed to fail"

Ultimately that's dependant on the ability of the Fed to maintain it's QE.  Past about mid-January, I'm real uncertain on that one.  US government spending crash = global economic crash.

Mon, 07/26/2010 - 13:59 | 488834 Dismal Scientist
Dismal Scientist's picture

The old adage is that the bond market is usually right, when it diverges from the equity market in terms of macro outlook. Bonds at 3% for 10 years versus the SPX at 1,100 and a yield of 2% simply means one (or both) of those prices is wrong. There is a fear and deflation premium built into the bond market at these levels, while equities just look outright expensive in a world of low (who knows how much lower) sustainable growth. I'll buy equities with a yield well over 5% to take on the risk of higher volatility and slower growth ... and I won't buy bonds at all for that kind of yield. Bear markets end with single digit PE multiples and revulsion re equities in general. We are nowhere near that point. Rallies in equities should be rented, not owned. No need to be a stock market pimp.

Mon, 07/26/2010 - 14:05 | 488839 rubearish10
rubearish10's picture

Well PUT, get it!

Mon, 07/26/2010 - 14:19 | 488861 Dismal Scientist
Dismal Scientist's picture

My only question is how much theta I'll have to pay before the inevitable...

Mon, 07/26/2010 - 14:26 | 488875 rubearish10
rubearish10's picture

No doubt, deep pockets are required to be rewarded. You must have some upside participation with net short bias. You do this by small adds to shorts in rising markets and covered call writing in GLD and other commodity stocks.

Mon, 07/26/2010 - 14:29 | 488881 Astute Investor
Astute Investor's picture

Nothing more satisfying to the marginal student than grading on a curve....

Mon, 07/26/2010 - 14:39 | 488899 Dismal Scientist
Dismal Scientist's picture

Possibly. Am with you on shorting GLD at least. Would be nice to see the VIX get down below 20 again over next few weeks, then load up on what will by then be comfortably out of the money S&P 1100 Puts.

Mon, 07/26/2010 - 15:51 | 489042 hooligan2009
hooligan2009's picture

ummm...just doing some maths. 8% tier 1, implies 12.5 times leverage at 100% risk weighted capital.

If 250 billion euros of impaired assets leaps to 2.6 trillion euros then the additional impaired capital is 2.35 trillion euros. If this only requires 30 billion in additional equity, then the risk weighting of the capital is only just over 1% which implies that the assets aren't impaired at all, but are (think  CDS protection for soveriegn assets) European government quality.

I am agreeing with your sentiment, just that the scale of the problem is much larger. Impaired assets presumably woudl have crap ratings and hence be closer to 50-100% risk weighted, implying an equity infusion of 1.3 trillion euros.

This fits rather nicely into the camp of "intervention = loans retained on banks balance sheets funded by the ECB until the underling companies pay them back in full". I can hold my breath for 3 minutes...on a good day, I don't fancy my chances of companies repaying loans!..oops does this mean that companies only make a profit if they borrow more money from shareholders/governments..oh ..no that would be a ponzi scheme!

Well let's see if Barton Biggs is right, the free cash flow profits of $90 for S&P 500 companies would repay the loans on banks balance sheets in what? 60 years? and the FCF profits of Europe's companies a little longer? Hmm..does that mean that there is a new metric that says "the real maturity date of the debt issued by a company will always equal the length of time it takes to repay the loan in full, with interest?".

scusi, i need to find an aqualung if I disobey the "don't hold your breath" maxim

Mon, 07/26/2010 - 16:22 | 489102 hooligan2009
hooligan2009's picture

talks to myself again and ponders whether the automatic debt multiples that are seemingly applied to companies that make a "profit" means that every "profit" is automatically eligible to be leveraged 20-30 times by the company, then another "fractional reserve" system of another 20-30 times by banks ...woahhh..now we are tripping. Surely merely packaging loans doesn't mean that leverage is used and then more loans are guaranteed by the central banks? Naw, that would be ummm...would be..."funny money"!

Mon, 07/26/2010 - 22:30 | 489638 Privatus
Privatus's picture

Tower of Basel.

Tue, 07/27/2010 - 02:54 | 489794 Moonrajah
Moonrajah's picture

How about lowering it to 5% T1? Ya know, 5 is a nice round number, easier to grasp. With that all the Banks pass the test, collect 200$ and don't go to jail. And guess what, after that the American Economy (aka the HFT-lobotomized securities market) will surge up and up, since US doesn't have to bail out Europe any more. A solid win, mark my words!

Tue, 07/27/2010 - 08:03 | 489920 themosmitsos
themosmitsos's picture

I have to say, what seems farcical to me is that an impaired balance sheet of ~€2.6trill can be capitalized by a mere €30bill.

I used to be pretty good at math until the BushBama administrations.

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