Colin Barr

Following the money in banking, economics, and Washington

Can Geithner sell Europe on stress tests?

May 26, 2010: 6:38 AM ET

Tim Geithner has a monster of a sales job of ahead of him.

Geithner, the Treasury secretary, is planning to push European officials this week to conduct bank stress tests, CNBC reported. He'll make the case that holding the tests, publishing the results, and helping laggards to raise new capital could help restore flagging investor confidence in European banks. The tests did the trick a year ago in the United States, after all.

The catch is that European leaders haven't exactly been tripping over themselves to stress test their stressed-out banks.

Stressing transparency

Geithner's pitch is certainly timely. The shares of the biggest European banks, such as Spain's Banco Bilbao (BBVA), have lost almost half their value this year amid rising worries about struggling local economies and massive government debt burdens. The cost of insuring against a debt default by cash-strapped southern European nations and their banks has risen sharply.

"The rise of counterparty risk to the European banking system has been dramatic," said Jacob Funk Kirkegaard, a research fellow at the Peterson Institute for International Economics. "If they let this go on, they could end up with a general credit crunch that would be bad for everyone."

But let it go on they might. European Central Bank chief Jean-Claude Trichet said last year that each European nation is responsible for looking after its own banks. He told the Wall Street Journal in January that criticism of loss reserving practices in Europe is baseless.

"The theory according to which the European banks would be less transparent than other banks in the industrialized world is not confirmed by what we know," he said. "We call upon our banks as well as all other banks to be as transparent as possible."

A lot of good that has done him. The failure of a Spanish savings institution this weekend raised fears of a wave of bank closings there, and the International Monetary Fund warned that the Spanish central bank must stand ready to act.

But officials in European countries are loath to undertake tests at a time when their neighbors aren't doing so. The condition of Europe's banks vary greatly within nations and from country to country. In Germany, for instance, Deutsche Bank (DB) appears sound, but some of the state-owned Landesbanks have been strained by investment losses, including bad bets on U.S. subprime-related debt.

"Standardized stress tests would end up requiring much more action in some places than in others," said Douglas Elliott, an economic studies fellow at the Brookings Institute in Washington. "It is possible, but it would take tremendous political will."

Political will has been in short supply as it is, with European policymakers taking heavy criticism for their dithering over what to do about this spring's debt market attack on Greece. And needless to say, the money remains a problem, with Europe lacking a dedicated bailout fund like the Treasury's Troubled Asset Relief Program to fund capital injections for banks that are found wanting.

Not that TARP was a panacea anyway. No one wants to be seen aiding the banks at a time when there is a general consensus that the bankers have yet to atone for the sins that resulted in the last crisis.

"It's hard to do a bank bailout unless the situation gets much more serious than it is now," said Elliott. "What we're looking at in the euro zone right now is pain but not disaster."

This is the same dynamic that has drawn the Greek mess out for months, and it may well delay any resolution in dealing with Europe's banks. Elliott notes, for instance, that bringing the financial crisis of 2008 under control took six months in the U.S., even with the Federal Reserve and Treasury working toward common goals with little friction. Add in the longstanding tensions between various European nations and you have a recipe for a problem that could simmer for months.

"This is going to take a long time to figure out," said Elliott.

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for since November 2007. Previously he was a writer and editor for, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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